===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarter ended March 31, 1999
|_| 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 (I.R.S. Employer
incorporation or organization) Identification No.)
10900 Nuckols Road, 3rd Floor, Glen Allen, Virginia 23060
(Address of principal executive offices) (Zip Code)
(804) 217-5800
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days. |X| Yes |_| No
On April 30, 1999, the registrant had 46,032,949 shares of common stock of
$.01 value outstanding, which is the registrant's only class of common stock.
<PAGE>
DYNEX CAPITAL, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1999 and
December 31, 1998........................................................3
Consolidated Statements of Operations for the three months
ended March 31, 1999 and 1998............................................4
Consolidated Statement of Shareholders' Equity for
the three months ended March 31, 1999....................................5
Consolidated Statements of Cash Flows for
the three months ended March 31, 1999 and 1998...........................6
Notes to Unaudited Consolidated Financial
Statements...............................................................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations..............................................................14
Item 3. Quantitative and Qualitative Disclosures about Market
Risk....................................................................38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
................................................................................41
Item 2. Changes in Securities and Use of
Proceeds...............................................................41
Item 3. Defaults Upon Senior
Securities.............................................................41
Item 4. Submission of Matters to a Vote of Security
Holders................................................................41
Item 5. Other
Information............................................................41
Item 6. Exhibits and Reports on Form 8-K.......................................41
SIGNATURES......................................................................42
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DYNEX CAPITAL, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands except share data)
<TABLE>
<CAPTION>
March 31, December 31,
ASSETS 1999 1998
------------------ ------------------
<S> <C> <C>
Investments:
Collateral for collateralized bonds $ 4,160,921 $ 4,293,528
Securities 238,932 243,984
Other investments 34,653 30,371
Loans held for securitization 238,550 388,782
------------------ ------------------
4,673,056 4,956,665
Investments in and advances to Dynex Holding, Inc. 184,118 169,384
Cash 28,716 30,103
Accrued interest receivable 3,293 4,162
Other assets 16,812 18,488
================== ==================
$ 4,905,995 $ 5,178,802
================== ==================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Non-recourse debt $ 3,653,751 $ 3,665,316
Recourse debt:
Secured by collateralized bonds retained 197,698 298,695
Secured by investments 455,801 588,735
Unsecured 127,922 145,303
------------------ ------------------
------------------ ------------------
4,435,172 4,698,049
Accrued interest payable 4,732 8,403
Accrued expenses and other liabilities 11,935 16,318
Dividends payable 3,228 3,228
------------------ -----------------
4,455,067 4,725,998
------------------ ------------------
SHAREHOLDERS' EQUITY
Preferred stock, par value $.01 per share,
50,000,000 shares authorized:
9.75% Cumulative Convertible Series A,
1,309,061 and 1,309,061 issued and outstanding, respectively 29,900 29,900
9.55% Cumulative Convertible Series B,
1,912,434 and 1,912,434 issued and outstanding, respectively 44,767 44,767
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 shares authorized,
46,030,814 and 46,027,426 issued and outstanding, respectively 460 460
Additional paid-in capital 352,331 352,382
Accumulated other comprehensive loss (3,953) (3,097)
Accumulated deficit (25,317) (24,348)
------------------ ------------------
450,928 452,804
------------------ ------------------
$ 4,905,995 $ 5,178,802
================== ==================
<FN>
See notes to unaudited consolidated financial statements.
</FN>
</TABLE>
<PAGE>
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands except share data)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Interest income:
Collateral for collateralized bonds $ 71,238 $ 71,580
Securities 4,590 15,029
Other investments 584 1,317
Loans held for securitization 7,373 6,754
Net advances to Dynex Holding, Inc. 3,333 2,352
--------------- ---------------
87,118 97,032
--------------- ---------------
Interest and related expense:
Non-recourse debt 55,207 57,915
Recourse debt 16,175 20,065
Other 730 426
--------------- ---------------
72,112 78,406
--------------- ---------------
Net interest margin before provision for losses 15,006 18,626
Provision for losses (3,793) (1,480)
--------------- ---------------
Net interest margin 11,213 17,146
Equity in net (loss) earnings of Dynex Holding, Inc. (369) 391
(Loss) gain on sale of investments and trading activities (926) 4,464
Other income 1,359 419
--------------- ---------------
Net revenue 11,277 22,420
General and administrative expenses (2,008) (2,375)
Net administrative fees and expenses to Dynex Holding, Inc. (5,924) (5,613)
--------------- ---------------
Income before extraordinary item 3,345 14,432
Extraordinary item - loss on extinguishment of debt (1,086) -
--------------- ---------------
Net income after extraordinary item 2,259 14,432
Dividends on preferred stock (3,228) (3,287)
=============== ===============
Net (loss) income available to common shareholders $ (969) $ 11,145
=============== ===============
Per common share before extraordinary item:
Basic $ - $ 0.25
=============== ===============
Diluted $ - $ 0.25
=============== ===============
Per share after extraordinary item:
Basic $ (0.02) $ 0.25
=============== ===============
Diluted $ (0.02) $ 0.25
=============== ===============
<FN>
See notes to unaudited consolidated financial statements.
</FN>
</TABLE>
<PAGE>
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the three months ended March 31, 1999
(amounts in thousands)
<TABLE>
<CAPTION>
Accumulated
Additional Other
Preferred Common Paid-in Comprehensive Accumulated
Stock Stock Capital Loss Deficit Total
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1998 $ 127,407 $ 460 $ 352,382 $ (3,097) $ (24,348) $ 452,804
Comprehensive income:
Net income - three months ended
March 31, 1999 - - - - 2,259 2,259
Change in net unrealized loss on
investments classified as
available-for-sale during the period - - - (856) - (856)
----------------------------------------------------------------------------------
Total comprehensive income - - - (856) 2,259 1,403
Issuance of common stock - - 18 - - 18
Forfeitures of restricted stock awards - - (69) - - (69)
Dividends on preferred stock - - - - (3,228)
(3,228)
----------------------------------------------------------------------------------
Balance at March 31, 1999 $ 127,407 $ 460 $ 352,331 $ (3,953) $ (25,317) $ 450,928
==================================================================================
<FN>
See notes to unaudited consolidated financial statements.
</FN>
</TABLE>
<PAGE>
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------
(amounts in thousands) March 31,
1999 1998
------------------ ------------------
<S> <C> <C>
Operating activities:
Net (loss) income $ (969) $ 11,145
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Provision for losses 3,793 1,480
Net loss (gain) on sale of investments and trading activities 926 (4,464)
Equity in loss (earnings) of Dynex Holding, Inc. 369 (391)
Amortization and depreciation 9,868 13,225
Net increase in accrued interest, other assets and other (6,430) (1,212)
liabilities
------------------ ------------------
Net cash provided by operating activities 7,557 19,783
------------------ ------------------
Investing activities:
Collateral for collateralized bonds:
Fundings of investments subsequently securitized (280,783) -
Principal payments on collateral 396,198 533,702
Decrease in accrued interest receivable 2,987 3,636
Net increase in funds held by trustee (1,090) (56)
Net decrease (increase) in loans held for securitization 149,210 (836,603)
Purchase of other investments (7,237) (1,627)
Payments received on other investments 2,997 5,339
Purchase of securities (23,513) (462,083)
Payments received on securities 20,045 19,752
Proceeds from sales of securities 16,181 -
Investment in and advances to Dynex Holding, Inc. (15,103) (15,119)
Proceeds from sale of single family operations - 9,500
Capital expenditures (6) (110)
------------------ ------------------
Net cash provided by (used for) investing activities 259,886 (743,669)
------------------ ------------------
Financing activities:
Collateralized bonds:
Proceeds from issuance of bonds 372,189 -
Principal payments on bonds (388,763) (541,962)
Increase (decrease) in accrued interest payable 2,858 (1,642)
(Repayments of) proceeds from recourse debt borrowings, net (251,904) 1,291,503
Net proceeds from issuance of common stock 18 2,760
Retirement of common stock - (118)
Dividends paid (3,228) (19,493)
------------------ ------------------
Net cash (used for) provided by financing activities (268,830) 731,048
------------------ ------------------
Net (decrease) increase in cash (1,387) 7,162
Cash at beginning of year 30,103 18,502
================== ==================
Cash at end of year $ 28,716 $ 25,664
================== ==================
Cash paid for interest $ 70,691 $ 76,378
================== ==================
Supplemental disclosure of non-cash activities:
Collateral for collateralized bonds subsequently securitized $ 1,161,475 $ -
================== ==================
<FN>
See notes to unaudited consolidated financial statements.
</FN>
</TABLE>
<PAGE>
DYNEX CAPITAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(amounts in thousands except share data)
NOTE 1--BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. The consolidated financial statements include the
accounts of Dynex Capital, Inc. and its qualified REIT subsidiaries (together,
"Dynex REIT"). The loan production operations are primarily conducted through
Dynex Holding, Inc. ("DHI"), a taxable affiliate of Dynex REIT. Dynex REIT owns
all the outstanding non-voting preferred stock of DHI which represents a 99%
economic ownership interest in DHI. Prior to December 1998, Dynex REIT had
consolidated DHI for financial reporting purposes. The common stock of DHI
represents a 1% economic ownership of DHI and is owned by certain officers of
Dynex REIT. In light of these factors, DHI is accounted for under a method
similar to the equity method. Dynex REIT has revised the 1998 accompanying
financial statements to give retroactive effect to the change in accounting
method during 1998. The accounting change had no impact on net income. Under the
equity method, Dynex REIT's original investment in DHI is recorded at cost and
adjusted by Dynex REIT's share of earnings or losses and decreased by dividends
received. References to the "Company" mean Dynex Capital, Inc., its consolidated
subsidiaries, and DHI and its consolidated subsidiaries. All significant
intercompany balances and transactions with Dynex REIT's consolidated
subsidiaries have been eliminated in consolidation of Dynex REIT.
In the opinion of management, all material adjustments, consisting of
normal recurring adjustments, considered necessary for a fair presentation of
the consolidated financial statements have been included. The Consolidated
Balance Sheets at March 31, 1999 and December 31, 1998, the Consolidated
Statements of Operations for the three months ended March 31, 1999 and 1998, the
Consolidated Statement of Shareholders' Equity for the three months ended March
31, 1999, the Consolidated Statements of Cash Flows for the three months ended
March 31, 1999 and 1998 and related notes to consolidated financial statements
are unaudited. Operating results for the three months ended March 31, 1999 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. For further information, refer to the audited
consolidated financial statements and footnotes included in the Company's Form
10-K for the year ended December 31, 1998.
Certain reclassifications have been made to the financial statements for
1998 to conform to presentation for 1999.
NOTE 2--EARNINGS PER SHARE
Earnings per share ("EPS") as shown on the consolidated statements of
operations for the three months ended March 31, 1999 and 1998 is presented on
both a basic and diluted EPS basis. Diluted EPS assumes the conversion of the
convertible preferred stock into common stock, using the if-converted method,
and stock appreciation rights ("SARs"), using the treasury stock method but only
if these items are dilutive. 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.
