UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
Virginia 52-1549373
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer I.D. No.)
10900 Nuckols Road, 3rd Floor, Glen Allen, Virginia 23060
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (804) 217-5800
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
<TABLE>
<CAPTION>
<S> <C>
Title of each class Name of each exchange on which registered
Series A 9.75% Cumulative Convertible Preferred Stock, Nasdaq National Market
$.01 par value
Series B 9.55% Cumulative Convertible Preferred Stock, $.01 Nasdaq National Market
par value
Series C 9.73% Cumulative Convertible Preferred Stock, $.01 Nasdaq National Market
par value
</TABLE>
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes __ No XX
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
As of March 31, 2000, the aggregate market value of the voting stock held
by non-affiliates of the registrant was approximately $64,373,558 (11,444,188
shares at a closing price on The New York Stock Exchange of $5.625). Common
stock outstanding as of March 31, 2000 was 11,444,188 shares.
DOCUMENTS INCORPORATED BY REFERENCE Portions of the Definitive Proxy
Statement to be filed pursuant to Regulation 14A within 120 days from December
31, 1999, are incorporated by reference into Part III.
DYNEX CAPITAL, INC.
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
PART I
Item 1. BUSINESS.............................................. 3
Item 2. PROPERTIES........................................... 12
Item 3. LEGAL PROCEEDINGS.................................... 12
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS... 13
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS...................... 13
Item 6. SELECTED FINANCIAL DATA.............................. 14
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS........ 15
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK.......................................... 29
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......... 31
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE............... 31
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT... 31
Item 11. EXECUTIVE COMPENSATION............................... 32
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT................................ 32
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....... 32
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K.............................. 32
SIGNATURES ..................................................... 34
Item 1. BUSINESS
GENERAL
Dynex Capital, Inc. (the "Company") was incorporated in the Commonwealth of
Virginia in 1987. The Company is a financial services company which invests in a
portfolio of securities and investments backed principally by single family
mortgage loans, commercial mortgage loans and manufactured housing installment
loans. Such loans have been funded generally by the Company's loan production
operations or purchased in bulk in the market. The Company's primary loan
production operations have included commercial mortgage lending, single family
mortgage lending (which was sold in 1996) and manufactured housing lending
(which was sold in 1999). Through its specialty finance business, the Company
also has provided for the purchase and leaseback of single family model homes to
builders (which was sold in 1999) and the purchase and management of delinquent
property tax receivables. Loans funded through the Company's production
operations have generally been pooled and pledged (i.e. securitized) as
collateral for non-recourse bonds ("collateralized bonds"), which provides
long-term financing for such loans while limiting credit, interest rate and
liquidity risk.
The Company's principal source of earnings is net interest income from its
investment portfolio. The Company's investment portfolio consists primarily of
collateral for collateralized bonds, asset-backed securities and loans held for
sale or securitization. The Company funds its investment portfolio with both
borrowings and funds raised from the issuance of equity. For the portion of the
investment portfolio funded with borrowings, the Company generates net interest
income to the extent that there is a positive spread between the yield on the
interest-earning assets and the cost of borrowed funds. The cost of the
Company's borrowings may be increased or decreased by interest rate swap, cap or
floor agreements. For the other portion of the investment portfolio funded with
equity, net interest income is primarily a function of the yield generated from
the interest-earning asset.
References to "Dynex REIT" mean the parent company and its wholly-owned
subsidiaries, consolidated for financial reporting purposes, while references to
the "Company" mean the parent company, its wholly-owned subsidiaries and Dynex
Holding, Inc. ("DHI") and its subsidiaries, which are not consolidated for
financial reporting or tax purposes. All of the outstanding non-voting preferred
stock (which represents a 99% economic interest in DHI) is owned by Dynex REIT.
All of the outstanding voting common stock (which represents a 1% economic
interest in DHI) is owned by certain senior officers of Dynex REIT. In light of
these factors, DHI is accounted for under a method similar to the equity method.
Dynex REIT has elected to be treated as a real estate investment trust ("REIT")
for federal income tax purposes under the Internal Revenue Code of 1986, as
amended, and, as such, must distribute substantially all of its taxable income
to shareholders and will generally not be subject to federal income tax.
During 1999, as a result of the difficult market environment for specialty
finance companies such as the Company, the Company sold both its manufactured
housing lending operations and model home purchase/leaseback business.
Additionally, to conserve capital and to minimize its recourse borrowings, the
Company decided in the fourth quarter of 1999 not to extend approximately $255.6
million of forward commitments to fund commercial mortgage loans and to sell
versus securitize the commercial loans the Company held in inventory. This
difficult market environment was a result of the disruption in the fixed income
markets during the fourth quarter of 1998. As a result of such disruption,
investors in fixed income securities generally demanded higher yields in order
to purchase securities issued by such specialty finance companies. Additionally,
the Company believes the ratings agencies imposed higher credit enhancement
levels and other requirements on securitizations sponsered by specialty finance
companies. The net result of such changes in the market (which appear to be
permanent versus temporary at this time) reduced the Company's ability to
compete against larger finance companies, investment banks and depository
institutions, which generally have not been penalized by investors or ratings
agencies when issuing fixed income securities. In addition, interim lenders that
provided short-term funding to support the accumulation of loans for
securitization have generally reduced their credit lines to specialty finance
companies and otherwise tightened terms. As a result of the decision not to
extend the forward commitments on commercial mortgage loans and the related
decision to sell (versus securitize) many of the commercial mortgage loans in
inventory, the Company recorded a charge in the fourth quarter of 1999 of $54.6
million.
As more fully described in Note 1 in the accompanying consolidated
financial statements, the Company is currently subject to certain significant
risks and uncertainties, including violations of covenants in credit facilities,
litigation, and the lack of access to new sources of capital. Management's plans
concerning these risks and uncertainties are discussed in Note 1.
Business Focus and Strategy
The Company strives to create a diversified investment portfolio that in
the aggregate generates stable income for the Company in a variety of interest
rate environments and preserves the capital base of the Company. The Company
historically focused on markets where it believed that it could generate
investments for its portfolio at a lower cost than if these investments were
purchased in the secondary market. Over the past five years, the markets that
the Company has participated in have included single family mortgage lending,
commercial mortgage lending, manufactured housing lending, and various specialty
finance businesses, including purchase/leaseback of model homes and the purchase
and collection of delinquent property tax receivables. As previously indicated,
the Company sold its single family lending business in 1996, and its
manufactured housing lending operations and its purchase/leaseback model home
business in 1999. As a result of these sales and the decision not to extend the
forward commitments on commercial mortgage loans, the Company expects very
limited direct fundings in the foreseeable future.
The Company has sought to generate growth in earnings and dividends per
share in a variety of ways, including (i) adding investments to its portfolio
when opportunities in the market are favorable; (ii) developing production
capabilities to originate and acquire financial assets in order to create
attractively priced investments for its portfolio, as well as control the
underwriting and servicing of these assets; and (iii) increasing the efficiency
with which the Company utilizes its equity capital over time. To increase
potential returns to shareholders, the Company has employed leverage through the
use of secured borrowings and repurchase agreements to fund a portion of its
investment portfolio.
Prior Lending Operations
The Company generally has been a vertically integrated lender by performing
the sourcing, underwriting, funding and servicing of loans to maximize
efficiency and provide superior customer service. The Company generally has
focused on loan products that maximize the advantages of the REIT tax election
and has emphasized direct relationships with the borrower and minimized, to the
extent practical, the use of origination intermediaries. The Company has
historically utilized internally generated guidelines to underwrite loans for
all product types and maintained centralized loan pricing, and performed the
servicing function for loans on which the Company has credit exposure.
The following table summarizes the loan production activity for the three
years ended December 31, 1999, 1998 and 1997.
Loan Production Activity
($ in thousands)
<TABLE>
<CAPTION>
------------------------------------------------ ------------------------------------------------------------
For the Years Ended December 31
------------------------------------------------------------
1999 1998 1997
------------------------------------------------ ------------------- ------------------- --------------------
<S> <C> <C> <C>
Commercial (1) $ 224,264 $ 674,086 $ 290,988
Manufactured housing 494,081 482,979 265,906
Specialty finance 140,763 196,224 168,965
------------------------------------------------ ------------------- ------------------- --------------------
Total fundings through direct production 859,108 1,353,289 725,859
Secured funding notes (2) 13,654 149,189 -
Securities acquired through bond calls 224 455,714 493,152
Single family fundings through bulk purchases - 562,045 1,271,479
------------------------------------------------ ------------------- ------------------- --------------------
Total fundings $ 872,986 $ 2,520,237 $ 2,490,490
------------------------------------------------ ------------------- ------------------- --------------------
Principal amount of loans and securities
securitized or sold $ 738,711 $ 1,891,075 $ 2,278,633
------------------------------------------------ ------------------- ------------------- --------------------
<FN>
(1) Included in commercial fundings were $136.7 million, $228.6 million, and $49.2 million of
multifamily construction loans closed during years ended December 31, 1999, 1998 and 1997, respectively. As
of December 31, 1999, $414.5 million of multifamily construction loans have closed, of which only the amount
drawn for these loans of $115.5 million is included in the balance of the loans held for sale or
securitization at December 31, 1999.
(2) Secured by automobile installment contracts
</FN>
</TABLE>
During 1999, the Company funded $224.3 million of commercial loans
consisting of $136.7 million of construction loans, $57.3 million of multifamily
loans and $30.3 million in other types of commercial loans. The majority of the
multifamily loans funded in 1999 consist of mortgage loans on properties that
have been allocated low income housing tax credits. As of March 31, 2000,
commitments to fund commercial loans were approximately $26.0 million.
Prior to the sale of the manufactured housing lending operations to Bingham
Financial Services Corporation ("Bingham") (NASDAQ: BSFC) in December 1999, the
Company funded $494.1 million of manufactured housing loans during 1999. The
Company sold $77.3 million of such loans to Bingham as part of the sale
transaction. The Company securitized a total of $601.8 million of its
manufactured housing loans (including current and prior years' production)
through the issuance of collateralized bonds during 1999.
At December 31, 1999, the Company owned the right to call $353.9 million of
securities previously issued by the Company once the outstanding balance of such
securities reaches 10% or less of the original amount issued.
The Company did not purchase any loans on a bulk basis in 1999, compared to
$562.0 million of single family adjustable-rate ("ARM") loans bulk purchased in
1998. All of the single family ARM loans purchased in 1998 were securitized
through the issuance of collateralized bonds.
During June 1998, the Company entered into a series of agreements with
AutoBond Acceptance Corporation ("AutoBond") (OTC: AUBD) to purchase "funding
notes" secured by automobile contracts originated by AutoBond. The gross amount
of funding notes purchased by the Company was $162.8 million. In February 1999,
the Company suspended purchasing the funding notes as a result of the findings
of compliance reviews done by third parties and other breeches of the
agreements. As a result, AutoBond and related entities sued the Company in the
district court of Travis County, Texas. On March 9, 2000, a jury entered a
verdict in favor of AutoBond in an amount approximating $69 million. On April
17, 2000, based on motions filed by the Company, the judge presiding over the
matter in Travis County proposed a judgement of approximately $27 million (which
includes estimated prejudgment interest), in lieu of the approximate $69 million
jury verdict. As a result, the Company recorded a litigation provision of $27.0
million effective for the year ended December 31, 1999. See Item 3. Legal
Proceedings.
Asset Servicing
As mentioned above, the Company's philosophy is generally to service assets
that it has originated due to the retention of a portion of the credit risk on
that asset. The Company established the capability to service both commercial
and manufactured housing loans funded through its production operations in 1996.
The manufactured housing servicing operations, and the associated $1.1 billion
servicing portfolio, were sold in December 1999. The Company has retained credit
risk on these loans through overcollateralization of approximately $110 million.
As of December 31, 1999, the 60-plus day delinquencies on these $1.1 billion of
loans was 1.42%. As of December 31, 1999, the Company had a commercial servicing
portfolio totaling $1.2 billion. There were no delinquencies in the commercial
loan servicing portfolio as of December 31, 1999. The Company may sell its
commercial loan servicing portfolio during 2000.
During 1997, the Company established a servicing function in Pittsburgh,
Pennsylvania, to manage the collection of the Company's delinquent property tax
receivables. The Company's responsibilities as servicer include contacting
property owners, collecting voluntary payments, and foreclosing, rehabilitating
and selling remaining properties if collection efforts fail. During 1999, the
Company also established a satellite servicing office in Cleveland, Ohio. As of
December 31, 1999, the Company had a servicing portfolio of $84.6 million of
property tax receivables in seven states.
Securitization
The Company historically has used funds provided by its senior notes, bank
borrowings, repurchase agreements and equity to finance loan production when
loans are initially funded. When a sufficient volume of loans was accumulated,
generally between $300 million and $1 billion in principal amount, the loans
were securitized through the issuance of mortgage or asset-backed securities in
the form of collateralized bonds. The length of time between when the Company
committed to fund the loan and when it securitized the loan varied depending on
certain factors, including the length of the loan commitment (the Company has
committed to fund various commercial and multifamily loans on a forward-basis),
the loan volume by product type, market forces (e.g., whether there exists in
the market place sufficient purchasers of these types of mortgage or
asset-backed securities), and variations in the securitization process. In
adverse market conditions, the Company may be unable to securitize the loans.
Though the Company utilizes primarily committed facilities to finance its loan
production prior to securitization, in adverse market conditions, the Company
may have to sell loans at losses in order to repay these facilities. In the
current environment, the Company is unable to economically securitize commercial
mortgage loans. As a result, commercial mortgage loans remaining in the
Company's inventory as of December 31, 1999 are now considered held for sale.
Since late 1995, the Company's predominate securitization structure has
been collateralized bonds. Generally, for accounting and tax purposes, the loans
and securities financed through the issuance of collateralized bonds are treated
as assets of the Company, and the collateralized bonds are treated as debt of
the Company. The Company earns the net interest spread between the interest
income on the securities and the interest and other expenses associated with the
collateralized bond financing. The net interest spread is directly impacted by
the levels of prepayments of the underlying mortgage loans and, to the extent
collateralized bond classes are variable-rate, may be affected by changes in
short-term rates. The Company retains an investment in the collateralized bonds,
typically referred to as the overcollateralization.
Master Servicing
The Company performs the function of master servicer for certain of the
securities it has issued. The master servicer's function typically includes
monitoring and reconciling the loan payments remitted by the servicers of the
loans, determining the payments due on the securities and determining that the
funds are correctly sent to a trustee or investors for each series of
securities. Master servicing responsibilities also include monitoring the
servicers' compliance with its servicing guidelines. As master servicer, the
Company is paid a monthly fee based on the outstanding principal balance of each
such loan master serviced or serviced by the Company as of the last day of each
month. As of December 31, 1999, the Company master serviced $3.0 billion in
securities.
Investment Portfolio
The core of the Company's earnings is derived from its investment
portfolio. The Company's strategy for its investment portfolio is to create a
diversified portfolio of high quality assets that in the aggregate generates
stable income in a variety of interest rate and prepayment environments and
preserves the Company's capital base. In many instances, the investment strategy
involves not only the creation of the asset, but also structuring the related
securitization or borrowing to create a stable yield profile and reduce interest
rate and credit risk.
The Company continuously monitors the aggregate cash flow, projected net
yield and market value of its investment portfolio under various interest rate
and prepayment environments. While certain investments may perform poorly in an
increasing or decreasing interest rate environment, certain other investments
may perform well, and others may not be impacted at all. Generally, the Company
adds investments to its portfolio which are designed to increase the
diversification and reduce the variability of the yield produced by the
portfolio in different interest rate environments.
Credit Quality. Excluding certain securities where the risk is primarily
the rate of prepayments and not credit, 90.0 % of the Company's investments
relate to securities rated AA or AAA by at least one nationally-recognized
rating agency. These ratings are based on AAA rated bond insurance, third-party
guarantees, mortgage pool insurance or subordination. On securities where the
Company has retained a portion of the credit risk below the investment grade
level (BBB), the Company's exposure to credit losses below the investment grade
level was $229.3 million as of December 31, 1999. This credit exposure is
reduced by reserves, discounts and third party guarantees of $49.9 million.
Composition. The following table presents the balance sheet composition of
the investment portfolio at fair market value by investment type and the
percentage of the total investments as of December 31, 1999 and 1998.
<TABLE>
<CAPTION>
- -------------------------------------------- --------------------------------------------------------------
As of December 31,
1999 1998
------------------------------- ------------------------------
(amounts in thousands) Balance % of Total Balance % of Total
- -------------------------------------------- ----------------- ------------- ---------------- -------------
<S> <C> <C> <C> <C>
Investments:
Collateral for collateralized bonds $ 3,700,714 90.0% $ 4,293,528 86.6%
Securities:
Funding Notes and Securities 95,027 2.3 122,009 2.5
Adjustable-rate mortgage securities 11,410 0.3 47,728 1.0
Fixed-rate mortgage securities 9,623 0.2 28,981 0.6
Derivative and residual securities 11,651 0.3 18,894 0.4
Other securities - - 26,372 0.5
Other investments 48,927 1.2 30,371 0.6
Loans held for sale or securitization 232,384 5.7 388,782 7.8
- -------------------------------------------- ----------------- ------------- ---------------- -------------
Total investments $ 4,109,736 100% $ 4,956,665 100%
- -------------------------------------------- ----------------- ------------- ---------------- -------------
</TABLE>
Collateral for collateralized bonds. Collateral for collateralized bonds
represents the single largest investment in the Company's portfolio. Collateral
for collateralized bonds is composed primarily of securities backed primarily by
adjustable-rate and fixed-rate mortgage loans secured by first liens on single
family homes, fixed-rate mortgage loans secured by multifamily residential
housing properties and commercial properties, manufactured housing installment
loans secured by either a UCC filing or a motor vehicle title, and property tax
receivables. Interest margin on the net investment in collateralized bonds
(defined as the principal balance of collateral for collateralized bonds less
the principal balance of the collateralized bonds outstanding) is derived
primarily from the difference between (i) the cash flow generated from the
collateral pledged to secure the collateralized bonds and (ii) the amounts
required for payment on the collateralized bonds and related insurance and
administrative expenses. Collateralized bonds are generally non-recourse to the
Company. The Company's yield on its net investment in collateralized bonds is
affected primarily by changes in interest rates and prepayment rates and credit
losses on the underlying loans. The Company may retain for its investment
portfolio certain classes of the collateralized bonds issued and pledge such
classes as collateral for repurchase agreements.
Funding Notes and Securities. Funding Notes and Securities consist of
fixed-rate securities secured by fixed-rate automobile installment contracts
made to borrowers with limited access to traditional sources of credit. Such
Funding Notes and Securities were purchased from limited purpose subsidiaries of
AutoBond. The Funding Notes and Securities are carried at their estimated net
realizable value.
ARM securities. Another segment of the Company's portfolio is the
investments in ARM securities. The interest rates on the majority of the
Company's ARM securities reset every six months and the rates are subject to
both periodic and lifetime limitations. Generally, the Company finances a
portion of its ARM securities with repurchase agreements, which have a fixed
rate of interest over a term that ranges from 30 to 90 days and, therefore, are
not subject to repricing limitations. As a result, the net interest margin on
the ARM securities could decline if the spread between the yield on the ARM
security versus the interest rate on the repurchase agreement was reduced.
Fixed-rate mortgage securities. Fixed-rate mortgage securities consist of
securities that have a fixed-rate of interest for specified periods of time. The
Company's yields on these securities are primarily affected by changes in
prepayment rates. Such yields will decline with an increase in prepayment rates
and will increase with a decrease in prepayment rates. The Company generally
borrows against its fixed-rate mortgage securities through the use of repurchase
agreements. Additionally, the net interest margin the Company realizes on its
fixed-rate mortgage securities will be subject to the spread between the yield
on the fixed-rate mortgage securities and the effective interest rate on the
repurchase agreements. The effective interest rates on the repurchase agreements
generally resets within 30-day intervals.
Derivative and residual securities. Derivative and residual securities
consist primarily of interest-only securities ("I/Os"), principal-only
securities ("P/Os") and residual interests which were either purchased or were
created through the Company's production operations. An I/O is a class of a
collateralized bond or a mortgage pass-through security that pays to the holder
substantially all interest. A P/O is a class of a collateralized bond or a
mortgage pass-through security that pays to the holder substantially all
principal. Residual interests represent the excess cash flows on a pool of
mortgage collateral after payment of principal, interest and expenses of the
related mortgage-backed security or repurchase arrangement. Residual interests
may have little or no principal amount and may not receive scheduled interest
payments. Included in the residual interests at December 31, 1999 was $8.6
million of equity ownership in residual trusts which own collateral financed
with repurchase agreements, which had a fair value of $2.8 million. The
Company's borrowings against its derivative and residual securities is limited
by certain loan covenants to 3% of shareholders' equity. The yields on these
securities are affected primarily by changes in prepayment rates and by changes
in short-term interest rates.
Other securities. Other securities consisted primarily of a corporate bond
at December 31, 1998.
Other investments. Other investments consists primarily of an installment
note receivable received in connection with the sale of the Company's single
family mortgage operations in May 1996, and property tax receivables.
Loans held for sale or securitization. As of December 31, 1999, all loans
are held for sale and consist principally of multifamily permanent and
construction mortgage loans. Since these loans are held for sale, the loans are
carried at the lower of cost or market. Loans as of December 31, 1998 consisted
principally of multifamily permanent and construction mortgage loans, commercial
mortgage loans and manufactured housing loans. These loans were primarily held
for securitization as of that date.
Investment Portfolio Risks
The Company is exposed to several types of risks inherent in its investment
portfolio. These risks include credit risk (inherent in the loans before
securitization and the security structure after securitization),
prepayment/interest rate risk (inherent in the underlying loan) and margin call
risk (inherent in the security if it is used as collateral for recourse
borrowings).
Credit Risk. Credit risk is the risk of loss to the Company from the
failure by a borrower (or the proceeds from the liquidation of the underlying
collateral) to fully repay the principal balance and interest due on a loan. A
borrower's ability to repay, or the value of the underlying collateral, could be
negatively influenced by economic and market conditions. These conditions could
be global, national, regional or local in nature. When a loan is funded and
becomes part of the Company's investment portfolio, the Company has all of the
credit risk on the loan should it default. Upon securitization of the pool of
loans, the credit risk retained by the Company is generally limited to the net
investment in collateralized bonds and subordinated securities. The Company
provides for reserves for expected losses based on the current performance of
the respective pool of loans; however, if losses are experienced more rapidly
due to market conditions than the Company has provided for in its reserves, the
Company may be required to provide for additional reserves for these losses.
The Company began to retain a portion of the credit risk on securitized
mortgage loans in 1994 as mortgage pool insurance became less available in the
market and as the Company diversified into other products. The Company evaluates
and monitors its exposure to credit losses and has established reserves and
discounts for probable credit losses based upon anticipated future losses on the
loans, general economic conditions and historical trends in the portfolio. As of
December 31, 1999, the Company's credit exposure on securities rated below
investment grade or as to overcollateralization was $229.3 million. This amount
excludes funding notes and securities which are carried at estimated net
realizable value, other investments and loans held for sale or securitization
which are carried at the lower of cost or market. This amount is reduced by
on-balance sheet reserves and discounts of $19.6 million, and third party
guarantees of $30.3 million.
Prepayment/Interest Rate Risk. The interest rate environment may also
impact the Company. For example, in a rising rate environment, the Company's net
interest margin may be reduced, as the interest cost for its funding sources
(collateralized bonds, repurchase agreements, and committed lines of credit)
could increase more rapidly than the interest earned on the associated asset
financed. The Company's funding sources are substantially based on the one-month
London InterBank Offered Rate ("LIBOR") and reprice monthly, while the
associated assets are principally six-month LIBOR or one-year Constant Maturity
Treasury ("CMT") based and generally reprice every six-to-twelve months. In a
declining rate environment, net interest margin may be enhanced for the opposite
reasons. However, in a period of declining interest rates, loans in the
investment portfolio will generally prepay more rapidly (to the extent that such
loans are not prohibited from prepayment), which may result in additional
amortization expense of asset premium. In a flat yield curve environment (i.e.,
when the spread between the yield on the one-year Treasury and the yield on the
ten-year Treasury is less than 1.0%), single-family ARM loans tend to rapidly
prepay, causing additional amortization of asset premium. In addition, the
spread between the Company's funding costs and asset yields would most likely
compress, causing a further reduction in the Company's net interest margin.
Lastly, the Company's investment portfolio may shrink, or proceeds returned from
prepaid assets may be invested in lower yielding assets. The severity of the
impact of a flat yield curve to the Company would depend on the length of time
the yield curve remained flat.
The Company strives to structure its investment portfolio to provide stable
spread income in a variety of prepayment and interest rate scenarios. To manage
prepayment risk (i.e. from a decline in long-term rates on fixed rate assets, or
a flattening or inverse yield curve as to ARM assets), the Company minimizes the
amount of "interest-only" investments or premium on assets. The Company has, in
aggregate, $30.2 million of asset premium relating to assets with prepayment
lockouts or yield maintenance provision for at least seven years, and $3.9
million of asset premium on its remaining assets. In addition, future earnings
may be lower as a result of the reduction in the interest-earning assets from
increased prepayment speeds or if the Company is otherwise unable to invest in
new assets.
The Company also views its hedging activities as a tool to manage interest
rate risk. As mentioned previously, the Company finances its adjustable-rate
assets, which primarily reprice typically every six months based on six-month
LIBOR and one-year CMT and typically are limited to an interest rate adjustment
of 1% increase every six months or a 2% increase every twelve months, with
borrowings that reprice monthly indexed to one-month LIBOR and have no periodic
caps. To manage the periodic interest rate risk associated with the Company's
borrowings to the extent that interest rates rise more than 1% in a six-month
period, the Company has entered into an interest rate swap agreement that has
effectively capped the increase in the borrowing costs on $1.02 billion of
borrowings to 1% during any six-month period. The terms of the swap are such
that the Company pays the lesser of current six-month LIBOR, or six-month LIBOR,
in effect 180 days prior plus 1%, and receives current six-month LIBOR. As this
is an interest rate swap agreement, the Company recognizes the net additional
interest income or expense from the interest rate swap as an adjustment to
interest expense recognized on the borrowings. This swap agreement expires in
2001. As the adjustable-rate assets also have lifetime interest rate caps, the
Company has $1.4 billion in interest rate cap agreements (with contracted rates
between 9.0% and 11.5% based on six-month LIBOR and one-year CMT) to provide the
Company with additional cash flow should short-term rates rise significantly.
These cap agreements expire from 2001 to 2004.