The following table reconciles the numerator and denominator for both the
basic and diluted EPS for the three months ended March 31, 1999 and 1998.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
------------------------------------------------------------------
1999 1998
- ------------------------------------------------------------------------------------------------------------------------
Weighted-Average Weighted-Average
Number of Number of
Shares Shares
Income Income
------------- ------------- ------------- ----------------
<S> <C> <C> <C> <C>
Income before extraordinary item $ 3,345 $ 14,432
Extraordinary item - loss on extinguishment of debt (1,086) -
------------- -------------
Net income after extraordinary item 2,259 14,432
Less: Dividends paid to preferred stock (3,228) (3,287)
------------- ------------- ------------- -------------
Basic and diluted $ (969) 46,029,722 $ 11,145 45,421,134
============= ============= ============= =============
Earnings per share before extraordinary item:
Basic EPS $ - $ 0.25
============= =============
Diluted EPS $ - $ 0.25
============= =============
Earnings per share after extraordinary item:
Basic EPS $ (0.02) $ 0.25
============= =============
Diluted EPS $ (0.02) $ 0.25
============= =============
Reconciliation of anti-dilutive shares:
Dividends and additional shares of
preferred stock:
Series A $ 766 2,618,122 $ 794 2,707,591
Series B 1,119 3,824,868 1,150 3,872,464
Series C 1,343 3,680,000 1,343 3,680,000
Expense and incremental shares of stock
appreciation rights 2 115,056 500 170,812
------------- ------------- ------------- -------------
$ 3,230 10,238,046 $ 3,787 10,430,867
============= ============= ============= =============
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
NOTE 3--COLLATERAL FOR COLLATERALIZED BONDS AND SECURITIES
The following table summarizes Dynex REIT's amortized cost basis and fair
value of investments, as of March 31, 1999 and December 31, 1998, classified as
available-for-sale and the related average effective interest rates:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
March 31, 1999 December 31, 1998
- ---------------------------------------------------------------------------------------------------------------------
Effective Effective
Interest Interest
Fair Value Rate Fair Value Rate
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Collateral for collateralized bonds:
Amortized cost $ 4,157,223 7.1% $ 4,288,520 7.5%
Allowance for losses (15,970) (16,593)
- ------------------------------------------ ---------------- ------------- ----------------- ----------------
Amortized cost, net 4,141,253 4,271,927
Gross unrealized gains 62,454 67,236
Gross unrealized losses (42,786) (45,635)
- ------------------------------------------ ---------------- ------------- ----------------- ----------------
$ 4,160,921 $ 4,293,528
- ------------------------------------------ ---------------- ------------- ----------------- ----------------
Securities:
Funding notes $ 131,801 7.8% $ 122,009 8.0%
Adjustable-rate mortgage securities 52,753 6.0% 58,935 6.2%
Fixed-rate mortgage securities 13,813 8.4% 28,851 8.3%
Derivative and residual securities 29,296 1.9% 33,480 2.9%
Other securities 37,537 6.5% 28,153 7.5%
- ------------------------------------------ ---------------- ------------- ----------------- ----------------
265,200 271,428
Allowance for losses (2,647) (2,746)
--------------------------------------- ---------------- ------------- ----------------- ----------------
Amortized cost, net 262,553 268,682
Gross unrealized gains 1,675 1,566
Gross unrealized losses (25,296) (26,264)
- ------------------------------------------ ---------------- ------------- ----------------- ----------------
$ 238,932 $ 243,984
- ------------------------------------------ ---------------- ------------- ----------------- ----------------
</TABLE>
Collateral for collateralized bonds. Collateral for collateralized bonds
consists primarily of securities backed by adjustable-rate and fixed-rate
mortgage loans secured by first liens on single family housing, fixed-rate loans
on multifamily and 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. Dynex REIT's exposure to loss on collateral for
collateralized bonds is generally limited to the principal 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 Dynex REIT.
During the three months ended March 31, 1999, Dynex REIT securitized $1.4
billion of collateral, through the issuance of one series of collateralized
bonds. The collateral securitized was primarily single-family mortgage loans and
manufactured housing loans. The securitization was accounted for as financing of
the underlying collateral pursuant to Statement of Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("FAS No. 125") as Dynex REIT retained call rights which were
substantially in excess of a clean-up call.
Securities. Funding notes consist of fixed-rate funding notes secured by
fixed-rate automobile installment contracts. Adjustable-rate mortgage securities
("ARM") 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 securities consists primarily of
a corporate bond purchased by Dynex REIT.
Sale of Investments. Securities with an aggregate principal balance of $15,971
were sold during the three months ended March 31, 1999 for an aggregate gain of
$210. The specific identification method is used to calculate the basis of
securities sold. Gain on sale of investments and trading activities also
includes realized losses of $2,051 related to the sale or writedown of $10,764
of commercial loans during the three months ended March 31, 1999 and realized
gains of $431 on various trading positions entered into during the three months
ended March 31, 1999. There were no open trading positions at March 31, 1999.
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.
NOTE 4 -- RECOURSE DEBT
Dynex REIT utilizes repurchase agreements, notes payable and warehouse credit
facilities (together, "recourse debt") to finance certain of its investments.
The following table summarizes Dynex REIT's recourse debt outstanding at March
31, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
- ----------------------------------------------------- ------------------- -----------------
March 31, 1999 December 30, 1998
- ----------------------------------------------------- ------------------- -----------------
<S> <C> <C>
Recourse debt secured by:
Collateralized bonds $ 197,698 $ 298,695
Securities 178,723 192,706
Other investments 165,353 142,883
Loans held for securitization 109,160 250,589
Other assets 2,565 2,557
---------------- ----------------
653,499 887,430
Unsecured debt:
7.875% senior notes 98,808 98,718
Series B 10.03% senior notes 26,135 26,116
Series A 9.56% senior notes 2,979 2,969
Bank credit facility - 17,500
- ----------------------------------------------------- ---------------- ----------------
$ 781,421 $ 1,032,733
- ----------------------------------------------------- ---------------- ----------------
</TABLE>
Of the $653,499 of secured recourse debt outstanding at March 31, 1999, $271,704
was outstanding under repurchase agreements, $379,230 represented amounts
outstanding under committed credit facilities and $2,565 represented amounts
outstanding under a capital lease.
NOTE 5 -- ADOPTION OF FINANCIAL ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS No. 133"). FAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. FAS No. 133 is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. The
Company is in the process of determining the impact of adopting FAS No. 133.
NOTE 6 -- DERIVATIVE FINANCIAL INSTRUMENTS
Dynex REIT may enter into interest rate swap agreements, interest rate cap
agreements, interest rate floor 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, Dynex REIT
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 income 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 and hedge an
available for sale investment which is carried at its fair value are also
carried at fair value, with unrealized gains and losses reported as accumulated
other comprehensive income.
As a part of Dynex REIT's interest rate risk management process, Dynex REIT may
be required periodically to terminate hedge instruments. Any realized gain or
loss resulting from the termination of a hedge is amortized into income or
expense of the corresponding hedged instrument over the remaining period of the
original hedge or hedged instrument as a yield adjustment.
Dynex REIT 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 in a collateralized bond structure,
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 the underlying asset, liability or commitment 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 as trading activities 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.
NOTE 7 - EMPLOYEE BENEFITS
During the three months ended March 31, 1999, 14,215 Stock Appreciation Rights
("SARs") under the Employee Incentive Plan were forfeited. No SARs were awarded
or exercised during the first quarter of 1999. The total SARs remaining to be
exercised were 864,565 at March 31, 1999. The Company expensed $2 related to the
Employee and Board Incentive Plans during the three months ended March 31, 1999.
NOTE 8 -- COMMITMENTS
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.
Dynex REIT facilitates the issuance of tax-exempt multifamily housing bonds, the
proceeds of which are used to fund mortgage loans on multifamily properties.
Dynex REIT is required to pay principal and interest to the bondholders in the
event there is a payment shortfall from the construction proceeds. In addition,
Dynex REIT is required to purchase the bonds if such bonds are not able to be
remarketed by the remarketing agent. Therefore, Dynex REIT enters into standby
letter of credit agreements to cover such commitments. At March 31, 1999, Dynex
REIT provided letters of credit to support its obligations in amounts equal
$147,451.
NOTE 9 -- RELATED PARTY TRANSACTIONS
Dynex REIT has a credit arrangement with DHI whereby DHI and any of DHI's
subsidiaries can borrow funds from Dynex REIT to finance its production
operations. Under this arrangement, Dynex REIT can also borrow funds from DHI.
The terms of the agreement allow DHI and its subsidiaries to borrow up to $50
million from Dynex REIT at a rate of Prime plus 1.0%. Dynex REIT can borrow up
to $50 million from DHI at a rate of one-month LIBOR plus 1.0%. This agreement
has a one-year maturity which is extended automatically unless notice is
received from one of the parties to the agreement within 30 days of the
anticipated termination of the agreement. As of March 31, 1999 and December 31,
1998 , net borrowings due to DHI under this agreement totaled $10,635 and
$8,583, respectively. Net interest expense under this agreement was $26 and $142
for the three months ended March 31, 1999 and 1998, respectively.
Dynex REIT also has a loan origination agreement with Dynex Financial, Inc.
("DFI"), an operating subsidiary of DHI, whereby Dynex REIT pays DFI on a fee
plus cost basis for the origination of manufactured housing loans on behalf of
Dynex REIT. During the three months ended March 31, 1999 and 1998, Dynex REIT
paid DFI $4,439 and $3,713, respectively under such agreement.
Dynex REIT has a funding agreement with Dynex Commercial, Inc. ("DCI"), an
operating subsidiary of DHI, whereby Dynex REIT pays DCI a fee per commercial
loan originated on behalf of Dynex REIT. Dynex REIT paid DCI $844 and $1,632,
respectively under this agreement for the three months ended March 31, 1999 and
1998.
Dynex REIT has various note agreements with Dynex Residential, Inc. ("DRI"), an
operating subsidiary of DHI, and DRI's subsidiaries whereby DRI and its
subsidiaries can borrow up to $287,000 from Dynex REIT on a secured basis to
finance the acquisition of model homes from single-family home builders. The
interest rate on the notes is adjustable and is based on 30-day LIBOR plus
2.875%. The outstanding balance of the note as of March 31, 1999 and December
31, 1998 was $177,498 and $159,377, respectively. Interest income recorded by
Dynex REIT for the three months ended March 31, 1999 and 1998 was $3,360 and
$2,493, respectively.
Dynex REIT has entered into subservicing agreements with DCI and DFI to service
commercial, single family, consumer and manufactured housing loans. For
servicing the commercial loans, DCI receives an annual servicing fee of 0.02% of
the aggregate unpaid principal balance of the loans. For servicing the single
family mortgage, consumer and manufactured housing loans, DFI receives annual
fees of ranging from sixty dollars ($60) to one hundred forty-four dollars
($144) per loan and certain incentive fees. Servicing fees paid by Dynex REIT
under such agreements were $550 and $141 during the three months ended March 31,
1999 and 1998, respectively.
Dynex REIT through its ownership of preferred stock, has a 99% economic
ownership interest in DHI.
NOTE 10 -- INVESTMENT IN AND ADVANCES TO DYNEX HOLDING, INC.
In December 1998, Dynex REIT changed its method of accounting for its investment
in DHI from the full consolidation method to a method that approximates the
equity method. The accounting change had no impact on net income. For
consistency purposes, Dynex REIT has revised the March 1998 financial statements
to give retroactive effect to the change in accounting method.
Investments in and advances to DHI accounted for under a method similar to the
equity method amounted to $184,118 and $169,384 at March 31, 1999 and December
31, 1998, respectively. The results of operations and financial position of DHI
are summarized below:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
Three Months ended March 31,
Condensed Income Statement Information 1999 1998
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Total revenues $ 11,049 $ 9,671
Total expenses 11,421 9,276
Net (loss) income (372) 395
- ---------------------------------------------------------------------------------------------
March 31, December 31,
Condensed Balance Sheet Information 1999 1998
- ---------------------------------------------------------------------------------------------
Total assets $ 225,737 $ 203,541
Total liabilities 207,753 184,267
Total equity 17,984 19,274
- ---------------------------------------------------------------------------------------------
</TABLE>
NOTE 11 -- OTHER MATTERS
During the three months ended March 31, 1999, the Company issued 3,388 shares of
its common stock pursuant to its dividend reinvestment program for net proceeds
of $18.
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Dynex Capital, Inc. (the "Company") is a financial services company that
originates primarily mortgage loans secured by multifamily and commercial
properties and loans secured by manufactured homes. The Company will generally
securitize the loans funded as collateral for collateralized bonds, thereby
limiting its credit and liquidity risk and providing long-term financing for its
investment portfolio.
FINANCIAL CONDITION
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
March 31, December 31,
(amounts in thousands except per share data) 1999 1998
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Investments:
Collateral for collateralized bonds $ 4,160,921 $ 4,293,528
Securities 238,932 243,984
Other investments 34,653 30,371
Loans held for securitization 238,550 388,782
Non-recourse debt - collateralized bonds 3,653,751 3,665,316
Recourse debt 781,421 1,032,733
Shareholders' equity 450,928 452,804
Book value per common share 6.90 6.94
- -------------------------------------------------------------------------------------------
</TABLE>
Collateral for collateralized bonds
Collateral for collateralized bonds consists primarily of securities backed
by adjustable-rate and fixed-rate mortgage loans secured by first liens on
single family properties, fixed-rate loans secured by first liens on multifamily
and commercial properties, manufactured housing installment loans secured by
either a UCC filing or a motor vehicle title and property tax receivables. As of
March 31, 1999, the Company had 28 series of collateralized bonds outstanding.
The collateral for collateralized bonds decreased to $4.2 billion at March 31,
1999 compared to $4.3 billion at December 31, 1998. This decrease of $0.1
billion is primarily the result of $396.2 million in paydowns on collateral,
which was principally offset by the net addition of $0.3 million of collateral
as a result of a $1.4 billion issuance of collateralized bonds in March 1999, of
which $1.2 billion related to the collapse and re-securitization of seven series
of previously issued collateralized bonds.
Securities
Securities consist primarily of fixed-rate "funding notes" secured by
automobile installment contracts, adjustable-rate and fixed-rate mortgage-backed
securities, and corporate bonds. Securities also include derivative and residual
securities. 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. Securities decreased to $238.9 million
at March 31, 1999 compared to $244.0 million at December 31, 1998. This decrease
was primarily the result of $20.0 million of paydowns and the sale of $16.0
million of securities during the three months ended March 31, 1999. These
decreases were partially offset by the purchase of $23.5 million of securities
during the three months ended March 31, 1999.
Other investments
Other investments consists primarily of a note receivable received in
connection with the sale of the Company's single family mortgage operations in
May 1996 and property tax receivables. Other investments increased from $30.4
million at December 31, 1998 to $34.7 million at March 31, 1999. This increase
of $4.3 million is primarily the result of the purchase of $4.7 million of
property tax receivables during the three months ended March 31, 1999.
Loans held for securitization
Loans held for securitization decreased from $388.8 million at December 31,
1998 to $238.6 million at March 31, 1999. This decrease was due to the
securitization of $277.7 million of loans held for securitization as collateral
for collateralized bonds issued during March 1999. This decrease was partially
offset by new loan fundings from the Company's production operations totaling
$155.1 million during the three months ended March 31, 1999.
Non-recourse debt
Collateralized bonds issued by Dynex REIT are recourse only to the assets
pledged as collateral, and are otherwise non-recourse to Dynex REIT. Compared to
December 31, 1998, the collateralized bonds remained essentially unchanged at
$3.7 billion at March 31, 1999. During the first three months of 1999, Dynex
REIT added $1.4 billion of collateralized bonds, of which $1.0 billion related
to the collapse and re-securitization of seven series of collateralized bonds.
This increase was offset by the paydowns on all collateralized bonds of $388.8
million during the three months ended March 31, 1999.
Recourse debt
Recourse debt decreased to $0.8 billion at March 31, 1999 from $1.0 billion
at December 31, 1998. This decrease was primarily due to the securitization of
$277.7 million of manufactured housing loans. These loans were previously
financed by $190.7 million of repurchase agreements and $57.5 million of notes
payable, as collateral for collateralized bonds during the three months ended
March 31, 1999. This decrease was partially offset by the net addition of $62.6
million of notes payable resulting from additional loan fundings during the
first quarter.
Shareholders' equity
Shareholders' equity decreased to $450.9 million at March 31, 1999 from
$452.8 million at December 31, 1998. This decrease was primarily the result of a
$0.9 million increase in the net unrealized loss on investments
available-for-sale from $3.1 million at December 31, 1998 to $4.0 at March 31,
1999. Additionally, during the three months ended March 31, 1999, the dividends
declared by Dynex REIT exceeded its earnings (based on generally accepted
accounting principles) by $1.0 million, resulting in a decline in shareholders'
equity of such amount.
Loan Production Activity
($ in thousands)
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------
Three Months Ended
March 31,
---------------------------------
1999 1998
---------------------------------------------------------------------------------------
<S> <C> <C>
Commercial (1) $ 48,658 $ 203,339
Manufactured housing 108,972 83,948
Specialty finance 48,363 33,403
---------------------------------
Total fundings through direct production 205,993 320,690
Secured funding notes (2) 13,654 -
Securities acquired through bond calls - 288,930
Single family fundings through bulk purchases - 562,045
---------------------------------------------------------------------------------------
Total fundings $ 219,647 $ 1,171,665
---------------------------------------------------------------------------------------
<FN>
(1) Included in commercial fundings were $25.2 million and $32.7 million of
multifamily construction loans which closed during the three months ended
March 31, 1999 and 1998, respectively. As of March 31, 1999, $303.0
million of multifamily construction loans have closed, of which only the
amount drawn for these loans of $66.0 million is included in the balance
of the loans held for securitization at March 31, 1999.
(2) Secured by automobile installment contracts.
</FN>
</TABLE>
Direct loan production for the first three months of 1999 totaled $206.0
million compared to $320.7 million for the same period in 1998. This decrease in
loan production was due to decreased origination volume of commercial loans
during 1999. This decreased volume was partially offset by increased origination
volume of both manufactured housing loans and specialty finance loans during
1999. Additionally, the Company funded $13.7 million of funding notes during the
three months ended March 31, 1999. There were no bulk purchases or bond calls
during the first three months of 1999 compared to $562.0 million of bulk
purchases and $288.9 million of bond calls during the same period in 1998.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------------------------
(amounts in thousands except per share information) 1999 1998
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Net interest margin $ 11,213 $ 17,146
Equity in net (loss) earnings of Dynex Holding, Inc. (369) 391
(Loss) gain on sale of investments and trading activities (926) 4,464
General and administrative expenses 2,008 2,375
Net administrative fees and expenses to Dynex Holding, Inc. 5,924 5,613
Net income 2,259 14,432
Basic net income per common share (0.02) 0.25
Diluted net income per common share (0.02) 0.25
Dividends declared per share:
Common $ - $ 0.30
Series A and B Preferred 0.585 0.60
Series C Preferred 0.730 0.73
- --------------------------------------------------------------------------------------------------
</TABLE>
Three Months Ended March 31, 1999 Compared to Three Months Ended March 31, 1998.
The decrease in net income during the three months ended March 31, 1999 as
compared to the same period in 1998 is primarily the result of a decrease in net
interest margin and a decrease in the gain on sale of investments and trading
activities. The decrease in net income per common share during the three months
ended March 31, 1999 as compared to the same period in 1998 is primarily the
result of the decrease in net income for the first quarter of 1999.
Net interest margin for the three months ended March 31, 1999 decreased to
$11.2 million, or 35% below the $17.1 million for the same period for 1998. This
decrease was primarily the result of the net interest spread on the investment
portfolio decreasing to 1.07% for the three months ended March 31, 1999 from
1.19% for the three months ended March 31, 1998. The decrease in the net
interest spread for the three months ended March 31, 1999 relative to the same
period in 1998 is primarily the result of the amortization of premium from the
commercial securitization in December 1998 and the decline in yield on the loans
underlying the collateral for collateralized bonds, which have reset to lower
rates due to the 0.75% reduction in short-term interest rates in the latter half
of 1998. Also, the investment portfolio continues to be impacted by prepayments,
as average interest-earning assets declined from $5.1 billion in the first
quarter of 1998 to $4.8 billion in the first quarter of 1999. In addition,
provision for losses increased to $3.8 million or 0.31% on an annualized basis
of average interest-earning assets during the three months ended March 31, 1999
compared to $1.5 million and 0.12% during the three months ended March 31, 1998.
This increase in provision for losses was a result of increasing the provision
for potential losses on the commercial loans that collateralize the
securitization issued in December 1998 and increasing the reserves for potential
losses on single family and manufactured housing loans.
The (loss) gain on sale of investments and trading activities for the first
quarter of 1998 decreased to a $0.9 million loss, as compared to a $4.5 million
gain for the first quarter of 1998. This decrease is primarily the result of a
$2.1 million loss related to the sale or writedown of $10.8 million of
commercial loans during the three months ended March 31, 1999. This decrease was
partially offset by a $0.2 million gain related to the sale of $16.0 million of
securities and a $0.4 million gain on various trading positions closed during
the three months ended March 31, 1999. The gain on sale of investments and
trading activities for the first quarter of 1998 is primarily the result of
gains recognized of $4.6 million on trading positions entered into during the
first quarter of 1998.
Net administrative fees and expenses to DHI increased $0.3 million, or 6%,
to $5.9 million in the first quarter 1999. This increase is primarily the result
of the continued growth in the Company's production operations, primarily in the
manufactured housing business.
The following table summarizes the average balances of interest-earning
assets and their average effective yields, along with the average
interest-bearing liabilities and the related average effective interest rates,
for each of the periods presented.
Average Balances and Effective Interest Rates
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
-----------------------------------------------------------
1999 1998
- ----------------------------------------------------------------------------------------------------------------
Average Effective Average Effective
Balance Rate Balance Rate
---------------------------- -----------------------------
<S> <C> <C> <C> <C>
Interest-earning assets: (1)
Collateral for collateralized bonds (2) (3) $ 3,974,145 7.17% $ 3,917,023 7.31%
Securities 265,579 6.91 705,872 8.52
Other investments 205,000 7.69 197,749 7.71
Loans held for securitization 372,759 7.91 299,547 9.02
---------------------------- -----------------------------
Total interest-earning assets $ 4,817,483 7.24% $ 5,120,191 7.59%
============================ =============================
Interest-bearing liabilities:
Non-recourse debt (3) $ 3,512,582 6.20% $ 3,424,160 6.62%
Recourse debt - collateralized bonds retained 285,406 5.49 501,937 5.88
---------------------------- -----------------------------
3,797,988 6.15 3,926,097 6.52
Recourse debt secured by investments:
Securities 179,341 5.93 506,244 5.61
Other investments 152,081 5.98 78,218 7.01
Loans held for securitization 293,986 5.60 141,047 2.93
Recourse debt - unsecured 153,318 8.25 139,541 8.87
================= =========== =============================
Total interest-bearing liabilities $ 4,576,714 6.17% $ 4,791,147 6.40%
================= =========== =============================
Net interest spread on all investments (3) 1.07% 1.19%
=========== ============
Net yield on average interest-earning assets (3) 1.38% 1.60%
=========== ============
- --------------------------------------------------------------------------------------------------------------------
<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 $1,898 and $2,190
for the three months ended March 31, 1999 and March 31, 1998, respectively.
(3) Effective rates are calculated excluding non-interest related
collateralized bond expenses and provision for credit losses.