Margin Call Risk. The Company uses repurchase agreements to finance a
portion of its investment portfolio. Margin call risk is the risk that the
Company will be required to provide additional collateral to the counterparties
of its secured recourse borrowings should the value of the asset pledged as
collateral for the recourse borrowings decline. Generally, the Company pledges
only investment grade rated securities or whole loans as collateral for recourse
borrowings. The value of the pledged security or loan is impacted by a variety
of factors, including the perceived credit risk of the security or loan, the
type and performance of the underlying loans in the security, current market
volatility, and the general amount of liquidity in the market place for the
asset financed. In instances where market volatility is high, there are credit
issues on the collateral, or where overall liquidity in the market has been
reduced, the Company may experience margin calls from its lenders. Depending on
the Company's current liquidity position, the Company may be forced to sell
assets to meet margin calls, which may result in losses. The Company attempts to
manage its margin call risk, and thereby limit its liquidity risk, by limiting
the amount of its recourse borrowings to less than 2.5 times equity. As of
December 31, 1999, the Company had repurchase agreements outstanding of $163.0
million. As of March 31, 2000, the Company had reduced the repurchase agreements
outstanding to approximately $81.0 million.
The Company also has liquidity risk inherent to its investment in certain
residual trusts. These trusts are subject to margin calls and the Company, at
its option, may provide additional equity to the trust to meet the margin call.
Should the Company not provide the additional equity, the assets of the trust
could be sold to meet the trusts' obligations, resulting in a potential loss to
the Company. At December 31, 1999, the total amount of such investments was $8.6
million.
Since 1996, the Company has structured all of its securitizations as
non-recourse collateralized bonds, with the financing, in effect, incorporated
into the bond structure. This structure eliminates the need for repurchase
agreements on such collateral, and consequently eliminates the margin call risk
and to a lesser degree the interest rate risk. During 1999, 1998 and 1997, the
Company issued approximately $2.1 billion, $2.0 billion and $2.6 billion,
respectively, in collateralized bonds. To the extent the Company were to issue
securities in the future, the Company plans to continue to use collateralized
bonds as its primary securitization vehicle.
FEDERAL INCOME TAX CONSIDERATIONS
General
Dynex REIT believes it has complied and, intends to comply in the future,
with the requirements for qualification as a REIT under the Internal Revenue
Code (the "Code"). To the extent that Dynex REIT qualifies as a REIT for federal
income tax purposes, it generally will not be subject to federal income tax on
the amount of its income or gain that is distributed to shareholders. DHI and
its subsidiaries, which conduct the production operations, are not qualified
REIT subsidiaries and are not consolidated with Dynex REIT for either tax or
financial reporting purposes. Consequently, the taxable income of DHI and its
subsidiaries is subject to federal and state income taxes. Dynex REIT will
include in taxable income amounts earned by DHI only when DHI remits its
after-tax earnings in the form of a dividend to Dynex REIT.
The REIT rules generally require that a REIT invest primarily in real
estate-related assets, that its activities be passive rather than active and
that it distribute annually to its shareholders substantially all of its taxable
income. Dynex REIT could be subject to income tax if it failed to satisfy those
requirements or if it acquired certain types of income-producing real property.
Although no complete assurances can be given, Dynex REIT does not expect that it
will be subject to material amounts of such taxes.
Failure to satisfy certain Code requirements could cause Dynex REIT to lose
its status as a REIT. If Dynex REIT failed to qualify as a REIT for any taxable
year, it would be subject to federal income tax (including any applicable
alternative minimum tax) at regular corporate rates and would not receive
deductions for dividends paid to shareholders. As a result, the amount of
after-tax earnings available for distribution to shareholders would decrease
substantially. While the Board of Directors intends to cause Dynex REIT to
operate in a manner that will enable it to qualify as a REIT in future taxable
years, there can be no certainty that such intention will be realized.
In December 1999, with an effective date of January 1, 2001, Congress
signed into law several changes to the provisions of the Code relating to REITs.
The most significant of these changes relates to the reduction of the
distribution requirement from 95% to 90% of taxable income and the allowance of
REITS to own 100% interest in its taxable REIT subsidiaries.
Qualification of the Company as a REIT
Qualification as a REIT requires that Dynex REIT satisfy a variety of tests
relating to its income, assets, distributions and ownership. The significant
tests are summarized below.
Sources of Income. To continue qualifying as a REIT, Dynex REIT must
satisfy two distinct tests with respect to the sources of its income: the "75%
income test" and the "95% income test". The 75% income test requires that Dynex
REIT derive at least 75% of its gross income (excluding gross income from
prohibited transactions) from certain real estate-related sources. In order to
satisfy the 95% income test, 95% Dynex REIT's gross income for the taxable year
must consist either of income that qualifies under the 75% income test or
certain other types of passive income.
If Dynex REIT fails to meet either the 75% income test or the 95% income
test, or both, in a taxable year, it might nonetheless continue to qualify as a
REIT, if its failure was due to reasonable cause and not willful neglect and the
nature and amounts of its items of gross income were properly disclosed to the
Internal Revenue Service. However, in such a case Dynex REIT would be required
to pay a tax equal to 100% of any excess non-qualifying income.
Nature and Diversification of Assets. At the end of each calendar quarter,
three asset tests must be met by Dynex REIT. Under the 75% asset test, at least
75% of the value of Dynex REIT's total assets must represent cash or cash items
(including receivables), government securities or real estate assets. Under the
"10% asset test", Dynex REIT may not own more than 10% of the outstanding voting
securities of any single non-governmental issuer, if such securities do not
qualify under the 75% asset test. Under the "5% asset test," ownership of any
stocks or securities that do not qualify under the 75% asset test must be
limited, in respect of any single non-governmental issuer, to an amount not
greater than 5% of the value of the total assets of Dynex REIT.
If Dynex REIT inadvertently fails to satisfy one or more of the asset tests
at the end of a calendar quarter, such failure would not cause it to lose its
REIT status, provided that (i) it satisfied all of the asset tests at the close
of a preceding calendar quarter and (ii) the discrepancy between the values of
Dynex REIT's assets and the standards imposed by the asset tests either did not
exist immediately after the acquisition of any particular asset or was not
wholly or partially caused by such an acquisition. If the condition described in
clause (ii) of the preceding sentence was not satisfied, Dynex REIT still could
avoid disqualification by eliminating any discrepancy within 30 days after the
close of the calendar quarter in which it arose.
Distributions. With respect to each taxable year, in order to maintain its
REIT status, Dynex REIT generally must distribute to its shareholders an amount
at least equal to 95% of the sum of its "REIT taxable income" (determined
without regard to the deduction for dividends paid and by excluding any net
capital gain) and any after-tax net income from certain types of foreclosure
property minus any "excess noncash income." The Code provides that distributions
relating to a particular year may be made in the following year, in certain
circumstances. Dynex REIT will balance the benefit to the shareholders of making
these distributions and maintaining REIT status against their impact on the
liquidity of Dynex REIT. In an unlikely situation, it may benefit the
shareholders if Dynex REIT retained cash to preserve liquidity and thereby lose
REIT status. Effective January 1, 2001, the Code has reduced the distribution
requirement from 95% of REIT taxable income to 90% of REIT taxable income.
Ownership. In order to maintain its REIT status, Dynex REIT must not be
deemed to be closely held and must have more than 100 shareholders. The closely
held prohibition requires that not more than 50% of the value of Dynex REIT's
outstanding shares be owned by five or fewer persons at anytime during the last
half of Dynex REIT's taxable year. The more than 100 shareholder rule requires
that Dynex REIT have at least 100 shareholders for 335 days of a twelve-month
taxable year. In the event that Dynex REIT failed to satisfy the ownership
requirements Dynex REIT would be subject to fines and required to take curative
action to meet the ownership requirements in order to maintain its REIT status.
For federal income tax purposes, Dynex REIT is required to recognize income
on an accrual basis and to make distributions to its shareholders when income is
recognized. Accordingly, it is possible that income could be recognized and
distributions required to be made in advance of the actual receipt of such funds
by Dynex REIT. The nature of Dynex REIT's investments is such that it expects to
have sufficient assets to meet federal income tax distribution requirements.
Taxation of Distributions by Dynex REIT
Assuming that Dynex REIT maintains its status as a REIT, any distributions
that are properly designated as "capital gain dividends" will generally be taxed
to shareholders as long-term or mid-term capital gains, regardless of how long a
shareholder has owned his shares. Any other distributions out of Dynex REIT's
current or accumulated earnings and profits will be dividends taxable as
ordinary income. Distributions in excess of Dynex REIT's current or accumulated
earnings and profits will be treated as tax-free returns of capital, to the
extent of the shareholder's basis in his shares and, as gain from the
disposition of shares, to the extent they exceed such basis. Shareholders may
not include on their own tax returns any of Dynex REIT ordinary or capital
losses. Distributions to shareholders attributable to "excess inclusion income"
of Dynex REIT will be characterized as excess inclusion income in the hands of
the shareholders. Excess inclusion income can arise from Dynex REIT's holdings
of residual interests in real estate mortgage investment conduits and in certain
other types of mortgage-backed security structures created after 1991. Excess
inclusion income constitutes unrelated business taxable income ("UBTI") for
tax-exempt entities (including employee benefit plans and individual retirement
accounts) and it may not be offset by current deductions or net operating loss
carryovers. In the unlikely event that Dynex REIT's excess inclusion income is
greater than its taxable income, Dynex REIT's distribution would be based on
Dynex REIT's excess inclusion income. Dividends paid by Dynex REIT to
organizations that generally are exempt from federal income tax under Section
501(a) of the Code should not be taxable to them as UBTI except to the extent
that (i) purchase of shares of Dynex REIT was financed by "acquisition
indebtedness" or (ii) such dividends constitute excess inclusion income. In
1999, Dynex REIT's excess inclusion income was de minimus.
Taxable Income
Dynex REIT uses the calendar year for both tax and financial reporting
purposes. However, there may be differences between taxable income and income
computed in accordance with GAAP. These differences primarily arise from timing
differences in the recognition of revenue and expense for tax and GAAP purposes.
Dynex REIT has not yet finalized the determination of its taxable income for the
year ended December 31, 1999. However, the Company believes that it has met all
of the REIT distribution requirements of the Code.
REGULATION
Prior to the sale of its manufactured housing lending operation, the
Company was an approved mortgage and consumer loan originator and servicer, and
therefore was subject to various federal and state regulations. A violation of
such regulations while the Company owned such business may still result in a
loss to the Company as a result of various representations and warranties made
by the Company in regard to the sale of such business.
Such rules and regulations, among other things, prohibit discrimination and
establish underwriting guidelines that include provisions for inspections and
appraisals, require credit reports on prospective borrowers and fix maximum loan
amounts. In particular, the Company was subject to, among other laws, the Equal
Credit Opportunity Act, Federal Truth-in-Lending Act and the Real Estate
Settlement Procedures Act and the regulations promulgated thereunder that
prohibit discrimination and require the disclosure of certain basic information
to mortgagors concerning credit terms and settlement costs. The Company's
servicing activities were also subject to, among other laws, the Fair Credit
Reporting Act and the Fair Debt Collections Practices Act. The Company's
existing consumer-related servicing activities consist of collections on the
delinquent property tax receivables. Such servicing operations are managed in
compliance with the Fair Debt Collections Practices Act.
The Company believes that it is in material compliance with all material
rules and regulations to which it is subject.
COMPETITION
The Company competes with a number of institutions with greater financial
resources in originating and purchasing loans. In addition, in purchasing
portfolio investments and in issuing securities, the Company competes with
investment banking firms, savings and loan associations, commercial banks,
mortgage bankers, insurance companies and federal agencies and other entities
purchasing mortgage assets, many of which have greater financial resources than
the Company.
EMPLOYEES
As of December 31, 1999, Dynex REIT had 31 employees and DHI had 65
employees.
Item 2. PROPERTIES
The Company's executive and administrative offices and operations offices
are both located in Glen Allen, Virginia, on properties leased by the Company
which consist of approximately 32,000 square feet. The address is 10900 Nuckols
Road, 3rd Floor, Glen Allen, Virginia 23060. The lease expires in 2003. DHI and
subsidiaries also occupy space located in Glen Allen, Virginia; Shrewesberry,
New Jersey; Cleveland, Ohio; Pittsburgh, Pennsylvania; and Versailles,
Pennsylvania. These locations consist of approximately 14,250 square feet, and
the leases associated with these properties, if any, expire in 2000 through
2001.
Item 3. 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 the Credit Agreement, dated June 9, 1998, by and
among AutoBond, Funding and the Company. The terms of the Credit Agreement
provided for the purchase by the Company of funding notes issued by Funding, and
collateralized by automobile installment contracts ("Auto Contracts") acquired
by AutoBond. The Company suspended purchasing the funding notes in February 1999
on grounds that AutoBond and Funding had violated certain provisions of the
Credit Agreement. The Plaintiffs also alleged 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.
On August 26, 1999, the District Court of Travis County ordered AutoBond
and Funding, through a temporary injunction action, to cooperate with the
Company and permit the transfer of the servicing of the Auto Contracts from
AutoBond to a third party servicer selected by the Company. The servicing was
transferred on September 3, 1999.
On March 9, 2000, a jury in the AutoBond action returned a verdict in favor
of the Plaintiffs, and awarded AutoBond and Funding $18.7 million in direct lost
profits and $50.5 million in lost future profits, for a total of $69.2 million.
The Company filed on March 24, 2000 with the Court motions to set aside the
verdict and to reduce the amount of the verdict, and on the same date, AutoBond
filed a motion to the court to enter judgment. On April 17, 2000, in response to
the various motions filed, the judge presiding over the matter in Travis County
reduced the $69.2 million verdict awarded by the jury to approximately $27
million (which includes estimated prejudgment interest). As a result, the
Company recorded a litigation provision of $27.0 million for the amount of the
reduced judgment. Should AutoBond not accept the proposed judgment, the judge
has indicated that he will grant Dynex a new trial. Should AutoBond accept the
judgment, the Company is evaluating its options in the matter, which may include
the appeal of the verdict and the resulting judgment. Factors for the Company to
consider include the potential inability of the Company to post the amount of
appeal bond necessary to secure an appeal. Should Dynex REIT not be able to
secure an appeal bond for the full amount of the proposed judgement of $27
million, Texas State law would allow for Dynex REIT to present evidence to
reduce the required amount of the appeal bond or to provide other collateral for
the appeal. There can be no assurance that Dynex REIT will be allowed to post a
reduced bond.