</FN>
</TABLE>
The net interest spread declined to 1.07% for the three months ended March
31, 1999 from 1.19% for the same period in 1998. This decrease was primarily due
to the amortization of premium from the commercial securitization in December
1998 and the decline in yield on ARM loans, which have reset to lower rates due
to the 0.75% reduction in the target Federal Funds rate in the latter half of
1998. The overall yield on interest-earning assets also decreased to 7.24% for
the three months ended March 31, 1999 from 7.59% for three months ended March
31, 1998 while the cost of interest-bearing liabilities decreased to 6.17% from
6.40% for the three months ended March 31, 1999 and 1998, respectively.
Individually, the net interest spread on collateral for collateralized
bonds increased 23 basis points, from 79 basis points for the three months ended
March 31, 1998 to 102 basis points for the same period in 1999. This increase
was primarily due to a 58 basis point decrease in the effective average
one-month LIBOR from 5.74% for the quarter ended March 31, 1998 to 5.16% for the
quarter ended March 31, 1999 since the ARM loans underlying the collateralized
bonds take on average three to six months to adjust to lower interest rates. The
net interest spread on securities decreased 193 basis points, from 291 basis
points for the three months ended March 31, 1998 to 98 basis points for the
three months ended March 31, 1999. This decrease was primarily the result of the
sale of certain higher coupon collateral during the third quarter of 1998. In
addition, certain assets were placed on non-accrual status subsequent to the
first quarter of 1998. The net interest spread on other investments increased
101 basis points, from 70 basis points for the three months ended March 31,
1998, to 171 basis points for the same period in 1999, due to a higher interest
rate paid by Dynex Residential, Inc. ("DRI"), an operating subsidiary of DHI, to
Dynex REIT in conjunction with the Company's single family model home purchase
and leaseback business, effective as of January 1, 1999. The net interest spread
on loans held for securitization decreased 378 basis points, from 609 basis
points from the three months ended March 31, 1998, to 231 basis points for the
same period in 1999. This decrease is primarily attributable to higher borrowing
costs under certain credit facilities, and the reduced benefit of compensating
balance credits relative to the larger amount of recourse debt on loans held for
securitization.
Interest Income and Interest-Earning Assets
Average interest-earning assets declined to $4.8 billion for the three
months ended March 31, 1999, a decrease of approximately 6% from $5.1 billion of
average interest-earning assets during the same period of 1998. This decrease in
average interest-earning assets was primarily the result of $2.2 billion of
principal payments during the twelve months ended March 31, 1999. In addition,
$246.2 million of investments were sold during the same period. These decreases
were partially offset by loans originations of $1.2 billion for the twelve
months ended March 31, 1999. In addition, Dynex REIT purchased $176.3 million of
securities and $79.4 million of other investments during the twelve months ended
March 31, 1999. Dynex REIT also exercised call rights on $166.8 million of
securities during the same period. Also, Dynex REIT purchased $562.0 million of
single family loans through bulk purchases during the latter part of March 1998.
Total interest income decreased approximately 10%, from $97.2 million for the
three months ended March 31, 1998 to $87.1 million for the same period of 1999.
This decrease in total interest income was due to both the decline in average
interest-earnings assets and to a decline in the yield on interest-earning
assets. Overall, the yield on interest-earning assets declined to 7.24% for the
three months ended March 31, 1999 from 7.59% for the three months ended March
31, 1998, due primarily to an overall decrease in interest rates during the
latter half of 1998 and the first quarter of 1999.
Earning Asset Yield
($ in millions)
<TABLE>
<CAPTION>
- ---------------------------- ----------------------------------------------------------------------
Average Interest-
Average Interest- Interest Income Earnings Asset Yield
Earning Assets (2)
- ---------------------------- ----------------------------------------------------------------------
<S> <C> <C> <C>
1997, Quarter 2 $ 4,321.1 $ 84.9 (1) 7.86%
1997, Quarter 3 4,801.2 91.8 (1) 7.65%
1997, Quarter 4 5,143.0 99.2 (1) 7.72%
1998, Quarter 1 5,120.2 97.2 7.59%
1998, Quarter 2 5,780.5 110.0 7.61%
1998, Quarter 3 5,571.7 104.5 (1) 7.50%
1998, Quarter 4 5,138.3 95.9 7.46%
1999, Quarter 1 4,817.5 87.1 7.24%
- ---------------------------- ----------------------------------------------------------------------
<FN>
(1) Interest income includes amounts related to the gross interest income on
certain securities which are accounted for net of the related interest
expense.
(2) Interest income excludes amounts related to the net interest income on
advances to DHI.
</FN>
</TABLE>
Approximately $2.4 billion of the investment portfolio as of March 31, 1999
is comprised of loans or securities that have coupon rates which adjust over
time (subject to certain periodic and lifetime limitations) in conjunction with
changes in short-term interest rates. Approximately 63% of the ARM loans
underlying the ARM securities and collateral for collateralized bonds are
indexed to and reset based upon the level of six-month LIBOR; approximately 29%
are indexed to and reset based upon the level of the one-year Constant Maturity
Treasury (CMT) index. The following table presents a breakdown, by principal
balance, of the Company's collateral for collateralized bonds and fixed and ARM
mortgage securities by type of underlying loan. This table excludes other
derivative and residual securities, other securities, other investments and
loans held for securitization.
Investment Portfolio Composition (1)
($ in millions)
<TABLE>
<CAPTION>
- --------------------------- -------------------------------------------------------------------------------------------
Other Indicies
LIBOR Based ARM CMT Based ARM Based Arm Loans Fixed-Rate Loans
Loans Loans Total
- --------------------------- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998, Quarter 1 $ 2,128.3 $ 656.1 $ 283.3 $ 1,564.2 $ 4,631.9
1998, Quarter 2 2,153.5 1,159.8 240.2 1,467.0 5,020.5
1998, Quarter 3 1,873.7 978.3 208.0 1,351.0 4,411.0
1998, Quarter 4 1,644.0 720.4 195.4 1,704.0 4,263.8
1999, Quarter 1 1,411.6 629.8 159.4 1,927.6 4,128.4
- --------------------------- -------------------------------------------------------------------------------------------
<FN>
(1) Includes only the principal amount of collateral for collateralized bonds,
ARM securities and fixed-rate mortgage securities.
</FN>
</TABLE>
The average asset yield is reduced for the amortization of premiums, net of
discounts on the investment portfolio. As indicated in the table below, premiums
on the collateral for collateralized bonds, ARM securities and fixed-rate
mortgage securities at March 31, 1999 were $65.4 million, or approximately 1.57%
of the aggregate investment portfolio. Of this $65.4 million, $37.4 million
relates to the premium on multifamily and commercial mortgage loans that have
prepayment lockouts or yield maintenance for at least seven years. Amortization
expense as a percentage of principal paydowns has declined to 1.46% for the
three months ended March 31, 1999, from 1.56% for the same period in 1998 as the
investment portfolio mix changed to assets funded at lower premiums, at par, or
at a discount. The increase in the amortization expense as a percentage of
principal paydowns from the fourth quarter 1998 is due to the multifamily and
commercial securitization during the fourth quarter of 1998. The principal
repayment rate for the Company (indicated in the table below as "CPR Annualized
Rate") was approximately 38% for the three months ended March 31, 1999, which
was a decrease from 47% one year ago. CPR or "constant prepayment rate" is a
measure of the annual prepayment rate on a pool of loans. Excluded from this
table are the Company's loans held for securitization, which are carried at a
net discount of $3.9 million at March 31, 1999.
Premium Basis and Amortization
($ in millions)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Amortization
CPR Expense as a % of
Amortization Annualized Principal Principal Paydowns
Net Premium Expense Rate Paydowns
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997, Quarter 2 $ 62.7 $ 4.0 30% $ 205.1 1.94%
1997, Quarter 3 57.9 4.8 29% 258.8 1.85%
1997, Quarter 4 56.9 5.8 37% 319.6 1.80%
1998, Quarter 1 49.5 8.5 47% 546.7 1.56%
1998, Quarter 2 45.7 7.0 36% 563.0 1.24%
1998, Quarter 3 39.0 6.3 40% 603.0 1.05%
1998, Quarter 4 77.8 5.7 41% 502.5 1.12%
1999, Quarter 1 65.4 5.9 38% 402.8 1.46%
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
Interest Expense and Cost of Funds
Dynex REIT's largest expense is the interest cost on borrowed funds. Funds
to finance the investment portfolio are borrowed primarily in the form of
non-recourse collateralized bonds or repurchase agreements. The interest rates
paid on collateralized bonds are either fixed or floating rates; the interest
rates on the repurchase agreements are floating rates. Dynex REIT 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 they relate.
Average borrowed funds decreased from $4.8 billion for the three months ended
March 31, 1998 to $4.6 billion for the same period in 1999. This decrease
resulted primarily from the decline in interest-earning assets of $0.3 billion
during the twelve months ended March 31, 1999 and the paydown of the related
borrowings. For the three months ended March 31, 1999, interest expense
decreased to $70.6 million from $76.6 million for the three months ended March
31, 1998, while the average cost of funds decreased to 6.17% for the three
months ended March 31, 1999 compared to 6.40% for the same period in 1998. The
decreased average cost of funds for the first quarter of 1999 compared to the
first quarter of 1998 was mainly a result of a decrease in the one-month LIBOR
rate during the latter half of 1998.
Cost of Funds
($ in millions)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
Average Interest Cost
Borrowed Funds Expense (1)(2) of Funds
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1997, Quarter 2 $ 3,869.7 $ 61.3 6.34%
1997, Quarter 3 4,357.9 68.8 6.31%
1997, Quarter 4 4,570.3 74.1 6.49%
1998, Quarter 1 4,791.1 76.6 6.40%
1998, Quarter 2 5,520.7 88.8 6.44%
1998, Quarter 3 5,377.7 86.0 6.39%
1998, Quarter 4 4,941.6 75.7 6.13%
1999, Quarter 1 4,576.7 70.6 6.17%
- ----------------------------------------------------------------------------------------------
<FN>
1) Excludes non-interest collateralized bond-related expenses.
(2) Includes the net amortization expense of bond discounts and bond premiums.
</FN>
</TABLE>
Interest Rate Agreements
As part of the asset/liability management process for its investment
portfolio, Dynex REIT may enter 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, the funding of fixed interest rates on certain portfolio investments with
floating rate borrowings 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 Dynex REIT in the event that short-term interest rates rise
quickly.
The following table includes all interest rate agreements in effect as of
the various quarter ends for asset/liability management of the investment
portfolio. This table excludes all interest rate agreements in effect for the
loan production operations as generally these agreements are used to hedge
interest rate risk related to forward commitments to fund loans. 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. Amounts
presented are aggregate notional amounts. To the extent any of these agreements
are terminated, gains and losses are generally amortized over the remaining
period of the original agreement.
Instruments Used for Interest Rate Risk Management Purposes (1)
($ in millions)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
Interest Interest
Notional Amounts Rate Caps Rate Swaps
- -----------------------------------------------------------------------------
<S> <C> <C>
1997, Quarter 2 $ 1,599 $ 1,442
1997, Quarter 3 1,599 1,381
1997, Quarter 4 1,599 1,354
1998, Quarter 1 1,599 1,559
1998, Quarter 2 1,599 1,726
1998, Quarter 3 1,599 1,561
1998, Quarter 4 1,599 1,140
1999, Quarter 1 1,364 1,122
- -----------------------------------------------------------------------------
<FN>
(1) Excludes all interest rate agreements in effect for the Company's loan
production operations.
</FN>
</TABLE>
Net Interest Rate Agreement Expense
The net interest rate agreement expense, or hedging expense, equals the
cost of the agreements presented in the previous table, net of any benefits
received from these agreements. For the quarter ended March 31, 1999, net
hedging expense amounted to $1.12 million compared to $1.72 million and $1.23
million for the quarters ended December 31, 1998 and March 31 1998,
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 loans funded and amortized over the life
of the loans as an adjustment to their yield. The net interest rate agreement
expense decreased for the three months ended March 31, 1999 compared to the same
period in 1998, primarily due to the expiration of $235 million of interest rate
caps during January 1999. In addition, the Company terminated $34.2 million of
interest rate swap agreements for a total loss of $0.1 million during the first
quarter of 1999 as the collateral which the interest rate swap was hedging was
amortizing at a faster rate than the original swap. This loss is being amortized
into interest income over the estimated remaining life of the collateral as a
yield adjustment.