The Company is also subject to other lawsuits or claims which arise in the
ordinary course of its business, some of which seek damages in amounts which
could be material to the financial statements. Although no assurance can be
given with respect to the ultimate outcome of any such litigation or claim, the
Company believes the resolution of such lawsuits or claims will not have a
material affect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Dynex Capital, Inc.'s common stock is traded on the New York Stock Exchange
under the trading symbol DX. The common stock was held by approximately 3,663
holders of record as of February 29, 2000. During the last two years, the high
and low closing stock prices and cash dividends declared on common stock,
adjusted for the two-for-one stock split effective May 5, 1997 and the
one-for-four reverse stock split effective August 2, 1999, were as follows:
- --------------------------------------- -------------- ------------- -----------
Cash
Dividends
High Low Declared
- --------------------------------------- -------------- ------------- -----------
1999:
First quarter $ 22 $ 11 $ -
Second quarter 16 8 1/4 -
Third quarter 13 3/16 5 1/2 -
Fourth quarter 8 5/8 6 -
1998:
First quarter $ 54 1/2 $ 47 3/4 $1.20
Second quarter 49 1/2 39 3/4 1.20
Third quarter 46 32 1/2 1.00
Fourth quarter 32 1/2 17 1/4 -
- ----------------------------------- -------------- ------------- ---------------
Item 6. SELECTED FINANCIAL DATA
(amounts in thousands except share data)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
Years ended December 31, 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net interest margin $ 48,015 $ 66,538 $ 83,454 $ 73,750 $ 41,778
Write-downs associated with commercial production (59,962) - - - -
operations
(Loss) gain on sale of investments and trading (12,682) (2,714) 11,584 (385) (7,060)
activities
Gain on sale of loan production operations 7,676 - - 21,512 -
Impairment charge and litigation provision - AutoBond (31,732) (17,632) - - -
Equity in net (loss) earnings of Dynex Holding, Inc. (1,923) 2,456 (1,109) (4,309) 11,600
Other income 1,673 2,852 1,716 606 294
General and administrative expenses (7,740) (8,973) (9,531) (8,365) (5,036)
Net administrative fees and expenses to Dynex (16,943) (22,379) (12,116) (9,761) (4,666)
Holding, Inc.
Extraordinary item - loss on extinguishment of debt (1,517) (571) - - -
- ----------------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (75,135) $ 19,577 $ 73,998 $ 73,048 $ 36,910
- ----------------------------------------------------------------------------------------------------------------------------
Total revenue $ 350,798 $ 410,821 $ 346,859 $ 333,029 $ 250,830
- ----------------------------------------------------------------------------------------------------------------------------
Total expenses $ 425,933 $ 391,244 $ 272,861 $ 259,981 $ 213,920
- ----------------------------------------------------------------------------------------------------------------------------
Income per common share before extraordinary item:
Basic(1) $ (7.53) $ 0.62 $ 5.50 $ 6.17 $ 3.40
Diluted (1) (7.53) 0.62 5.48 5.94 3.40
Net income per common share after extraordinary item:
Basic(1) $ (7.67) $ 0.57 $ 5.50 $ 6.17 $ 3.40
Diluted (1) (7.67) 0.57 5.48 5.94 3.40
Dividends declared per share:
Common (1) $ - $ 3.40 $ 5.42 $ 4.532 $ 3.36
Series A Preferred 1.17 2.37 2.71 2.375 1.17
Series B Preferred 1.17 2.37 2.71 2.375 0.42
Series C Preferred 1.46 2.92 2.92 0.600 -
Return on average common shareholders' equity (2) (27.3%) 2.0% 17.9% 21.6% 12.5%
Total fundings $ 872,986 $2,520,237 $2,490,490 $1,508,780 $ 916,570
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------
Investments (3) $4,109,736 $4,956,665 $5,211,009 $3,918,989 $3,421,470
Total assets 4,190,896 5,178,848 5,367,413 3,980,820 3,482,702
Non-recourse debt 3,282,378 3,665,316 3,632,079 2,149,068 843,856
Recourse debt 537,098 1,032,733 1,133,536 1,294,972 2,237,571
Total liabilities 3,865,824 4,726,044 4,806,504 3,477,203 3,127,879
Shareholders' equity 325,072 452,804 560,909 503,617 354,823
Number of common shares outstanding 11,444,099 46,027,426 45,146,242 20,653,593 20,198,654
Average number of common shares (1) 11,483,977 11,436,599 10,757,845 10,222,395 10,061,386
Book value per common share (1) $ 17.53 $ 27.75 $ 37.59 $ 34.60 $ 26.11
- ----------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Adjusted for two-for-one common stock split effective May 5, 1997 and the one-for-four reverse common stock split effective
August 2, 1999.
(2) Excludes unrealized gain/loss on investments available-for-sale.
(3) Investments classified as available for sale are shown at fair value.
</FN>
</TABLE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company is a financial services company which invests in a portfolio of
securities and investments backed principally by single family mortgage loans,
commercial mortgage loans and manufactured housing installment loans. Such loans
have been funded generally by the Company's loan production operations or
purchased in bulk in the market. Loans funded through the Company's production
operations have generally been pooled and pledged as collateral using a
collateralized bond security structure, which provides long-term financing for
the loans while limiting credit, interest rate and liquidity risk. FINANCIAL
CONDITION
- --------------------------------------------------------------------------------
December 31,
(amounts in thousands except per share data) 1999 1998
- ----------------------------------------------------------- --------------------
Investments:
Collateral for collateralized bonds $ 3,700,714 $ 4,293,528
Securities 127,711 243,984
Other investments 48,927 30,371
Loans held for sale securitization 232,384 388,782
Non-recourse debt 3,282,378 3,665,316
Recourse debt 537,098 1,032,733
Shareholders' equity 325,072 452,804
Book value per common share 17.53 27.75
- -------------------------------------- -------------------- --------------------
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 December 31, 1999, Dynex REIT
had 27 series of collateralized bonds outstanding. The collateral for
collateralized bonds decreased to $3.7 billion at December 31, 1999 compared to
$4.3 billion at December 31, 1998. This decrease of $0.6 billion is primarily
the result of $1.1 billion in paydowns on collateral, offset by the net addition
of $0.6 billion of collateral as a result of the issuance of three series of
collateralized bonds during 1999.
Securities Securities consist primarily of fixed-rate "funding notes and
securities" secured by automobile installment contracts and adjustable-rate and
fixed-rate mortgage-backed securities. 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 $127.7 million at December 31, 1999 compared to $244.0 million at
December 31, 1998. The decrease was primarily the result of $79.0 million of
paydowns and the sale of $70.7 million of securities during 1999. These
decreases were partially offset by the purchase of $23.7 million of securities
during 1999.
Other Investments Other investments consist primarily of property tax
receivables and a note receivable received in connection with the sale of the
Company's single family mortgage operations in May 1996. Other investments
increased from $30.4 million at December 31, 1998 to $48.9 million at December
31, 1999. This increase of $18.5 million is primarily the result of the purchase
of $20.5 million of property tax receivables during 1999.
Loans Held for Sale or Securitization Loans held for sale or securitization
decreased from $388.8 million at December 31, 1998 to $232.4 million at December
31, 1999. This decrease was primarily due to the securitization of $605.2
million of loans as collateral for collateralized bonds, the sale of $62.9
million of loans and the receipt of $27.7 million of paydowns during 1999. In
addition, Dynex REIT recorded $31.6 million of writedowns on the commercial
loans held for sale and wrote-off $28.4 million of deferred hedging positions
which related to expired commercial loan commitments. These decreases were
partially offset by new loan fundings from the Company's production operations
totaling $639.3 million during 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. Collateralized bonds decreased to $3.3 billion at December 31, 1999
from $3.7 billion at December 31, 1998. This decrease was primarily a result of
principal paydowns made on all collateralized bonds of $1.1 billion during 1999.
This decrease was partially offset by Dynex REIT adding $2.1 billion of
collateralized bonds during 1999. Of this $2.1 billion of collateralized bonds,
$1.5 billion related to the collapse and resecuritization of eight series of
previously issued collateralized bonds.
Recourse Debt Recourse debt decreased to $0.5 billion at December 31, 1999
from $1.0 billion at December 31, 1998. This decrease was primarily due to the
securitization of $601.8 million of manufactured housing loans as collateral for
collateralized bonds during 1999. These loans and securities were previously
financed with $190.7 million of repurchase agreements and $328.4 million of
notes payable. In addition, Dynex REIT paid off $175.8 million of notes payable
primarily as a result of the sale of the Company's model home purchase/leaseback
operations during 1999 and sold $70.7 million of securities which had been
financed with $48.1 million of repurchase agreements during 1999. Also,
repurchase agreements decreased $88.0 million as a result of the
re-securitization of the collateral on the previously retained collateralized
bonds during 1999. These decreases were partially offset by the addition of
$391.8 million of notes payable as a result of additional loan fundings during
1999.
Shareholders' Equity Shareholders' equity decreased to $334.1 million at
December 31, 1999 from $452.8 million at December 31, 1998. This decrease was a
combined result of a $45.4 million increase in the net unrealized loss on
investments available for sale from $3.1 million at December 31, 1998 to $48.5
million at December 31, 1999 and a net loss after extraordinary item of $66.1
million during 1999. Dynex REIT also declared dividends of $6.5 million during
1999, resulting in a decline in shareholder's equity of such amount. In
addition, Dynex REIT repurchased 66,100 of its common shares at an aggregate
purchase price of $0.7 million during 1999.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
- ---------------------------------------------------------------- -------------------------------------------------
For the Year Ended December 31,
(amounts in thousands except per share information) 1999 1998 1997
- ---------------------------------------------------------------- ---------------- --------------- ----------------
<S> <C> <C> <C>
Net interest margin $ 48,015 $ 66,538 $ 83,454
Write-downs associated with commercial production operations
(59,962) - -
(Loss) gain on sale of investments and trading activities (12,682) (2,714) 11,584
Gain on sale of loan production operations 7,676 - -
Impairment charge and litigation provision - AutoBond (31,732) (17,632) -
Equity in (losses) earnings of DHI (1,923) 2,456 (1,109)
General and administrative expenses 7,740 8,973 9,531
Net administrative fees and expenses to Dynex Holding, Inc. 16,943 22,379 12,116
Net income (loss) before preferred stock dividends (75,135) 19,577 73,998
Basic net income (loss) per common share(1) $ (7.67) $ 0.57 $ 5.50
Diluted net income (loss) per common share(1) $ (7.67) $ 0.57 $ 5.48
Dividends declared per share:
Common(1) $ - 3.40 5.42
Series A and B Preferred 1.17 2.37 2.71
Series C Preferred 1.46 2.92 2.92
- ---------------------------------------------------------------- ---------------- --------------- ----------------
<FN>
(1)Adjusted for both the two-for-one common stock split effective May 5, 1997 and the one-for-four reverse common
stock split effective August 2, 1999.
</FN>
</TABLE>
1999 Compared to 1998. The decrease in net income and net income per common
share during 1999 as compared to 1998 is primarily the result of (i) a decrease
in net interest margin (ii) an increase in the loss on sale of investments and
trading activities and (iii) write-downs associated with the commercial loan
production operations. These decreases were partially offset by the reduction in
general and administrative expenses and net administrative fees and expenses to
Dynex Holding, Inc. and the gain on the sale of the model home
purchase/leaseback and the manufactured housing lending operations in 1999.
Net interest margin for the year ended December 31, 1999 decreased to $48.0
million, or 27.8%, over net interest margin of $66.5 million for the same period
in 1998. This decrease in net interest margin was primarily the result of the
decline in average interest-earning assets from $5.4 billion for the year ended
December 31, 1998 to $4.6 billion for the year ended December 31, 1999. In
addition, provision for losses increased to $16.2 million or 0.35% on an
annualized basis of interest-earnings assets during the year ended December 31,
1999, compared to $6.4 million and 0.12% during the same period in 1998. This
increase in provision for losses was a result of increasing the reserve for
probable losses on the various loan pools pledged as collateral for
collateralized bonds where the Company has retained credit risk.
During 1999, Dynex REIT recorded a loss of $31.6 million related to the
writedown of $261.9 million of multifamily and commercial loans held for sale at
December 31, 1999. In addition, the Company realized losses of $28.4 million,
which were primarily related to the write-off of previously deferred hedging
costs on $255.6 million of multifamily and commercial loan commitments which
expired and were not extended by the Company during the fourth quarter of 1999
or during the first quarter of 2000. These costs were related to now-closed
options and futures positions entered into by the Company in 1998 and 1999.
The net loss on sale of investments and trading activities for the year
ended December 31, 1999 increased to $12.7 million, as compared to $2.7 million
for the same period in 1998. The increase for the year ended December 31, 1999
is primarily the result of a $9.3 million loss on the sale of $70.7 million of
securities during 1999 and a $7.4 million loss on the sale of $58.7 million of
commercial loans during 1999. These increases were partially offset by $4.2
million of realized gains on various derivative trading positions entered into
during 1999. The loss on sale of investments and trading activities during 1998
is primarily the results of net losses recognized of $1.4 million on trading
positions entered into during 1998.
During 1999, Dynex REIT recorded an impairment charge of $4.7 million
relating to the funding notes and other AutoBond securities held by the Company
at December 31, 1999. In addition, Dynex REIT recorded a charge of $27.0 million
related to the establishment of a reserve for the AutoBond litigation discussed
in Item 3. Legal Proceedings. During 1998, Dynex REIT recorded charges to
earnings totaling $17.6 million in regard to AutoBond related assets. This
charge included an impairment charge on the funding notes of $14.0 million and
$3.6 million to other AutoBond related securities.
Net administrative fees and expenses to Dynex Holding, Inc. decreased $5.5
million, or 24.3%, to $16.9 million in the year ended December 31, 1999. This
decrease is primarily the result of decreased origination volume of the
Company's commercial loan production operations and the sale of the Company's
model home purchase/leaseback and manufactured housing loan production
operations during 1999.
1998 Compared to 1997. The decrease in net income during 1998 as compared
to 1997 is primarily the result of (i) a decrease in net interest margin, (ii) a
decrease in the gain on sale of investments and trading activities, (iii) an
impairment charge on AutoBond related assets, and (iv) an increase in net
administrative fees and expenses to Dynex Holding, Inc. The decrease in net
income per common share during 1998 as compared to 1997 is the combined result
of the decrease in net income and an increase in the average number of common
shares outstanding due to the issuance of new common stock and the partial
conversion of outstanding preferred stock.
Net interest margin for the year ended December 31, 1998 decreased to $66.5
million, or 20.3%, over net interest margin of $83.5 million for the same period
in 1997. This decrease in net interest margin was primarily the result of a $9.1
million increase in premium amortization expense during the year ended December
31, 1998 compared to the year ended December 31, 1997. The increase in premium
amortization resulted from a higher rate of prepayments in the investment
portfolio during the year ended December 31, 1998 than during the same period in
1997. In addition, the net interest spread on the investment portfolio decreased
to 1.20% for the year ended December 31, 1998 from 1.42% for the same period in
1997. The decrease in the net interest spread is also primarily the result of
higher premium amortization as a result of the increase in principal prepayments
as well as the decrease in spreads between the indices on which the
interest-earning assets (primarily six-month LIBOR and the one-year Constant
Maturity Treasury) and interest-bearing liabilities (primarily one-month LIBOR)
are based.
The (loss) gain on sale of investments and trading activities for 1998
decreased to a $2.7 million loss, as compared to a $11.6 million gain for 1997.
This decrease is primarily the result of net losses recognized of $1.4 million
on trading positions entered into during the twelve months ended December 31,
1998. The gain on sale of assets during 1997 is primarily the result of premiums
received of $9.9 million on covered call options and put options written during
1997 and gains generated of $0.6 million on the sale of certain investments.
The Company recorded charges to earnings totaling $17.6 million in regard
to AutoBond related assets. This charge included an impairment charge on the
funding notes of $14.0 million. It also included a $0.6 million charge to the
Company's investment in AutoBond common and preferred stock to its quoted market
value at December 31, 1998. The Company also fully reserved for the $3.0 million
senior convertible note it acquired from AutoBond.
Net administrative fees and expenses to DHI increased $10.3 million, or
84.7%, to $22.4 million in 1998. This increase was primarily a result of the
continued growth in the Company's production operations, primarily in the
manufactured housing and commercial lending 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.
<TABLE>
<CAPTION>
Average Balances and Effective Interest Rates
- ----------------------------------------- ---------------------------------------------------------------------------------
(amounts in thousands) Year ended December 31,
- ----------------------------------------- ---------------------------------------------------------------------------------
1999 1998 1997
Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate
- ----------------------------------------- -------------- ------------ -------------- ----------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets (1):
Collateral for collateralized bonds $ 3,828,007 7.43% $ 4,094,030 7.43% $2,775,494 7.53%
(2) (3)
Securities 226,908 6.27 565,625 7.62 1,110,646 8.36
Other investments 202,111 8.50 196,759 8.17 136,189 8.27
Loans held for sale or securitization 329,507 7.97 546,272 8.14 499,115 7.95
-------------- ------------ -------------- ----------- -------------- -----------
============== ============ ============== =========== ============== ===========
Total interest-earning assets $ 4,586,533 7.46% $ 5,402,686 7.54% $4,521,444 7.80%
============== ============ ============== =========== ============== ===========
============== ============ ============== =========== ============== ===========
Interest-bearing liabilities:
Non-recourse debt (3) $ 3,363,095 6.18% $ 3,544,898 6.41% $2,226,894 6.67%
Recourse debt - collateralized bonds 271,919 5.71 523,208 5.90 419,621 5.82
retained
-------------- ------------ -------------- ----------- -------------- -----------
3,635,014 6.14 4,068,106 6.34 2,646,515 6.53
Recourse debt secured by investments:
Securities 143,392 6.51 422,164 5.91 931,334 5.74
Other investments 145,808 6.49 108,361 6.83 24,611 7.05
Loans held for sale or 259,061 5.50 415,778 5.57 354,116 5.83
securitization
Recourse debt - unsecured 121,743 8.78 143,378 8.97 87,881 9.23
============== ============ ============== =========== ============== ===========
Total interest-bearing $ 4,305,018 6.21% $ 5,157,787 6.34% $4,044,457 6.38%
liabilities
============== ============ ============== =========== ============== ===========
============== ============ ============== =========== ============== ===========
Net interest spread on all investments 1.25% 1.20% 1.42%
(3)
============ =========== ===========
============ =========== ===========
Net yield on average interest-earning 1.63% 1.49% 2.10%
assets
============ =========== ===========
------------ ----------- -----------
- ----------------------------------------- -------------- ------------ -------------- ----------- -------------- -----------
<FN>
(1) Average balances exclude adjustments made in accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," to record available for sale securities at fair
value.
(2) Average balances exclude funds held by trustees of $1,844, $3,189 and $2,481 for the years ended December 31, 1999,
1998 and 1997, respectively.
(3) Effective rates are calculated excluding non-interest related collateralized bond expenses and provision for credit
losses.
</FN>
</TABLE>
1999 compared to 1998. The net interest spread increased to 1.25% for the
year ended December 31, 1999 from 1.20% for the same period in 1998. This
increase was primarily due to a reduction in premium amortization expense
related to collateral for collateralized bonds, which decreased from $27.5
million for the year ended December 31, 1998 to $16.3 million for the year ended
December 31, 1999. The overall yield on interest-earnings assets decreased to
7.46% for the year ended December 31, 1999 from 7.54% for the same period in
1998. The cost of interest-bearing liabilities decreased to 6.21% for the year
ended December 31, 1999 from 6.34% for the same period in 1998.
Individually, the net interest spread on collateral for collateralized
bonds increased 20 basis points, from 109 basis points from the year ended
December 31, 1998 to 129 basis points for the same period in 1999. This increase
was primarily due to lower premium amortization caused by decreased prepayments
during the year ended December 31, 1999 compared to the same period in 1998. The
net interest spread on securities decreased 195 basis points, from 171 basis
points for the year ended December 31, 1998 to a negative 24 basis points for
the year ended December 31, 1999. This decrease was primarily the result of a
150 basis point increase during 1999 of the interest rate on the notes payable
secured by the Funding Notes, from one-month LIBOR plus 150 basis points to
one-month LIBOR plus 300 basis points, and the sale of certain higher coupon
collateral during the third quarter of 1998. In addition, several of the
Company's residual ARM trusts were placed on non-accrual status during the third
quarter of 1998. The net interest spread on other investments increased 67 basis
points, from 134 basis points for the year ended December 31, 1998 to 201 basis
points for the same period in 1999, primarily due to the purchase of higher
yielding property tax receivables during 1999. The net interest spread on loans
held for sale or securitization decreased 10 basis points, from 257 basis points
for the year ended December 31, 1998, to 247 basis points for the same period in
1999. This decrease is primarily attributable to the funding of lower coupon
collateral during 1999.
1998 compared to 1997. The net interest spread decreased to 1.20% for the
year ended December 31, 1998 from 1.42% for the same period in 1997. This
decrease was due to the reduction in interest-earning asset yields from
increased premium amortization expense and the addition of lower yielding assets
to the investment portfolio. The overall yield on interest-earning assets
decreased to 7.54% for year ended December 31, 1998, from 7.80% for the same
period in 1997 while the cost of interest-bearing liabilities remained
relatively flat for the year ended December 31, 1998 compared to the same period
in 1997.
Individually, the net interest spread on collateralized bonds increased 9
basis points, from 100 basis points for the year ended December 31, 1997 to 109
basis points for the same period in 1998. This slight increase was primarily due
to the securitization of collateral which has a lower premium as a percentage of
principal, during the second quarter of 1998. In addition, one-month LIBOR
decreased 27 basis points during the fourth quarter of 1998 which increased the
net interest spread on collateralized bonds 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 91 basis points,
from 262 basis points for the year ended December 31, 1997 to 171 basis points
for the year ended December 31, 1998. This decrease was primarily the result of
the sale of certain higher coupon collateral during the third quarter of 1998
along with the purchase of lower coupon fixed-rate mortgage securities during
the first quarter of 1998. In addition, certain assets were placed on
non-accrual status during 1998. The net interest spread on other investments
increased 12 basis points, from 122 basis points for the year ended December 31,
1997, to 134 basis points for the year ended December 31, 1998, due primarily to
lower borrowing costs associated with the Company's single family model home
purchase and leaseback business during 1998. The net interest spread on loans
held for securitization increased 45 basis points, from 212 basis points for the
year ended December 31, 1997, to 257 basis points for the same period in 1998.
This increase is primarily attributable to lower borrowing costs as a result of
higher level of compensating cash balances during the year ended December 31,
1998 compared to the same period in 1997. Credits earned from these compensating
cash balances are used by the Company to offset interest expense.
The following tables summarize the amount of change in interest income and
interest expense due to changes in interest rates versus changes in volume:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
1999 to 1998 1998 to 1997
- --------------------------------------------------------------------------------------------------------------------
Rate Volume Total Rate Volume Total
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Collateral for collateralized bonds $ 245 $ (19,769) $ (19,524) $ (2,895) $ 97,943 $ 95,048
Securities (6,582) (22,280) (28,862) (7,583) (42,135) (49,718)
Other investments 667 444 1,111 (141) 4,949 4,808
Loans held for sale or securitization (870) (17,303) (18,173) 933 3,820 4,753
- --------------------------------------------------------------------------------------------------------------------
Total interest income (6,540) (58,908) (65,448) (9,686) 64,577 54,891
- --------------------------------------------------------------------------------------------------------------------
Non-recourse debt (7,905) (11,401) (19,306) (5,991) 84,638 78,647
Recourse debt - collateralized bonds (939) (14,386) (15,325) 342 6,106 6,448
retained
- --------------------------------------------------------------------------------------------------------------------
Total collateralized bonds (8,844) (25,787) (34,631) (5,649) 90,744 85,095
Recourse debt secured by investments:
Securities 2,322 (18,174) (15,852) 1,603 (30,484) (28,881)
Other investments (391) 2,481 2,090 (55) 5,804 5,749
Loans held for sale or securitization (281) (8,739) (9,020) (990) 3,514 2,524
Recourse debt - unsecured (267) (1,905) (2,172) (235) 4,986 4,751
- --------------------------------------------------------------------------------------------------------------------
Total interest expense (7,461) (52,124) (59,585) (5,326) 74,564 69,238
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Net margin on portfolio $ 921 $ (6,784) $ (5,863) $ (4,360) $ (9,987) $ (14,347)
- --------------------------------------------------------------------------------------------------------------------
<FN>
Note: The change in interest income and interest expense due to changes in both volume and rate, which cannot be
segregated, has been allocated proportionately to the change due to volume and the change due to rate. This
table excludes net interest income on advances to DHI, other interest expense and provision for credit losses.
</FN>
</TABLE>
Interest Income and Interest-Earning Assets
Approximately $1.6 billion of the investment portfolio as of December 31,
1999 is comprised of loans or securities that have coupon rates which adjust
over time (subject to certain periodic and lifetime limitations) in conjunction
with changes in short-term interest rates. Approximately 64% of the ARM loans
underlying the ARM securities and collateral for collateralized bonds are
indexed to and reset based upon the level of six-month LIBOR; approximately 27%
are indexed to and reset based upon the level of the one-year Constant Maturity
Treasury (CMT) index. The following table presents a breakdown, by principal
balance, of the Company's collateral for collateralized bonds and ARM and fixed
mortgage securities by type of underlying loan. This table excludes other
derivative and residual securities, other securities, other investments and
loans held for securitization.
<TABLE>
<CAPTION>
Investment Portfolio Composition (1)
($ in millions)
- ------------------------------- ------------------ ------------------- --------------------- --------------- ---------------
Other Indices Based
LIBOR Based ARM CMT Based ARM ARM Loans Fixed-Rate
December 31, Loans Loans Loans Total
- ------------------------------- ------------------ ------------------- --------------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
1998 $ 1,644.0 $ 720.4 $ 195.4 $ 1,704.0 $ 4,263.8
1999 1,048.5 430.8 121.1 2,061.5 3,661.9
- ------------------------------- ------------------ ------------------- --------------------- --------------- ---------------
<FN>
(1) Includes only the principal amount of collateral for collateralized bonds, ARM securities and fixed 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
securities at December 31, 1999 were $38.3 million, or approximately 1.03% of
the aggregate balance of collateral for collateralized bonds, ARM securities and
fixed-rate securities. Of this $38.3 million, $34.5 million relates to the
premium on multifamily and commercial mortgage loans that have prepayment
lockouts or yield maintenance for at least seven years. Amortization expense as
a percentage of principal paydowns has increased to 1.43% for the year ended
December 31, 1999 from 1.24% primarily due to the multifamily and commercial
securitization during the fourth quarter of 1998. The amortization expense as a
percentage of principal paydowns decreased from 1.85% for the year ended
December 31, 1997 to 1.24% for the same period in 1998 as the investment
portfolio mix changed to assets funded primarily at par or at a discount during
1998. The principal repayment rate (indicated in the table below as "CPR
Annualized Rate") was 20 % for the year ended December 31, 1999. CPR or
"constant prepayment rate" is a measure of the annual prepayment rate on a pool
of loans. Excluded from this table are loans held for sale or securitization,
which are carried at the lower of cost or market as of December 31, 1999.