Net Interest Rate Agreement Expense
($ in millions)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Net Expense Net Expense as
Net Interest as Percentage Percentage of Average
Rate Agreement Expense of Average Borrowings (annualized)
Assets (annualized)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1997, Quarter 2 $ 1.23 0.09% 0.13%
1997, Quarter 3 1.35 0.11% 0.12%
1997, Quarter 4 1.39 0.11% 0.12%
1998, Quarter 1 1.23 0.10% 0.10%
1998, Quarter 2 1.83 0.13% 0.13%
1998, Quarter 3 1.92 0.14% 0.14%
1998, Quarter 4 1.72 0.13% 0.14%
1999, Quarter 1 1.12 0.09% 0.10%
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
Fair Value
The fair value of the available-for-sale portion of the investment
portfolio as of March 31, 1999, as measured by the net unrealized loss on
investments available-for-sale, was $4.0 million below its cost basis, which
represents a $0.9 million decrease from December 31, 1998. At December 31, 1998,
the fair value of the investment portfolio was $3.1 million below its amortized
cost basis. This decrease in the portfolio's value is primarily attributable to
the prepayment activity in the investment portfolio during the first quarter of
1999.
Credit Exposures
The Company securitizes its loan production into collateralized bonds or
pass-through securitization structures. With either structure, the Company may
use overcollateralization, subordination, reserve funds, bond insurance,
mortgage pool insurance or any combination of the foregoing as a form of credit
enhancement. With all forms of credit enhancement, the Company may retain a
limited portion of the direct credit risk after securitization.
The following table summarizes the aggregate principal amount of collateral
for collateralized bonds and pass-through securities outstanding; the maximum
direct credit exposure retained by the Company (represented by the amount of
overcollateralization pledged and subordinated securities rated below BBB owned
by the Company), net of the credit reserves maintained by the Company for such
exposure; and the actual credit losses incurred for each quarter. The table
excludes any risks related to representations and warranties made on loans
funded by the Company and securitized in mortgage pass-through securities
generally funded prior to 1995. This table also excludes any credit exposure on
loans held for securitization (which will be included as the loans are
securitized), funding notes and other investments. The increase in net credit
exposure as a percentage of the outstanding loan principal balance from 2.22% at
March 31, 1998 to 3.72% at March 31, 1999 is related primarily to the credit
exposure retained by the Company on its commercial securitization issued during
December 1998 and its single family and manufactured housing securitizations
issued during May 1998 and March 1999.
Credit Reserves and Actual Credit Losses
($ in millions)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
Maximum Credit Exposure, Net
Outstanding Loan Maximum Credit Actual Credit of Credit Reserves to
Principal Balance Exposure, Net Losses Outstanding Loan Balance
of Credit Reserves
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997, Quarter 2 $ 4,305.5 $ 50.3 $ 4.9 1.17%
1997, Quarter 3 3,975.7 50.2 5.8 1.26%
1997, Quarter 4 5,153.1 86.6 6.5 1.68%
1998, Quarter 1 4,209.5 93.6 6.3 2.22%
1998, Quarter 2 5,098.8 120.1 3.8 2.36%
1998, Quarter 3 4,440.2 132.4 6.4 2.98%
1998, Quarter 4 4,389.7 159.7 3.8 3.64%
1999, Quarter 1 4,340.8 161.6 4.3 3.72%
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes single family mortgage loan, manufactured
housing loan and commercial mortgage loan delinquencies as a percentage of the
outstanding collateral balance for those securities in which Dynex REIT has
retained a portion of the direct credit risk. The decrease in delinquencies as a
percentage of the outstanding collateral balance from 3.09% at March 31, 1998 to
2.69% at March 31, 1999 is primarily related to the fact that the single family
loans related to the Company's single family operations that were sold in 1996
are a smaller portion of the outstanding collateral at March 31, 1999, and that
the aggregate delinquency rate on the other single family loans, the
manufactured housing loans and the commercial mortgage loans were only 0.9%. The
Company monitors and evaluates its exposure to credit losses and has established
reserves based upon anticipated losses, general economic conditions and trends
in the investment portfolio. As of March 31, 1999, management believes the
credit reserves are sufficient to cover any losses which may occur as a result
of current delinquencies presented in the table below.
Delinquency Statistics (1)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
90 days and over delinquent
60 to 90 days delinquent (2) Total
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1997, Quarter 2 0.60% 3.25% 3.85%
1997, Quarter 3 0.89% 3.39% 4.28%
1997, Quarter 4 0.51% 2.82% 3.33%
1998, Quarter 1 0.44% 2.65% 3.09%
1998, Quarter 2 0.24% 1.82% 2.06%
1998, Quarter 3 0.39% 1.73% 2.12%
1998, Quarter 4 0.25% 2.11% 2.36%
1999, Quarter 1 0.45% 2.24% 2.69%
- -------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Excludes funding notes.
(2) Includes foreclosures, repossessions and REO.
</FN>
</TABLE>
The following table summarizes the credit ratings for collateral for
collateralized bonds and securities held in the investment portfolio. This table
excludes $15.5 million of other derivative and residual securities (as the risk
on such securities is primarily prepayment-related, not credit-related), other
investments and loans held for securitization. This table also excludes the
funding notes, aggregating $131.8 million which are not rated. The balance of
the investments rated below A are net of credit reserves and discounts. All
balances exclude the related mark-to-market adjustment on such assets. At March
31, 1999, securities with a credit rating of AA or better were $3.6 billion, or
90.9% of the total.
Investments by Credit Rating (1)
($ in millions)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
Below Below
AAA/AA A BBB BBB AAA /AA A BBB BBB
Carrying Carrying Carrying Carrying Percent of Percent Percent Percent
Value Value Value Value Total of Total of Total of Total
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998, Quarter 1 $4,369.9 $ 72.0 $ 50.0 $ 3.6 97.2% 1.6% 1.1% 0.1%
1998, Quarter 2 4,729.1 138.5 72.7 7.7 95.6% 2.8% 1.5% 0.1%
1998, Quarter 3 4,126.6 139.3 73.3 5.4 95.0% 3.2% 1.7% 0.1%
1998, Quarter 4 3,815.6 206.2 97.6 14.4 92.3% 5.0% 2.4% 0.3%
1999, Quarter 1 3,614.8 219.2 118.8 24.0 90.9% 5.5% 3.0% 0.6%
- -------------------------------------------------------------------------------------------------------------
<FN>
(1) Carrying value does not include funding notes, derivative and residual
securities, other investments and loans held for securitization. Balances
also exclude the mark-to-market adjustment. Carrying value also excludes
$231.1 million of overcollateralization at March 31, 1999.
</FN>
</TABLE>
General and Administrative Expenses
General and administrative expenses and net administrative fees and
expenses to DHI ("collectively, G&A expense") consist of expenses incurred in
conducting the production activities and managing the investment portfolio, as
well as various other corporate expenses. G&A expense remained relatively flat
for the three month period ended March 31, 1999 as compared to the same period
in 1998. The Company expects overall G&A expense levels to remain relatively
constant for the remainder of 1999.
The following table summarizes the ratio of G&A expense to average
interest-earning assets and the ratios of G&A expense to average total equity.
Operating Expense Ratios
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
G&A Expense/Average G&A Expense/Average
Interest-Earning Assets Total Equity
(Annualized) (Annualized) (1)
- -----------------------------------------------------------------------------------
<S> <C> <C>
1997, Quarter 2 0.39% 3.73%
1997, Quarter 3 0.43% 4.37%
1997, Quarter 4 0.62% 6.61%
1998, Quarter 1 0.62% 6.59%
1998, Quarter 2 0.50% 5.93%
1998, Quarter 3 0.56% 6.43%
1998, Quarter 4 0.66% 7.23%
1999, Quarter 1 0.66% 6.96%
- -----------------------------------------------------------------------------------
<FN>
(1) Average total equity excludes net unrealized gain (loss) on investments
available-for-sale.
</FN>
</TABLE>
Net Income and Return on Equity
Net income decreased from $14.4 million for the three months ended March
31, 1998 to $2.3 million for the three months ended March 31, 1999. Net income
available to common shareholders decreased from $11.1 million to a $1.0 million
loss for the same periods, respectively. Return on common equity (excluding the
impact of the net unrealized gain on investments available-for-sale) decreased
from 12.5% for the three months ended March 31, 1998 to a negative 1.2% for the
three months ended March 31, 1999. The decrease in the return on common equity
is a result primarily of the decline in net income available to common
shareholders from the quarter ended March 31, 1998 to the same period in 1999
and the issuance of new common shares during 1998.
Components of Return on Equity
($ in thousands)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Equity in
Earnings (Loss),
Net Interest Provision Permanent Gains (Losses) G&A Preferred
Margin/ for Losses Impairment / and Other Expense/ Dividend/ Return on
Average /Average Average Income Average Average Average Net Income
Common Equity Common Common /Average Common Common Common Equity Common Available to
(annualized) Equity Equity Equity Equity (annualized) Equity Common
(annualized) (annualized) (annualized) (annualized) (annualized) Shareholders
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1997, Quarter 2 27.7% 1.5% - 2.0% 5.3% 4.6% 18.3% $ 14,668
1997, Quarter 3 25.9% 1.3% - 4.8% 6.1% 4.5% 18.8% 15,784
1997, Quarter 4 26.2% 1.9% - 4.9% 9.0% 4.2% 16.0% 14,103
1998, Quarter 1 20.9% 1.6% - 5.9% 9.0% 3.7% 12.5% 11,145
1998, Quarter 2 21.1% 1.9% - 6.3% 8.0% 3.7% 13.8% 12,323
1998, Quarter 3 19.0% 2.4% - (0.5%) 8.7% 3.7% 3.7% 3,257
1998, Quarter 4 21.9% 1.2% (20.8%) (10.0%) 9.9% 3.8% (23.8%) (20,167)
1999, Quarter 1 18.3% 4.6% - (1.3%) 9.7% 3.9% (1.2%) (969)
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Dividends and Taxable Income
Dynex REIT has 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. Dynex REIT
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.
Dynex REIT intends to declare and pay out as dividends 100% of its taxable
income over time. Dynex REIT's current practice is to declare quarterly
dividends; however, no dividends on its common stock had been declared since
September 1998. Generally, Dynex REIT strives to declare a quarterly dividend
which will result in the distribution of most or all of the taxable income
earned during the applicable year. At the time of the dividend announcement,
however, the total level of taxable income for the quarter is unknown.
Additionally, Dynex REIT has considerations other than the desire to pay out
most of its taxable earnings, which may take precedence when determining the
level of dividends.
Dividend Summary
($ in thousands, except per share amounts)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Estimated Taxable Net Estimated
Income (Loss) Estimated Taxable Cumulative
Available to Common Net Income (Loss) Dividend Declared Dividend Undistributed
Shareholders Per Common Share Per Common Share Pay-out Ratio Taxable Income
(Loss)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997, Quarter 2 $ 12,016 $ 0.283 $ 0.335 118% $ 13,524
1997, Quarter 3 10,531 0.248 0.345 139% 9,392
1997, Quarter 4 10,132 0.228 0.350 154% 3,949
1998, Quarter 1 21,970 0.484 0.300 62% 12,293
1998, Quarter 2 11,339 0.245 0.300 122% 9,746
1998, Quarter 3 3,852 0.083 0.250 301% 2,045
1998, Quarter 4 (2,698) (0.059) - - (653)
1999, Quarter 1 (6,618) (0.144) - - (7,271)
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
Taxable income differs from the financial statement net income which is
determined in accordance with generally accepted accounting principles ("GAAP").
For the three months ended March 31, 1999, taxable net loss per common share
exceeded GAAP loss per common share principally due to the preferred dividend
paid in January 1999. The fourth quarter 1998 dividends were included in the
first quarter 1999 taxable income as a result of a January 1, 1999 record date.
Cumulative undistributed taxable income represents timing differences in the
amounts earned for tax purposes versus the amounts distributed. Such amounts can
be distributed for tax purposes in the subsequent year as a portion of the
normal quarterly dividend. Such amounts also include certain estimates of
taxable income until such time that Dynex REIT files its federal income tax
returns for each year.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS No. 133"). FAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. FAS No. 133 is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. The
Company is in the process of determining the impact of adopting FAS No. 133.
Year 2000
The Company is dependent upon purchased, leased, and internally-developed
software to conduct certain operations. In addition, the Company relies upon
certain counterparties such as banks and loan servicers who are also highly
dependent upon computer systems. The Company recognizes that some computer
software may incorrectly recognize dates beyond December 31, 1999. The ability
of the Company and its counterparties to correctly operate computer software in
the Year 2000 is critical to the Company's operations.
The Company uses several major and minor computer systems to conduct its
business operations. The computer systems deemed most important to the Company's
ability to continue operations are as follows:
- The internally-developed loan origination system for manufactured
housing operations
- The internally-developed loan origination and asset management system
for commercial loans
- The internally-developed investment portfolio analytics, securitization,
and securities administration software
- The purchased servicing system for commercial loans
- The purchased servicing system for single family and manufactured housing
loans
- The purchased general ledger accounting system
In addition, the Company is involved in data interchange with a number of
counterparties in the normal course of business. Each system or interface that
the Company relies on is being tested and evaluated for Year 2000 compliance.
The Company has contacted all of its key software vendors to determine
their Year 2000 readiness. The Company has received documentation from each of
the vendors providing assurances of Year 2000 compliance:
- Baan/CODA, vendor of the general ledger accounting system, has provided
confirmation that their current software release is fully Year 2000
compliant. The Company plans to apply this release by June 30, 1999.
- Synergy Software, vendor of the commercial loan servicing system, has
provided confirmation that the current release of their software is fully
Year 2000 compliant. The Company has installed and performed initial
testing on this version with no issues discovered.
- Interlinq Software, vendor of the single-family and manufactured housing
loan servicing software, has provided assurance that their software is Year
2000 compliant. The Company has begun Year 2000 assurance testing on this
product with no issues discovered to date.
All software developed internally by the Company was designed to be Year
2000 compliant. Nevertheless, the Company established a Year 2000 test-bed to
ensure that there were no design or development oversights that could lead to a
Year 2000 problem. Initial testing of all key applications was completed in
January of 1999, with only minor issues discovered and subsequently remedied.
Continued testing of certain applications will continue through June of 1999.
The Company has reviewed or is reviewing the Year 2000 progress of its
primary financial counterparties. Based on initial reviews, these counterparties
are expected to be in compliance. The Company, as master servicer of certain
securities, is in the process of assessing the Year 2000 readiness of its
external servicers, to ensure that these parties will be able to correctly remit
loan information and payments after December 31, 1999.
The Company believes that, other than its exposure to financial
counterparties, its most significant risk with respect to internal or purchased
software is the software systems used to service manufactured housing loans. The
Company will not be able to service these loans without the automated system.
Should these loans go unattended for a period greater than three months, the
result could have a material adverse impact on the Company.
The Company is also at significant risk if the systems of the financial
institutions that provide the Company financing and software for cash management
services should fail. In a worst case scenario, the Company would be unable to
fund its operations or pay on its obligations for an unknown period of failure.
This would have a material adverse impact on the Company.
The Company is also at significant risk if the voice and data
communications network supplied by its provider should fail. In such an instance
the Company would be unable to originate or efficiently service its manufactured
housing loans until the problem is remedied. The Company is closely monitoring
the Year 2000 efforts of its telecommunications provider and is developing
contingency plans in the event that the provider does not give sufficient
assurance of compliance by June 30, 1999.
The Company is also at significant risk should the electric utility company
for the Company's offices in Glen Allen, Virginia, fail to provide power for
several business days. In such an instance, the Company would be unable (i) to
communicate over its telecommunication systems, (ii) would be unable to process
data, and (iii) would be unable to originate or service loans until the problem
is remedied. The Company continues to monitor the Year 2000 status of its
utility provider, whose plan is scheduled to be completed in the fall of 1999.
The Company uses many other systems (including systems that are not
information technology oriented), both purchased and developed internally, that
could fail to perform accurately after December 31, 1999. Management believes
that the functions performed by these systems are either non-critical or could
be performed manually in the event of failure.
The Company will complete its Year 2000 test plan and remediation efforts
in the second quarter of 1999. Management believes that there is little
possibility of a significant disruption in business. The major risks are those
related to the ability of vendors and business partners to complete Year 2000
plans. The Company expects that those vendors and counterparties will complete
their Year 2000 compliance programs before January 1, 2000.
The Company has incurred less than $50,000 in costs to date in carrying out
its Year 2000 compliance program. The Company estimates that it will spend less
than $100,000 to complete the plan. Costs could increase in the event that the
Company determines that a counterparty will not be Year 2000 compliant.
The Company is still developing contingency plans in the event that a
system or counterparty is not Year 2000 compliant. These plans will be developed
by June 30, 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company finances its operations from a variety of sources. These
sources include cash flow generated from the investment portfolio, including net
interest income and principal payments and prepayments, common stock offerings
through the dividend reinvestment plan, short-term warehouse lines of credit
with commercial and investment banks, repurchase agreements and the capital
markets via the asset-backed securities market (which provides long-term
non-recourse funding of the investment portfolio via the issuance of
collateralized bonds). Historically, cash flow generated from the investment
portfolio has satisfied its working capital needs, and the Company has had
sufficient access to capital to fund its loan production operations, on both a
short-term (prior to securitization) and long-term (after securitization) basis.
However, if a significant decline in the market value of the investment
portfolio that is funded with recourse debt should occur, the 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, Dynex REIT 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 Dynex REIT would likely generate without such offerings. During the
first quarter 1999, Dynex REIT issued 3,388 shares of its common stock pursuant
to its dividend reinvestment program for preferred stockholders for net proceeds
of $18 thousand.
Certain aspects of Dynex REIT's funding strategies subject it to liquidity
risk. Liquidity risk stems from Dynex REIT's use of repurchase agreements, its
use of committed lines of credit with mark-to-market provisions and the reliance
on the asset-backed securitization markets for its long-term funding needs.
Liquidity risk also stems from hedge positions the Company may take to hedge its
commercial and manufactured housing loan production. Repurchase agreements are
generally provided by investment banks, and subject Dynex REIT to margin call
risk if the market value of assets pledged as collateral for the repurchase
agreements declines. Dynex REIT has established 'target equity' requirements for
each type of investment pledged as collateral, taking into account the price
volatility and liquidity of each such investment. Dynex REIT strives to maintain
enough liquidity to meet anticipated margin calls if short-term interest rates
increased 300 basis points in a twelve-month period.
Dynex REIT has committed lines of credit and uncommitted repurchase
facilities to finance the accumulation of assets for securitization. Dynex REIT
borrows on these lines of credit on a short-term basis to support the
accumulation of assets 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, Dynex
REIT's ability to acquire or fund additional assets may be substantially reduced
and it may experience losses. Dynex REIT currently has a total of $925 million
of committed lines of credit and $700 million of uncommitted repurchase
facilities to finance loans held for securitization and other investments. These
borrowings are paid down as Dynex REIT securitizes or sells assets. Generally
these borrowings allow for the warehousing of assets for a period of 180-365
days. Dynex REIT generally intends to securitize assets by product type every
120-365 days. If there exists a dislocation or disruption in the asset-backed
market, Dynex REIT may be unable to securitize the assets, or may only be able
to securitize the assets on unfavorable terms. In such a case, Dynex REIT would
be required to repay the lines of credit with either available liquidity or
would be required to liquidate the assets or other assets to generate liquidity.
In addition, lines of credit with commercial and investment banks may include
provisions by such banks to mark the collateral to market on a daily basis. To
the extent the market value of the associated asset has declined due to market
conditions, Dynex REIT may be required to provide additional collateral or sell
the associated asset which may result in losses.
As a part of its strategy to hedge exposure to changes in interest rates on
commercial mortgage loans funded and commitments to fund commercial mortgage
loans, Dynex REIT may enter into forward sales of Treasury futures. Such sales
are executed through third parties, which require cash collateral in the event
that movements in interest rates adversely impact the value of the futures
position. The value of the related loans or loan commitments will generally
increase in value as the futures position decreases; however, such value is
generally not recognized until the loans are securitized. In order to maintain
its hedge positions, Dynex REIT may therefore be exposed to additional cash
collateral requirements in adverse interest rate environments.
A substantial portion of the assets are pledged to secure indebtedness
incurred by Dynex REIT. Accordingly, those assets would not be available for
distribution to any general creditors or the stockholders of Dynex REIT in the
event of the liquidation, except to the extent that the value of such assets
exceeds the amount of the indebtedness they secure.
Non-recourse Debt
Dynex REIT, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds to fund the majority of
its investment portfolio. The obligations under the collateralized bonds are
payable solely from the collateral for collateralized bonds and are otherwise
non-recourse to Dynex REIT. Collateral for collateralized bonds are not subject
to margin calls. The maturity of each class of collateralized bonds is directly
affected by the rate of principal prepayments on the related collateral. Each
series is also subject to redemption according to specific terms of the
respective indentures, generally when the remaining balance of the bonds equals
35% or less of the original principal balance of the bonds. At March 31, 1999,
Dynex REIT had $3.7 billion of collateralized bonds outstanding as compared to
$3.7 billion at December 31, 1998.
Recourse Debt
Secured. At March 31, 1999, Dynex REIT had four committed credit facilities
aggregating $925 million, comprised of (i) a $250 million credit line, expiring
in April 2000, from a consortium of commercial banks primarily for the
warehousing of multifamily construction and permanent loans (including providing
the letters of credit for tax-exempt bonds) and manufactured housing loans, (ii)
a $400 million credit line, expiring in November 1999, from an investment bank
primarily for the warehousing of permanent loans on multifamily and commercial
properties, (iii) a $175 million credit line, expiring in June 1999, from a
consortium of commercial banks and finance companies to fund the purchase of
model homes, and (iv) a $100 million credit line, expiring in September 1999,
from an investment bank for the warehousing of the funding notes. Dynex REIT
expects these credit facilities will be renewed or replaced, if necessary, at
their respective expiration dates, although there can be no assurance of such
renewal or replacement. The lines of credit contain certain financial covenants
which Dynex REIT met as of March 31, 1999. However, changes in asset levels or
results of operations could result in the violation of one or more covenants in
the future. At March 31, 1999, Dynex REIT had $379.2 million outstanding under
its committed credit facilities.
Dynex REIT also uses repurchase agreements to finance a portion of its
investments, which generally have thirty day maturities. Repurchase agreements
allow Dynex REIT 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. Dynex
REIT has two uncommitted master repurchase facilities aggregating $700 million
for the accumulation of assets for securitization. These agreements expired in
April 1999 and are in the process of being renewed. Dynex REIT expects these
repurchase facilities will be renewed, although there can be no assurance of
such renewal. At March 31, 1999, outstanding obligations under all repurchase
agreements totaled $271.7 million compared to $528.3 million at December 31,
1998. The following table summarizes the outstanding balances of repurchase
agreements by credit rating of the related assets pledged as collateral to
support such repurchase agreements. The table excludes repurchase agreements
used to finance loans held for securitization.