<TABLE>
<CAPTION>
Premium Basis and Amortization
($ in millions)
- -----------------------------------------------------------------------------------------------------
Amortization
CPR Annualized Expense as a %
Net Premium Amortization Rate Principal of Principal
Expense Paydowns Paydowns
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997 $ 56.9 $ 18.4 37% $ 993.2 1.85%
1998 77.8 27.5 41% 2,215.2 1.24%
1999 38.3 16.3 20% 1,145.8 1.43%
- -----------------------------------------------------------------------------------------------------
</TABLE>
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, third-party guarantees, 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 ARM and fixed-rate mortgage pass-through securities
outstanding; the direct credit exposure retained by the Company (represented by
the amount of overcollateralization pledged and subordinated securities owned by
the Company and rated below BBB by one of the nationally recognized rating
agencies), net of the credit reserves maintained by the Company for such
exposure; and the actual credit losses incurred for each year. Credit reserves
maintained by the Company and included in the table below includes third-party
reimbursement guarantees of $30.3 million. The table excludes any risks related
to representations and warranties made on loans funded by the Company and
securitized in mortgage pass-through securities generally funded prior to 1995.
This table also excludes any credit exposure on loans held for sale or
securitization, funding notes and securities, and other investments. The
increase in net credit exposure as a percentage of the outstanding loan
principal balance from 3.64% at December 31, 1998 to 4.86% at December 31, 1999
is related primarily to the credit exposure retained by the Company on its
manufactured housing securitizations issued during 1999.
<TABLE>
<CAPTION>
Credit Reserves and Actual Credit Losses
($ in millions)
- -------------------------------------------------------------------------------------------------------------
Credit Exposure, Credit Exposure, Net of
Outstanding Loan Net Actual Credit Credit Reserves to Outstanding
Principal Balance of Credit Reserves Losses Loan Balance
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997 $ 5,153.1 $ 86.6 $ 19.8 1.68%
1998 4,389.7 159.7 20.3 3.64%
1999 3,770.3 183.2 19.7 4.86%
- -------------------------------------------------------------------------------------------------------------
</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 delinquencies as a percentage
of the outstanding collateral decreased to 1.64% at December 31, 1999 from 2.36%
at December 31, 1998. 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 December 31,
1999, management believes the level of 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)
- --------------------------------------------------------------------------------
60 to 89 days delinquent 90 days and over
December 31, delinquent (2) Total
- --------------------------------------------------------------------------------
1997 0.51% 2.82% 3.33%
1998 0.25% 2.11% 2.36%
1999 0.27% 1.37% 1.64%
- --------------------------------------------------------------------------------
(1) Excludes funding notes and securities.
(2) Includes foreclosures, repossessions and REO.
The following table summarizes the credit rating for collateral for
collateralized bonds, securities and certain other investments held in the
investment portfolio, presented on a gross basis (i.e., the collateralized bonds
are not netted against the associated pledged collateral). This table excludes
$18.1 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 sale or securitization. The table also excludes
the Funding Notes and Securities, aggregating $90.7 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 December 31, 1999, securities with a credit rating of AA or
better were $3.2 billion, or 90.4% of the total.
<TABLE>
<CAPTION>
Investments by Credit Rating (1)
($ in millions)
- ----------------- ------------- ------------- ------------- ------------- -------------- ------------- ------------- -------------
Below BBB
AAA/AA BBB Carrying AAA/AA BBB Percent Below BBB
Carrying A Carrying Carrying Value Percent of A Percent of Total Percent of
December 31, Value Value Value Total of Total Total
- ----------------- ------------- ------------- ------------- ------------- -------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998 $ 3,815.6 $ 206.2 $ 97.6 $ 14.4 92.3% 5.0% 2.4% 0.3%
1999 3,154.4 191.4 123.3 19.8 90.4% 5.5% 3.5% 0.6%
- ----------------- ------------- ------------- ------------- ------------- -------------- ------------- ------------- -------------
<FN>
(1) Carrying value does not include funding notes and securities, derivative and residual securities, certain other investments
which are not debt securities and loans held for securitization. Balances also exclude the mark-to-market adjustment.
Carrying value also excludes $238.3 million of overcollateralization, net of $55.1 million of reserves.
</FN>
</TABLE>
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. In June 1999, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No, 133" ("FAS No. 137"). FAS
No. 137 amends FAS No. 133 to defer its effective date to all fiscal quarters of
all fiscal years beginning after June 15, 2000. The Company is in the process of
determining the impact of adopting FAS No. 133.
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, market conditions since October 1998 have substantially reduced the
Company's access to capital. The Company is currently unable to access
additional short-term warehouse lines of credit to replace maturing lines, and
is unable to access efficiently the asset-backed securities market to meet its
long-term funding needs. Largely as a result of its inability to access
additional capital, the Company sold its manufactured housing and model home
purchase/leaseback operations in 1999, and ceased issuing new commitments in its
commercial lending operations. The Company is attempting to substantially reduce
both its short-term debt and capital requirements. The Company's current focus
is the repayment of its recourse debt, which includes substantially all of the
short-term warehouse lines of credit and repurchase agreements.
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 liquidation proceeds of
such assets exceeds the amount of the indebtedness they secure.
As more fully described below, the Company was in default of certain
covenants in its secured credit facilities and its unsecured senior notes issued
in September 1994. As of April 14, 2000, the Company had not secured waivers for
all of the defaults; however, none of the respective lenders had accelerated
amounts outstanding as of that date as a result of the defaults. See further
discussion in Liquidity and Capital Resources and Notes 1 and 7 in the
accompanying consolidated financial statements.
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 December 31,
1999, Dynex REIT had $3.3 billion of collateralized bonds outstanding as
compared to $3.7 billion at December 31, 1998.
Recourse Debt
Secured. At December 31, 1999, Dynex REIT had four committed credit
facilities aggregating $699 million, comprised of (i) a $195 million credit
line, expiring on May 29, 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), (ii) a $400 million
credit line, expiring on April 28, 2000 from an investment bank primarily for
the warehousing of permanent loans on multifamily and commercial properties,
(iii) a $100 million credit line, expiring on May 10, 2000 from an investment
bank for the warehousing of the funding notes and securities , and (iv) a $4
million credit line, expiring on December 15, 2000, from a finance company for
the warehousing of model homes not included in the sale of the related business.
While Dynex REIT has received bids for the sale of a substantial portion of the
assets that secure the credit lines expiring on April 28, 2000 and May 29, 2000,
it is unlikely that Dynex REIT will be able to payoff such credit lines by the
respective maturity dates. Although, the Company will seek extensions to the
maturity dates, there can be no assurances that the lenders will agree to such
extensions. In the event that the lenders declare an event of default, the
underlying credit line agreements provide for the liquidation of the pledged
collateral. In such a scenario it is likely that the Company will suffer losses
on the sale of the collateral. For the credit line expiring May 10, 2000, Dynex
REIT and the lender executed a letter of intent dated April 10, 2000 whereby the
collateral currently pledged to the line is instead pledged to a
senior/subordinate security structure. Under the terms of the letter, the lender
will "purchase" the senior security, the proceeds of which are then used to
repay the remaining amount outstanding under the credit line. Dynex REIT will
retain the subordinate class. The security will provide for the full
amortization of the senior class before any cash flow is paid on the subordinate
class. The above lines of credit include various representations and covenants.
Dynex REIT was in violation of certain covenants on the credit lines expiring on
April 28, 2000 and May 29, 2000 relating primarily to minimum net worth and
minimum senior unsecured ratings requirements, and the receipt of a going
concern opinion from its auditors. Dynex REIT has received waivers from the
investment bank on the credit line expiring on April 28, 2000 for the minimum
senior unsecured ratings and minimum net worth requirements. Dynex REIT has not
received a waiver for the uncured covenant violation for the receipt of a going
concern opinion. As of April 14, 2000, the investment bank has not notified the
Company formally in writing as required by the loan agreement that it has (i)
terminated its commitments to lend or (ii) declared all or a portion of the loan
due and payable. Dynex REIT has also not received waivers for any uncured
covenant violations from the bank consortium on the credit line expiring on May
29, 2000. As of April 14, 2000, the bank syndicate has not formally notified
Dynex REIT in writing as required by the loan documentation, that it has (i)
terminated its commitment to lend or (ii) declared all or a portion of the loan
due and payable. The Company's recourse credit facilities generally contain
cross-default provisions whereby a default under any one credit facility is a
default on each of the other credit facilities.
The following table summarizes the committed credit facilities at December
31, 1999 expiring in 2000. Dynex REIT had $246.2 million outstanding under its
committed credit facilities at December 31, 1999.
<TABLE>
<CAPTION>
Committed Credit Facilities
At December 31, 1999
($ in millions)
- -------------------------------------------- ----------------- ---------------- ----------------- -----------------------
Current Balance of
Outstanding Pledged Expiration of Facility
Collateral Type Credit Limit Borrowings Collateral
- -------------------------------------------- ----------------- ---------------- ----------------- -----------------------
<S> <C> <C> <C> <C>
Various (primarily commercial and
manufactured housing) $ 195.0 $ 111.6 $135.9 May 29, 2000
Commercial 400.0 83.6 135.4 April 28, 2000
Funding Notes and Securities 100.0 47.8 115.8 May 10, 2000
Model homes 3.7 3.7 4.1 December 15, 2000
----------------- ---------------- ----------------- -----------------------
698.7 246.7 391.2
Less: deferred facility expenses - (0.5) -
- -------------------------------------------- ----------------- ---------------- ----------------- -----------------------
Total $ 698.7 $ 246.2 $391.2
- -------------------------------------------- ----------------- ---------------- ----------------- -----------------------
</TABLE>
Dynex REIT also uses repurchase agreements to finance a portion of its
investments, which generally have maturities of thirty-days or less. 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. At December 31, 1999, outstanding obligations under all repurchase
agreements totaled $163.0 million compared to $529.1 million at December 31,
1998. As of April 14, 2000, Dynex REIT had repurchase agreements outstanding of
$74.7 million, substantially all with one counterparty. Dynex REIT has provided
collateral worth an estimated fair market value of $91.1 million to support the
amount of the repurchase agreement outstanding. All repurchase agreements with
such counterparty are on an "overnight" or one-day basis. The following table
summarizes the outstanding balances of repurchase agreements by credit rating of
the related assets pledged as collateral to support such repurchase agreements
as of December 31, 1999 and 1998. The table excludes repurchase agreements used
to finance loans held for sale or securitization.
<TABLE>
<CAPTION>
Repurchase Agreements by Rating of Investments Financed
($ in millions)
- --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
December 31, AAA AA A BBB Below BBB Total
- --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
<S> <C> <C> <C> <C> <C> <C>
1998 $ 124.5 $ 109.5 $ 91.4 $ 65.6 $ - $ 391.0
1999 77.9 14.9 4.4 65.3 0.5 163.0
- --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
</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 or receivables. 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. These notes payable had an outstanding
balance at December 31, 1999 of $110.8 million. The Company has $97.3 million
outstanding of its July 2002 senior notes (the "2002 Notes") and $13.5 million
outstanding on notes issued in September 1994 (the "1994 Notes"). During the
year ended December 31, 1999, Dynex REIT extinguished $2.75 million of the 2002
Notes resulting in a $0.6 million extraordinary gain. Effective May 15, 1999,
the Company amended the 1994 Notes. In return for certain covenant relief
related to the fixed-charge coverage requirements of the 1994 Notes, the Company
agreed to (i) convert the principal amortization of the 1994 Notes from annual
to monthly and (ii) shorten the remaining principal amortization period from 30
months to 16 months. Monthly amortization for the 1994 Notes through August 2000
approximates $1.7 million per month. As of December 31, 1999, the Company was in
violation of certain covenants in the 1994 Notes including the minimum net worth
requirement and the covenant requiring an unqualified audit opinion. These
violations resulted in an immediate event of default; however, the holders of
the 1994 Notes have not accelerated the remaining amounts due.
The 2002 Notes also contain covenants which provide for the acceleration of
amounts outstanding under the 2002 Notes should Dynex REIT default under other
credit agreements in excess of $10 million, and such amounts outstanding under
the other credit agreements are accelerated by the respective lender.
Total recourse debt decreased from $1.0 billion for December 31, 1998 to
$0.5 billion for December 31, 1999. This decrease was primarily due to the
securitization of $601.8 million of manufactured housing loans as collateral for
collateralized bonds during 1999. These loans and securities were previously
financed with $190.7 million of repurchase agreements and $328.4 million of
notes payable. In addition, Dynex REIT paid off $175.8 million of notes payable
as a result of the sale of the Company's model home and manufactured housing
operation during 1999 and sold $70.7 million of securities which had been
financed with $48.1 million of repurchased agreements during 1999. Also,
repurchase agreements decreased $88.0 million as a result of the
re-securitization of the collateral on the previously retained collateralized
bonds during 1999. These decreases were partially offset by the addition of
$391.8 million of notes payable as a result of additional loan fundings during
1999. Total recourse debt should continue to decline during 2000 as Dynex REIT
continues to sell loans held for sale and receives payments on the funding
notes.