Repurchase Agreements by Rating of Investments Financed
($ in millions)
<TABLE>
<CAPTION>
- --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
AAA AA A BBB Below BBB Total
- --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
<S> <C> <C> <C> <C> <C> <C>
1998, Quarter 3 $ 560.8 $ 91.2 $ 58.7 $ 51.9 $ - $ 762.6
1998, Quarter 4 124.5 109.5 91.4 65.6 - 391.0
1999, Quarter 1 86.3 63.2 64.2 57.9 - 271.7
- --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
</TABLE>
Increases in short-term interest rates, long-term interest rates, or market
risk could negatively impact the valuation of securities and may limit Dynex
REIT's borrowing ability or cause various lenders to initiate margin calls for
securities financed using repurchase agreements. Additionally, certain
investments are classes of securities rated AA, A, or BBB that are subordinated
to other classes from the same series of securities. Such subordinated 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 loans. In instances of a downgrade of
an insurer or the deterioration of the credit quality of the underlying
collateral, Dynex REIT 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.
Unsecured. Since 1994, Dynex REIT 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 March 31, 1999 of
$129.3 million.
Total recourse debt decreased from $1.0 billion for December 31, 1998 to
$0.8 billion for March 31, 1999. This decrease is primarily due to the $190.7
million and $57.5 million reduction on repurchase agreements and notes payable
due to the securitization of $277.7 million securities and loans as collateral
for collateralized bonds during March 1999. The decrease was partially offset by
the addition of $62.6 million of notes payable as a result of the purchase or
origination of additional assets.
Total Recourse Debt
($ in millions)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
Total Recourse Debt to Fixed Charge Coverage
Total Recourse Debt Equity Ratio
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1997, Quarter 2 $ 1,793.8 3.37% 1.74%
1997, Quarter 3 1,852.4 3.43% 1.87%
1997, Quarter 4 1,133.5 2.02% 1.77%
1998, Quarter 1 2,425.2 4.41% 1.72%
1998, Quarter 2 1,390.3 2.56% 1.48%
1998, Quarter 3 1,614.5 3.21% 1.28%
1998, Quarter 4 1,032.7 2.28% 0.27%
1999, Quarter 1 781.4 1.73% 1.14%
- -----------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
Table 1
Components of Collateral for Collateralized Bonds
($ in thousands)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------ ------------------ ------------------
March 31, 1999 December 31, 1998
- ------------------------------------------------------------------ ------------------ ------------------
<S> <C> <C>
Collateral for collateralized bonds $ 4,062,722 $ 4,177,592
Allowance for loan losses (15,970) (16,593)
Funds held by trustees 2,193 1,104
Accrued interest receivable 24,848 27,834
Unamortized premiums and discounts, net 67,460 81,990
Unrealized gain, net 19,668 21,601
- ------------------------------------------------------------------ ------------------ ------------------
Collateral for collateralized bonds $ 4,160,921 $ 4,293,528
- ------------------------------------------------------------------ ------------------ ------------------
</TABLE>
Table 2
Principal Balance of Collateral for Collateralized Bonds by Loan Type
($ in thousands)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------- ------------------- ---------------------
March 31, 1999 December 31, 1998
- ---------------------------------------------------------------- ------------------- ---------------------
<S> <C> <C>
Single family loans
ARMS:
1 month LIBOR $ 9,051 $ 9,905
3 month LIBOR 27,055 32,081
6 month LIBOR 1,339,141 1,506,431
Prime 99,110 119,833
6 month CD 50,420 63,649
1 year CMT 636,728 779,960
5 year CMT - 191
- ------------------------------------------------------------------ ------------------ --------------------
Total ARMs 2,161,505 2,512,050
Fixed 290,820 310,827
- ------------------------------------------------------------------ ------------------ --------------------
Total single-family 2,452,325 2,822,877
Manufactured housing loans:
ARM 14,557 13,288
Fixed 757,771 500,677
- ------------------------------------------------------------------ ------------------ --------------------
Total manufactured housing 772,328 513,965
Commercial loans 838,069 840,750
- ------------------------------------------------------------------ ------------------ --------------------
Total $ 4,062,722 $ 4,177,592
- ------------------------------------------------------------------ ------------------ --------------------
</TABLE>
Table 3
Collateral for Collateralized Bonds by Collateral Type
($ in thousands)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------ ------------------ --------------------
March 31, 1999 December 31, 1998
- ------------------------------------------------------------------ ------------------ --------------------
<S> <C> <C>
Single-family loans:
Single family detached $ 1,935,132 $ 2,194,304
Condominium 151,085 175,458
Single family attached 174,981 198,089
Planned unit development 117,274 143,293
Cooperative 36,307 41,633
Other 37,546 70,100
- ------------------------------------------------------------------ ------------------- ---------------------
Total single family 2,452,325 2,822,877
Manufactured housing loans:
Single wide 264,909 157,787
Multi-sectional 507,419 356,178
- ------------------------------------------------------------------ ------------------- ---------------------
Total manufactured housing 772,328 513,965
Commercial loans:
Multifamily (LIHTC) 530,276 531,233
Office 135,987 136,531
Motel/hotel 59,201 59,414
Industrial 34,072 34,217
Healthcare 30,234 30,342
Mixed use 27,964 28,600
Retail 16,681 16,744
Other 3,654 3,669
- ------------------------------------------------------------------ ------------------- ---------------------
Total commercial 838,069 840,750
- ------------------------------------------------------------------ ------------------- ---------------------
Total $ 4,062,722 $ 4,177,592
- ------------------------------------------------------------------ ------------------- ---------------------
</TABLE>
Table 4
Repricing Period for Adjustable-Rate Single-Family and
Manufactured Housing Collateral
As of March 31, 1999
($ in thousands)
<TABLE>
<CAPTION>
- -------------------------------------------- -------------------- -------------------- --------------------
Single- Manufactured
Family Housing Total
- -------------------------------------------- -------------------- -------------------- --------------------
<S> <C> <C> <C>
2nd Quarter 1999 $ 865,028 $ - $ 865,028
3rd Quarter 1999 751,474 - 751,474
4th Quarter 1999 70,364 - 70,364
1st Quarter 2000 61,448 - 61,448
2nd Quarter 2000 and beyond 413,191 14,557 427,748
- -------------------------------------------- -------------------- -------------------- --------------------
$ 2,161,505 $ 14,557 $ 2,176,062
- -------------------------------------------- -------------------- -------------------- --------------------
</TABLE>
Table 5
Commercial Loan Prepayment Protection Periods (1)
As of March 31, 1999
($ in thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------- -------------------- --------------------
Number of Loans Principal Balance
- ----------------------------------------------------- -------------------- --------------------
<S> <C> <C>
0 - 4 years 1 $ 12,750
5 - 10 years 27 112,623
11 - 16 years 200 658,822
Over 16 years 9 53,874
- ----------------------------------------------------- -------------------- --------------------
237 $ 838,069
- ----------------------------------------------------- -------------------- --------------------
<FN>
(1) The greater of prepayment lockout period or the yield maintenance period.
</FN>
</TABLE>
Table 6
Margin of Single Family Loans over Indices
<TABLE>
<CAPTION>
- ------------------------------------------------------------------ ------------------ --------------------
March 31, 1999 December 31, 1998
- ------------------------------------------------------------------ ------------------ --------------------
<S> <C> <C>
Single-family ARM loans
1 month LIBOR 3.27% 3.24%
3 month LIBOR 3.08 2.87
6 month LIBOR 3.07 3.06
Prime (1) 2.47 2.48
6 month CD 2.50 2.50
1 year CMT 2.85 2.85
5 year CMT - 2.88
- ------------------------------------------------------------------ ------------------- ---------------------
Total single-family ARM loans (weighted-average) 2.84 2.82
Manufactured housing loans (6-month LIBOR) 5.80 5.80
- ------------------------------------------------------------------ ------------------- ---------------------
Weighted average gross margin 2.85% 2.83%
- ------------------------------------------------------------------ ------------------- ---------------------
<FN>
(1) Relative to 1-month LIBOR, after giving effect to the Prime/LIBOR swap
owned by the Company.
</FN>
</TABLE>
Table 7
Weighted Average Coupon for Collateral for Collateralized Bonds
<TABLE>
<CAPTION>
- ------------------------------------------------------------------ ------------------ --------------------
March 31, 1999 December 31, 1998
- ------------------------------------------------------------------ ------------------ --------------------
<S> <C> <C>
Single-family loans:
ARM loans 8.16% 8.38%
Fixed 9.77 9.82
- ------------------------------------------------------------------ ------------------- ---------------------
Total 8.35 8.54
Manufactured housing loans:
ARM loans 9.33 9.48
Fixed 8.72 9.07
- ------------------------------------------------------------------ ------------------- ---------------------
Total 8.73 9.08
Commercial loans 8.01 8.01
- ------------------------------------------------------------------ ------------------- ---------------------
Aggregate weighted average coupon 8.35% 8.50%
- ------------------------------------------------------------------ ------------------- ---------------------
</TABLE>
Table 8
Net Balance Sheet (1)
($ in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---------------- -----------------
<S> <C> <C>
ASSETS
Investments:
Collateral for collateralized bonds $ 4,160,921 $ 4,293,528
Less: Collateralized bonds issued (3,909,874) (4,062,089)
---------------- -----------------
Net investment in collateralized bonds 251,047 231,439
Collateralized bonds retained 254,555 389,842
Securities 238,932 243,984
Other investments 34,653 30,371
Loans held for securitization 238,550 388,782
---------------- -----------------
1,017,737 1,284,418
Investment in and advances to Dynex Holding, Inc. 184,118 169,384
Cash 28,716 30,103
Accrued interest receivable 4,861 9,093
Other assets 16,812 18,488
---------------- -----------------
$ 1,252,244 $ 1,511,486
================ =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Repurchase agreements $ 271,704 $ 528,283
Notes payable 509,717 502,450
Accrued interest payable 4,732 8,403
Other liabilities 11,935 16,318
Dividends payable 3,228 3,228
---------------- -----------------
801,316 1,058,682
---------------- -----------------
Shareholders' Equity:
Preferred stock, par value $.01 per share,
50,000,000 shares authorized:
9.75% Cumulative Convertible Series A
1,309,061 and 1,309,061 issued and outstanding, respectively 29,900 29,900
9.55% Cumulative Convertible Series B
1,912,434 and 1,912,434 issued and outstanding, respectively 44,767 44,767
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 shares authorized,
46,030,814 and 46,027,426 issued and outstanding, respectively 460 460
Additional paid-in capital 352,331 352,382
Accumulated other comprehensive loss (3,953) (3,097)
Accumulated deficit (25,317) (24,348)
---------------- -----------------
450,928 452,804
---------------- -----------------
$ 1,252,244 $ 1,511,486
================ =================
<FN>
(1) This presents the balance sheet where the collateralized bonds are
"netted" against the collateral for collateralized bonds. This
presentation better illustrates the Company's net investment in the
collateralized bonds and the collateralized bonds retained for its
investment portfolio.
</FN>
</TABLE>
<PAGE>
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-Q made by the Company, that are
not historical fact constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such forward-looking statements may
involve factors that could cause the actual results of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. The Company cautions the public not to place
undue reliance on forward-looking statements, which may be based on assumptions
and anticipated events that do not materialize. The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.
Factors that may cause actual results to differ from historical results or
from any results expressed or implied by forward-looking statements include the
following:
Economic Conditions. The Company is affected by 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 commercial and 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.