<TABLE>
<CAPTION>
Total Recourse Debt
($ in millions)
- ----------------------------------------------------------------------------------------------------------
Total Recourse Debt to Recourse Interest
December 31, Total Recourse Debt Equity Coverage Ratio
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1997 $ 1,133.5 212% 1.82%
1998 1,032.7 194% 1.20%
1999 537.1 151% 0.26%
- -----------------------------------------------------------------------------------------------------------
</TABLE>
In connection with the AutoBond litigation as discussed in Item 3 Legal
Proceedings, in order to appeal the approximately $27 million proposed judgment,
Dynex REIT is generally required to post an appeal bond in an amount equal to
the judgment. Dynex REIT's ability to secure an appeal bond is dependent on the
amount of the collateral required by the surety bond provider. Generally, appeal
bonds are substantially secured by letters of credit or cash. Dynex REIT does
not have sufficient cash reserves to fully collateralize an appeal bond or to
post a letter of credit. Should Dynex REIT not be able to secure an appeal bond
for the full amount of the judgment, Texas State law would allow for Dynex REIT
to present evidence to reduce the required amount of the appeal bond or to
provide other collateral for the appeal. There can be no assurance that Dynex
REIT will be allowed to post a reduced bond.
FOURTH QUARTER REVIEW
The Company reported a net loss of $72.3 million for the fourth quarter of
1999 and a net loss per common share of $6.60. These results were an increase
from the fourth quarter of 1998 net loss of $16.9 million and a net loss per
common share of $1.75. The increase in the fourth quarter of 1999 compared to
the same period in 1998 is primarily due to a decrease in net interest margin,
write-downs associated with the commercial loan operations and the litigation
reserve.
Net interest margin for the fourth quarter of 1999 totaled $9.9 million
compared with $17.6 million for the fourth quarter of 1998. The decrease in the
net interest margin for the fourth quarter of 1999 was primarily due to an
increase in provision for losses and a $0.8 billion decrease in the average
interest-earnings assets for the fourth quarter of 1999 compared to the same
period in 1998.
The average interest-earning assets were $4.3 billion for the fourth
quarter of 1999 and $5.1 billion for same period in 1998. However, the average
asset yield for the quarter ended December 31, 1999 increased to 7.80% compared
to 7.46% for the fourth quarter of 1998. The increase in the yield during the
fourth quarter of 1999 was primarily due to lower premium amortization caused by
decreased prepayments during the fourth quarter of 1999. Additionally, the
average interest-bearing liabilities decreased $0.9 billion to $4.0 billion for
the fourth quarter of 1999 compared to $4.9 billion for the fourth quarter of
1998. The average cost of funds increased from 6.13% for the fourth quarter of
1998 to 6.59% for the fourth quarter of 1999. The increase in the average cost
of funds was due primarily to an increase in the average one-month LIBOR for the
fourth quarter of 1999 compared to the fourth quarter of 1998.
For the fourth quarter of 1999, the Company recognized a $4.2 million net
loss on the sale of investments and trading activities compared to a loss of
$9.0 million in the fourth quarter of 1998. The loss in the fourth quarter of
1999 was primarily due to $4.5 million of net losses on $21.9 million of
commercial loans sold during the fourth quarter of 1999, while the loss of $9.0
million in the fourth quarter of 1998 was primarily a result of $8.6 million of
net losses on $113.9 million of securities sold during the fourth quarter of
1998.
On March 9, 2000, the jury in the AutoBond related litigation returned a
verdict in favor of AutoBond, and awarded AutoBond $69 million in damages. On
April 17, 2000, based on motions filed by the Company, the judge presiding over
the matter in Travis County, Texas proposed a judgment of approximately $27
million (which includes estimated prejudgment interest) in lieu of the
approximate $69 million verdict. See Item 3. Legal Proceedings. As a result, the
Company recorded a litigation provision of $27.0 million. The charge was
reflected in impairment charges and litigation provision in the accompanying
financial statements
<TABLE>
<CAPTION>
Summary of Selected Quarterly Results (unaudited)
(amounts in thousands except share data)
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
First Second Third Quarter Fourth Quarter
Year ended December 31, 1999 Quarter Quarter
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Operating results:
Total revenues $ 88,477 $ 84,925 $ 86,308 $ 91,088
Net interest margin 11,213 14,594 12,274 9,934
Net income (loss) 2,259 3,574 320 (81,288)
Basic net income per common share (0.08) 0.03 (0.25) (7.39)
Diluted net income per common share (0.08) 0.03 (0.25) (7.39)
Cash dividends declared per common share - - - -
Annualized return on common shareholders'
equity (1.18%) 0.53% (3.52%) (111.43%)
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Average interest-earning assets 4,817,483 4,639,592 4,563,995 4,325,061
Average borrowed funds 4,576,714 4,379,658 4,253,524 4,010,174
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Net interest spread on interest-earning assets 1.07% 1.39% 1.32% 1.21%
Average asset yield 7.24% 7.24% 7.60% 7.80%
Net yield on average interest-earning assets (1) 1.38% 1.72% 1.74% 1.69%
Cost of funds 6.17% 5.85% 6.28% 6.59%
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Loans funded 219,647 294,624 236,384 122,331
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
First Second Third Quarter Fourth Quarter
Year ended December 31, 1998 Quarter Quarter
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Operating results:
Total revenues $ 97,842 $ $ $
111,813 104,434 96,732
Net interest margin 17,146 17,187 14,639 17,566
Net income (loss) 14,432 15,599 6,485 (16,939)
Basic net income per common share 0.98 1.08 0.28 (1.75)
Diluted net income per common share 0.98 1.08 0.28 (1.75)
Cash dividends declared per common share 1.20 1.20 1.00 -
Annualized return on common shareholders'
equity 12.50% 13.77% 3.68% (23.79%)
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Average interest-earning assets 5,120,191 5,780,504 5,571,742 5,138,306
Average borrowed funds 4,791,147 5,520,722 5,377,659 4,941,623
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Net interest spread on interest-earning assets 1.19% 1.17% 1.11% 1.33%
Average asset yield 7.59% 7.61% 7.50% 7.46%
Net yield on average interest-earning assets (1) 1.60% 1.47% 1.33% 1.57%
Cost of funds 6.40% 6.44% 6.39% 6.13%
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Loans funded 1,171,665 542,176 435,270 371,126
- ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
<FN>
(1) Computed as net interest margin excluding non-interest collateralized bond expenses.
</FN>
</TABLE>
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-K made by the Company, that are
not historical fact constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such forward-looking statements may
involve factors that could cause the actual results of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. The Company cautions the public not to place
undue reliance on forward-looking statements, which may be based on assumptions
and anticipated events that do not materialize. The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.
Factors that may cause actual results to differ from historical results or
from any results expressed or implied by forward-looking statements include the
following:
Economic Conditions. The Company is affected by general economic
conditions. 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 is in violation of
numerous covenants under its existing credit facilities. The Company's access to
alternative or additional sources of financing has been significantly reduced.
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, the Company's access to capital markets
in the future has been substantially reduced.
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.
Competition. The financial services industry is a highly competitive
market. Increased competition in the market could adversely affect the Company.
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
performance of the Company's securitized loan pools.
Significant Uncertainties and Risks. See Note 1 to the Company's financial
statements.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument due to fluctuations in
interest and foreign exchange rates and in equity and commodity prices. Market
risk is inherent to both derivative and non-derivative financial instruments,
and accordingly, the scope of the Company's market risk management extends
beyond derivatives to include all market risk sensitive financial instruments.
As a financial services company, net interest income comprises the primary
component of the Company's earnings. As a result, the Company is subject to risk
resulting from interest rate fluctuations to the extent that there is a gap
between the amount of the Company's interest-earning assets and the amount of
interest-bearing liabilities that are prepaid, mature or reprice within
specified periods. 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 December 31, 1999. This analysis represents
management's estimate of the percentage change in net interest margin given a
parallel shift in interest rates. The "Base" case represents the interest rate
environment as it existed as of December 31, 1999. 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 ranging from 5.5% to 70.1% 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.
Basis Point % Change in Net
Increase (Decrease) Interest Margin from
in Interest Rates Base Case
----------------------- -----------------------
+200 (33.56)%
+100 (17.12)%
Base -
-100 13.50%
-200 15.53%
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 not in compliance with its stated policy regarding the interest
rate sensitivity of net interest margin if interest rates increase 200 basis
points over a twelve month period.
Approximately $1.6 billion of the Company's investment portfolio as of
December 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 64% and 27%
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. 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. These
interest rate cap agreements expire 2001 to 2004. 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. These interest rate swap agreements
expire in 2001. 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 a 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 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.
Interest rate caps and interest rate swaps that the Company utilizes to
manage certain interest rate risks represent protection for the earnings and
cashflow of the investment portfolio in adverse markets. To date, market
conditions have not been adverse such that the caps and swaps have been
utilized.
The remaining portion of the Company's investments portfolio as of December
31, 1999, approximately $2.5 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 $1.8 billion as of
the same date. Overall, the Company's interest rate risk is related both to the
rate of change in short term interest rates, and to the level of short term
interest rates.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and the related notes,
together with the Independent Auditors' Reports thereon are set forth on pages
F-1 through F-28 of this Form 10-K.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 21, 1998, the Audit Committee of Dynex Capital, Inc. approved the
appointment of the accounting firm of Deloitte & Touche LLP ("D&T") as the
independent accountants for the year ending December 31, 1998 to replace KPMG
Peat Marwick LLP ("KPMG"), who were dismissed as the independent accountants
effective with such appointment.
The reports of KPMG on the Company's consolidated financial statements for
the year ended December 31, 1997 did not contain an adverse opinion or a
disclaimer of opinion and were not qualified or modified as to uncertainty,
audit scope or accounting principles.
In connection with the audits of the Company's consolidated financial
statements for the year ended December 31, 1997, and through July 21, 1998,
there have been no disagreements between the Company and KPMG on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope and procedures which, if not resolved to the satisfaction of KPMG, would
have caused them to make reference thereto in their report on the financial
statements for such years.
During the year ended December 31, 1997, and through July 21, 1998, the
Company had not consulted with D&T regarding either (i) the application of
accounting principles to a specified transaction, either completed or proposed;
or (ii) any matter that was either the subject of a disagreement, as that term
is defined in Item 304 (a) (1) (iv) of Regulation S-K and the related
instructions to Item 304 of Regulation S-K, or a reportable event, as that term
is defined in Item 304 (a) (1) (v) of Regulation S-K.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to directors and executive officers
of the Company is included in the Company's proxy statement for its 2000 Annual
Meeting of Stockholders (the 2000 Proxy Statement) in the Election of Directors
and Management of the Company sections and is incorporated herein by reference.
Item 11. EXECUTIVE COMPENSATION
The information required by Item 11 is included in the 2000 Proxy Statement
in the Management of the Company section and is incorporated herein by
reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is included in the 2000 Proxy Statement
in the Ownership of Common Stock section and is incorporated herein by
reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is included in the 2000 Proxy Statement
in the Compensation Committee Interlocks and Insider Participation section and
is incorporated herein by reference.
Part IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. and 2. Financial Statements and Financial Statement Schedule
The information required by this section of Item 14 is set forth in the
Consolidated Financial Statements and Independent Auditors' Report beginning at
page F-1 of this Form 10-K. The index to the Financial Statements and Schedule
is set forth at page F-2 of this Form 10-K.
3. Exhibits
Exhibit Number Exhibit 3.1 Articles of Incorporation of the Registrant, as
amended, effective as of February 4, 1988. (Incorporated herein by reference to
the Company's Amendment No. 1 to the Registration Statement on Form S-3 (No.
333-10783) filed March 21, 1997.)
3.2 Amended Bylaws of the Registrant (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31, 1992, as
amended.)
3.3 Amendment to the Articles of Incorporation, effective December 29, 1989
(Incorporated herein by reference to the Company's Amendment No. 1 to the
Registration Statement on Form S-3 (No. 333-10783) filed March 21, 1997.)
3.4 Amendment to Articles of Incorporation, effective June 27, 1995
(Incorporated herein by reference to the Company's Current Report on Form 8-K
(File No. 1-9819), dated June 26, 1995.)
3.5 Amendment to Articles of Incorporation, effective October 23, 1995
(Incorporated herein by reference to the Company's Current Report on Form 8-K
(File No. 1-9819), dated October 19, 1995.)
3.6 Amendment to the Articles of Incorporation, effective October 9, 1996
(Incorporated herein by reference to the Registrant's Current Report on Form
8-K, filed October 15, 1996.)
3.7 Amendment to the Articles of Incorporation, effective October 10, 1996
(Incorporated herein by reference to the Registrant's Current Report on Form
8-K, filed October 15, 1996.)
3.8 Amendment to the Articles of Incorporation, effective October 19, 1992.
(Incorporated herein by reference to the Company's Amendment No. 1 to the
Registration Statement on Form S-3 (No. 333-10783) filed March 21, 1997.)
3.9 Amendment to the Articles of Incorporation, effective August 17, 1992.
(Incorporated herein by reference to the Company's Amendment No. 1 to the
Registration Statement on Form S-3 (No. 333-10783) filed March 21, 1997.)
3.10 Amendment to Articles of Incorporation, effective April 25, 1997.
(Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997.)
3.11 Amendment to Articles of Incorporation, effective May 5, 1997.
(Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997.)
10.1 Dividend Reinvestment and Stock Purchase Plan (Incorporated herein by
reference to the CompRegistration Statement on Form S-3 (No. 333-35769).)
10.2 Executive Deferred Compensation Plan (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File
No. 1-9819) dated March 21, 1994.)