Capital Markets. The Company relies on the capital markets for the sale
upon securitization of its collateralized bonds or other types of securities.
While the Company has historically been able to sell such collateralized bonds
and securities into the capital markets, there can be no assurances that
circumstances relating either to the Company or the capital markets may limit or
preclude the ability of the Company to sell such collateralized bonds or
securities in the future.
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 March 31, 1999, the yield curve was
considered flat relative to its normal shape, and as a result, the Company
expects a continuation of relatively high prepayment rates during the second
quarter in 1999.
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.
<PAGE>
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument due to fluctuations in
interest and foreign exchange rates and in equity and commodity prices. Market
risk is inherent to both derivative and non-derivative financial instruments,
and accordingly, the scope of the Company's market risk management extends
beyond derivatives to include all market risk sensitive financial instruments.
As a financial services company, net interest income comprises the primary
component of the Company's earnings. As a result, the Company is subject to risk
resulting from interest rate fluctuations to the extent that there is a gap
between the amount of the Company's interest-earning assets and the amount of
interest-bearing liabilities that are prepaid, mature or reprice within
specified periods. The Company's strategy is to mitigate interest rate risk
through the creation of a diversified investment portfolio of high quality
assets that, in the aggregate, preserves the Company's capital base while
generating stable income in a variety of interest rate and prepayment
environments. 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 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 assumptions. While certain investments may perform poorly in an
increasing or decreasing interest rate environment, other investments may
perform well, and others may not be impacted at all. Generally, the Company adds
investments to its portfolio that are designed to increase the diversification
and reduce the variability of the yield produced by the portfolio in different
interest rate environments.
The Company's Portfolio Executive Committee ("PEC"), which includes
executive management representatives, monitors and manages the interest rate
sensitivity and repricing characteristics of the balance sheet components
consistent with maintaining acceptable levels of change in both the net
portfolio value and net interest income. The Company's exposure to interest rate
risk is reviewed on a monthly basis by the PEC and quarterly by the Board of
Directors.
The Company utilizes several tools and risk management strategies to
monitor and address interest rate risk, including (i) a quarterly sensitivity
analysis using option-adjusted spread ("OAS") methodology to calculate the
expected change in net interest margin as well as the change in the market value
of various assets within the portfolio under various extreme scenarios; and (ii)
a monthly static cash flow and yield projection under 49 different scenarios.
Such tools allow 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 market risk. 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.
The Company measures the sensitivity of its net interest income to changes
in interest rates. Changes in interest rates are defined as instantaneous,
parallel, and sustained interest rate movements in 100 basis point increments.
The Company estimates its interest income for the next twelve months assuming no
changes in interest rates from those at period end. Once the base case has been
estimated, cash flows are projected for each of the defined interest rate
scenarios. Those scenario results are then compared against the base case to
determine the estimated change to net interest income.
The following table summarizes the Company's net interest margin
sensitivity analysis as of March 31, 1999 and December 31, 1998. This analysis
represents management's estimate of the percentage change in net interest margin
given a parallel shift in interest rates. The "Base" case represents the
interest rate environment as it existed as of March 31, 1999 and December 31,
1998. The analysis is heavily dependent upon the assumptions used in the model.
The effect of changes in future interest rates, the shape of the yield curve or
the mix of assets and liabilities may cause actual results to differ from the
modeled results. In addition, certain financial instruments provide a degree of
"optionality." The model considers the effects of these embedded options when
projecting cash flows and earnings. The most significant option affecting the
Company's portfolio is the borrowers' option to prepay the loans. The model uses
a dynamic prepayment model that applies a Constant Prepayment Rate (CPR) ranging
from 6.0% for fixed-rate manufactured housing loans to 69.1% for single family
ARM loans indexed to the six month certificate of deposit rate. The model varies
the CPR based on the projected incentive to refinance for each loan type in any
given period. While the Company's model considers these factors, the extent to
which borrowers utilize the ability to exercise their option may cause actual
results to significantly differ from the analysis. Furthermore, its projected
results assume no additions or subtractions to the Company's portfolio, and no
change to the Company's liability structure. Historically, the Company has made
significant changes to its assets and liabilities, and is likely to do so in the
future. Therefore, the following estimates should not be viewed as a forecast
and no assurance can be given that actual results will not vary significantly
from the analysis below.
<TABLE>
<CAPTION>
-------------------- ------------------------------------------------
Basis Point
Increase
(Decrease) in
Interest Rates
Over 12 Months % Change in Net Interest Margin from Base Case
-------------------- ------------------------------------------------
March 31, 1999 December 31, 1998
-------------------- -----------------------
<S> <C> <C>
+200 (13.59)% (11.69)%
+100 (6.77)% (9.30)%
Base - -
-100 6.97% 9.65%
-200 14.57% 21.29%
-------------------- -------------------- --- -----------------------
</TABLE>
The March 31, 1999 analysis illustrates that net interest margin is less
sensitive to interest rate changes than it was at December 31, 1998. This change
is primarily the result of the securitization of $360.9 million of manufactured
housing loans which support $323.3 million of fixed-rate collateralized bonds at
March 31, 1999. This fixed rate financing replaced variable rate collateralized
bonds, repurchase agreements and bank borrowings and therefore reduced the
Company's interest rate risk on this portion of the Company's interest-bearing
liabilities.
The Company's investment policy sets forth guidelines for assuming interest
rate risk. The investment policy stipulates that given a 200 basis point
increase or decrease in interest rates over a twelve month period, the estimated
net interest margin may not change by more than 25% of current net interest
margin during the subsequent one year period. Based on the projections above,
the Company is in compliance with its stated policy regarding the interest rate
sensitivity of net interest margin.
Approximately $2.4 billion of the Company's investment portfolio as of
March 31, 1999 is comprised of loans or securities that have coupon rates which
adjust over time (subject to certain periodic and lifetime limitations) in
conjunction with changes in short-term interest rates. Approximately 63% and 29%
of the ARM loans underlying the Company's ARM securities and collateral for
collateralized bonds are indexed to and reset based upon the level of six-month
LIBOR and one-year CMT, respectively.
Generally, during a period of rising short-term interest rates, the
Company's net interest spread earned on its investment portfolio will decrease.
The decrease of the net interest spread results from (i) the lag in resets of
the ARM loans underlying the ARM securities and collateral for collateralized
bonds relative to the rate resets on the associated borrowings and (ii) rate
resets on the ARM loans which are generally limited to 1% every six months or 2%
every twelve months and subject to lifetime caps, while the associated
borrowings have no such limitation. As short-term interest rates stabilize and
the ARM loans reset, the net interest margin may be restored to its former level
as the yields on the ARM loans adjust to market conditions. Conversely, net
interest margin may increase following a fall in short-term interest rates. This
increase may be temporary as the yields on the ARM loans adjust to the new
market conditions after a lag period. In each case, however, the Company expects
that the increase or decrease in the net interest spread due to changes in the
short-term interest rates to be temporary. The net interest spread may also be
increased or decreased by the proceeds or costs of interest rate swap, cap or
floor agreements.
Because of the 1% or 2% 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. Liquidity risk also
exists with all other investments pledged as collateral for repurchase
agreements, but to a lesser extent.
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 interest rate agreements are used by the
Company to help mitigate the risk to the investment portfolio of fluctuations in
interest rates that would ultimately impact net interest income. To help protect
the Company's net interest income in a rising interest rate environment, the
Company has purchased interest rate caps with a notional amount of $1.4 billion,
which help reduce the Company's exposure to interest rate risk rising above the
lifetime interest rate caps on ARM securities and loans. These interest rate
caps provide the Company with additional cash flow should the related index
increase above the contracted rates. The contracted rates on these interest rate
caps are based on one-month LIBOR, six-month LIBOR or one-year CMT. The Company
will also utilize interest rate swaps to manage its exposure to changes in
financing rates of assets and to convert floating rate borrowings to fixed rate
where the associated asset financed is fixed rate. Interest rate caps and
interest rate swaps that the Company uses to manage certain interest rate risks
represent protection for the earnings and cash flow of the investment portfolio
in adverse markets. To date, short term interest rates have not risen at the
speed or to the extent such that the protective cashflows provided by the caps
and swaps have been realized.
The Company may also utilize futures and options on futures to moderate the
risks inherent in the financing of a portion of its investment portfolio with
floating-rate repurchase agreements. The Company uses these instruments to
synthetically lengthen the terms of repurchase agreement financing, generally
from one to three or six months. Interest rate futures and option agreements
have historically provided the Company a means of essentially locking-in
borrowing costs at specified rates for specified period of time. Under these
contracts, the Company will receive additional cash flow if the underlying index
increases above contracted rates, mitigating the net interest income loss that
results from the higher repurchase agreement rates The Company will pay
additional cash flow if the underlying index decreases below contracted rates.
The Company has not utilized futures or options on futures for this purpose
since 1997, as they primarily benefit the Company when expected rates as
measured by the forward yield-curve are less than current cash market rates.
The remaining portion of the Company's investments portfolio as of March
31, 1999, approximately $2.3 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,
and (ii) equity, which in the aggregate totals approximately $1.6 billion as of
the same date. 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>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On February 8, 1999, AutoBond Acceptance Corporation ("AutoBond"),
AutoBond Master Funding Corporation V ("Funding"), and its three
principal common shareholders (collectively, the "Plaintiffs")
commenced an action in the District Court of Travis County, Texas
(250th Judicial District) against the Company and James Dolph
(collectively, the "Defendants") alleging that the Company breached
the terms of a Credit Agreement, dated June 9, 1998, by and among
AutoBond, Funding and the Company. The Plaintiffs also allege that the
Defendants conspired to misrepresent and mischaracterize AutoBond's
credit underwriting criteria and its compliance with such criteria
with the intention of interfering and causing actual damage to
AutoBond's business, prospective business and contracts. In addition
to actual, punitive and exemplary damages, the Plaintiffs also seek
injunctive relief compelling the Company to fund immediately all
advances due AutoBond under the Credit Agreement. The Company believes
AutoBond's claims are without merit and intends to defend against them
vigorously. The Company filed a complaint against the Plaintiffs in
the United States District Court for the Eastern District of Virginia
(Richmond District) seeking declaratory relief and damages.
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 2. Changes in Securities and Use of Proceeds
Not Applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
Current Report on Form 8-K as filed with the Commission on
February 26, 1999, relating to certain recent developments.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNEX CAPITAL, INC.
By: /s/ Thomas H. Potts
Thomas H. Potts, President
(authorized officer of registrant)
/s/ Lynn K. Geurin
Lynn K. Geurin, Executive Vice
President and Chief Financial Officer
(principal accounting officer)
Dated: May 17, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-mos
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-START> Jan-01-1999
<PERIOD-END> Mar-31-1999
<CASH> 28,716
<SECURITIES> 4,434,506
<RECEIVABLES> 3,293
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0 <F1>
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 4,905,995
<CURRENT-LIABILITIES> 0 <F1>
<BONDS> 3,653,751
0
127,407
<COMMON> 460
<OTHER-SE> 323,061
<TOTAL-LIABILITY-AND-EQUITY> 4,905,995
<SALES> 0
<TOTAL-REVENUES> 88,477
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 13,185
<LOSS-PROVISION> 3,793
<INTEREST-EXPENSE> 71,382
<INCOME-PRETAX> 117
<INCOME-TAX> 0
<INCOME-CONTINUING> 117
<DISCONTINUED> 0
<EXTRAORDINARY> (1,086)
<CHANGES> 0
<NET-INCOME> (969)
<EPS-PRIMARY> (0.02)
<EPS-DILUTED> (0.02)
<FN>
<F1> The Company's balance sheet is unclassified.
</FN>
</TABLE>