10.3 Employment Agreement: Thomas H. Potts (Incorporated by reference to
Exhibits to the Company's Annual Report filed on Form 10-K for the year ended
December 31, 1994 (File No. 1-9819) dated March 31, 1995.)
10.4 Promissory Note, dated as of May 13, 1996, between the Registrant (as
Lender) and Dominion Mortgage Services, Inc. (as Borrower) (Incorporated herein
by reference to Exhibits to the Company's Form 10-Q for the quarter ended June
30, 1996 (File No. 1-9819) dated August 14, 1996.)
10.5 The Registrant's Bonus Plan (Incorporated by reference to Exhibits to
the Company's Annual Report filed on Form 10-K for the year ended December 31,
1996 (File No. 1-9819) dated March 31, 1997.)
10.6 The Directors Stock Appreciation Rights Plan (Incorporated herein by
reference to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997.)
10.7 1992 Stock Incentive Plan as amended (Incorporated herein by reference
to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
1997.)
21.1 List of consolidated entities of the Company (filed herewith)
23.1 Consent of Deloitte & Touche LLP (filed herewith)
23.2 Consent of KPMG LLP (filed herewith)
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DYNEX CAPITAL, INC.
(Registrant)
April 18, 2000 /s/ Thomas H. Potts
Thomas H. Potts
President
(Principal Executive Officer)
April 18, 2000 /s/ Lynn K. Geurin
Lynn K. Geurin
Executive Vice President and Chief Financial Officer
(Principal Accounting and Financial Officer)
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Capacity Date
/s/ Thomas H. Potts Director April 18, 2000
Thomas H. Potts
/s/ J. Sidney Davenport, IV Director April 18, 2000
J. Sidney Davenport, IV
/s/ Barry S. Shein Director April 18, 2000
Barry S. Shein
/s/ Donald B. Vaden Director April 18, 2000
Donald B. Vaden
DYNEX CAPITAL, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
INDEPENDENT AUDITORS' REPORT
For Inclusion in Form 10-K
Annual Report Filed with
Securities and Exchange Commission
December 31, 1999
DYNEX CAPITAL, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
Financial Statements: Page
Independent Auditors' Report for the Years Ended
December 31, 1999 and 1998 F-3
Independent Auditors' Report for the Year Ended
December 31, 1997 F-4
Consolidated Balance Sheets -- December 31, 1999 and 1998 F-5
Consolidated Statements of Operations -- Years ended
December 31, 1999, 1998 and 1997 F-6
Consolidated Statements of Shareholders' Equity -- Years ended
December 31, 1999, 1998 and 1997 F-7
Consolidated Statements of Cash Flows -- Years ended
December 31, 1999, 1998 and 1997 F-8
Notes to Consolidated Financial Statements --
December 31, 1999, 1998 and 1997 F-9
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Dynex Capital, Inc.
We have audited the accompanying consolidated balance sheets of Dynex
Capital, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related
consolidated statements of operations, shareholder's equity, and cash flows for
the years then ended. In connection with our audits of these consolidated
financial statements, we also have audited the financial statement schedule.
These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the companies as of December
31, 1999 and 1998, and the results of their operations and their cash flows for
the years then ended in conformity with generally accepted accounting principles
generally accepted in the United States of America. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole presents fairly, in all
material respects, the information set forth therein.
The accompanying consolidated financial statements for the year ended
December 31, 1999 have been prepared assuming that the Company will continue as
a going concern. As discussed in Note 1 to the consolidated financial
statements, litigation, the difficulty the Company is experiencing in accessing
new funding sources and the default of certain debt covenants which permit the
lenders to accelerate the maturity of the debt raise substantial doubt about its
ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of these
uncertainties.
DELOITTE & TOUCHE LLP
Richmond, Virginia
April 17, 2000
Independent Auditors' Report
The Board of Directors
Dynex Capital, Inc.:
We have audited the accompanying consolidated statements of operations,
shareholders' equity and cash flows of Dynex Capital, Inc. and subsidiaries for
the year ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of Dynex Capital, Inc. and subsidiaries for the year ended December 31,
1997, in conformity with generally accepted accounting principles.
KPMG LLP
Richmond, Virginia
February 4, 1998, except as to the 1997
information contained in note 17
which is as of April 14, 1999
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
DYNEX CAPITAL, INC.
December 31, 1999 and 1998
(amounts in thousands except share data)
1999 1998
----------------- -----------------
ASSETS
<S> <C> <C>
Investments:
Collateral for collateralized bonds $ 3,700,714 $ 4,293,528
Securities 127,711 243,984
Other investments 48,927 30,371
Loans held for sale or securitization 232,384 388,782
----------------- -----------------
4,109,736 4,956,665
Investments in and advances to Dynex Holding, Inc. 4,814 169,384
Cash, substantially restricted 48,601 30,103
Accrued interest receivable 2,208 4,162
Other assets 25,537 18,534
================= =================
$ 4,190,896 $ 5,178,848
================= =================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Non-recourse debt $ 3,282,378 $ 3,665,316
Recourse debt:
Secured by collateralized bonds retained 144,746 298,695
Secured by investments 282,479 588,735
Unsecured 109,873 145,303
-------------- --------------
--- ---
3,819,476 4,698,049
Accrued interest payable 6,303 8,403
Accrued expenses and other liabilities 40,045 16,364
Dividends payable - 3,228
-------------- --------------
--- ---
3,865,824 4,726,044
----------------- -----------------
Commitments and contingencies - Notes 1, 13 and 14
SHAREHOLDERS' EQUITY
Preferred stock, par value $.01 per share,
50,000,000 shares authorized:
9.75% Cumulative Convertible Series A,
1,309,061 issued and outstanding 29,900 29,900
9.55% Cumulative Convertible Series B,
1,912,434 issued and outstanding 44,767 44,767
9.73% Cumulative Convertible Series C,
1,840,000 issued and outstanding 52,740 52,740
Common stock, par value $.01 per share,
100,000,000 shares authorized,
11,444,099 and 46,027,426 issued and outstanding, respectively 114 460
Additional paid-in capital 351,995 352,382
Accumulated other comprehensive loss (48,507) (3,097)
Accumulated deficit (105,937) (24,348)
--------------
----------------- ---
325,072 452,804
-------------- --------------
=== ===
$ 4,190,896 $ 5,178,848
<FN>
================= =================
See notes to consolidated financial statements.
</FN>
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF OPERATIONS
DYNEX CAPITAL, INC.
Years ended December 31, 1999, 1998 and 1997
(amounts in thousands except share data)
1999 1998 1997
------------------- ------------------- -------------------
<S> <C> <C> <C>
Interest income:
Collateral for collateralized bonds $ 284,470 $ 303,994 $ 208,946
Securities 14,228 41,991 79,714
Other investments 4,388 4,099 4,909
Loans held for sale or securitization 26,276 44,450 34,099
Net advances to Dynex Holding, Inc. 12,087 10,979 5,891
------------------- ------------------- -------------------
341,449 405,513 333,559
------------------- ------------------- -------------------
Interest and related expense:
Non-recourse debt 210,794 231,242 152,678
Recourse debt 59,906 99,119 90,777
Other 6,580 2,193 1,717
------------------- ------------------- -------------------
277,280 332,554 245,172
------------------- ------------------- -------------------
Net interest margin before provision for losses 64,169 72,959 88,387
Provision for losses (16,154) (6,421) (4,933)
------------------- ------------------- -------------------
Net interest margin 48,015 66,538 83,454
Write-downs associated with commercial production operations (59,962) - -
(Loss) gain on sale of investments and trading activities (12,682) (2,714) 11,584
Gain on sale of loan production operations 7,676 - -
Impairment charge and litigation provision - AutoBond (31,732) (17,632) -
Equity in net (loss) earnings of Dynex Holding, Inc. (1,923) 2,456 (1,109)
Other income 1,673 2,852 1,716
------------------- ------------------- -------------------
(48,935) 51,500 95,645
General and administrative expenses (7,740) (8,973) (9,531)
Net administrative fees and expenses to Dynex Holding, Inc. (16,943) (22,379) (12,116)
------------------- ------------------- -------------------
(Loss) income before extraordinary item (73,618) 20,148 73,998
Extraordinary item - loss on extinguishment of debt (1,517) (571) -
--------------- --------------- ---------------
----- ----- -----
Net (loss) income (75,135) 19,577 73,998
Dividends on preferred stock (12,910) (13,019) (14,820)
=================== =================== ===================
Net (loss) income available to common shareholders $ (88,045) $ 6,558 $ 59,178
=================== =================== ===================
Net (loss) income per common share before extraordinary item:
Basic $ (7.53) $ 0.62 $ 5.50
=================== =================== ===================
Diluted $ (7.53) $ 0.62 $ 5.48
=================== =================== ===================
Net (loss) income per common share after extraordinary item:
Basic $ (7.67) $ 0.57 $ 5.50
=================== =================== ===================
Diluted $ (7.67) $ 0.57 $ 5.48
=================== =================== ===================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
DYNEX CAPITAL, INC.
Years ended December 31, 1999, 1998 and 1997
(amounts in thousands except share data)
Accumulated Retained
Additional Other Earnings
Preferred Common Paid-in Comprehensive (Accumulated
Stock Stock Capital (Loss) Income Deficit) Total
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997 $ 139,625 $ 207 $ 291,637 $ 64,402 $ 7,746 $ 503,617
Comprehensive income:
Net income - 1997 - - - - 73,998 73,998
Change in net unrealized gain on
investments classified as available
for sale during the period - - - 15,039 - 15,039
----------------------------------------------------------------------------------------
Total comprehensive income - - - 15,039 73,998 89,037
Issuance of common stock - 25 42,009 - - 42,034
Conversion of preferred stock (9,143) 6 9,137 - - -
Two-for-one common stock split - 213 (213) - - -
Dividends on common stock at $5.42
per share - - - - (58,959) (58,959)
Dividends on preferred stock - - - - (14,820) (14,820)
----------------------------------------------------------------------------------------
Balance at December 31, 1997 130,482 451 342,570 79,441 7,965 560,909
Comprehensive loss:
Net income - 1998 - - - - 19,577 19,577
Change in net unrealized gain on
investments classified as available
for sale during the period - - - (82,538) - (82,538)
----------------------------------------------------------------------------------------
Total comprehensive loss - - - (82,538) 19,577 (62,961)
Issuance of common stock - 7 7,652 - - 7,659
Conversion of preferred stock (3,075) 3 3,072 - - -
Retirement of common stock - (1) (912) - - (913)
Dividends on common stock at $3.40
per share - - - - (38,871) (38,871)
Dividends on preferred stock - - - - (13,019) (13,019)
----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
Balance at December 31, 1998 127,407 460 352,382 (3,097) (24,348) 452,804
Comprehensive loss:
Net loss - 1999 - - - - (75,135) (75,135)
Change in net unrealized loss on
investments classified as available
for sale during the period - - - (45,410) - (45,410)
----------------------------------------------------------------------------------------
Total comprehensive loss - - - (45,410) (75,135) (120,545)
Issuance of common stock - - 30 - - 30
One-for-four reverse common stock
split - (345) 345 - - -
Retirement of common stock - (1) (699) - - (700)
Issuance of restricted stock awards - - 6 - - 6
Forfeitures of restricted stock - - (69) - - (69)
awards
Dividends on preferred stock - - - - (6,454) (6,454)
========================================================================================
Balance at December 31, 1999 $ 127,407 $ 114 $ 351,995 $ (48,507) $ (105,937) $ 325,072
========================================================================================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
DYNEX CAPITAL, INC.
Years ended December 31, 1999, 1998 and 1997
(amounts in thousands except share data)
1999 1998 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
Operating activities:
Net (loss) income $ (75,135) $ 19,577 $ 73,998
Adjustments to reconcile net (loss) income to cash provided by operating
activities:
Provision for losses 16,154 6,421 4,933
Write-downs associated with winding down of commercial loan production 59,962 - -
operations
Net loss (gain) from sale of investments and trading activities 12,682 2,714 (11,584)
Gain on sale of loan production operations (7,676) - -
Impairment charge and litigation provision - AutoBond 31,732 17,632 -
Equity in net (earnings) loss of Dynex Holding, Inc. 1,923 (2,456) 1,109
Extraordinary item - loss on extinguishment of debt 1,517 571 -
Amortization and depreciation 28,133 43,938 26,389
Net (increase) decrease in accrued interest, other assets and other (15,257) (4,471) 10,983
liabilities
--------------- --------------- ---------------
Net cash provided by operating activities 54,035 83,926 105,828
--------------- --------------- ---------------
Investing activities:
Collateral for collateralized bonds:
Fundings of investments subsequently securitized (627,290) (1,857,617) (2,302,831)
Principal payments on collateral 1,119,841 2,112,473 940,613
Decrease (increase) in accrued interest receivable 5,080 1,057 (10,316)
Net (increase) decrease in funds held by trustee (1,051) 889 396
Net decrease (increase) in loans held for sale or securitization 84,762 (155,497) 29,767
Purchase of other investments (33,348) (38,192) (50,525)
Payments received on other investments 11,254 16,977 18,547
Purchase of securities (23,737) (599,869) (848,663)
Payments received on securities 79,009 122,693 62,184
Proceeds from sales of securities 61,415 424,338 847,339
Investment in and advances to Dynex Holding, Inc. (26,335) (47,572) (82,086)
Proceeds from sale of loan production operations 213,591 19,000 9,500
Capital expenditures (281) (402) (2,094)
--------------- --------------- ---------------
Net cash provided by (used for) investing activities 862,910 (1,722) (1,388,169)
--------------- --------------- ---------------
Financing activities:
Collateralized bonds:
Proceeds from issuance of bonds 1,069,048 1,817,179 2,400,191
Principal payments on bonds (1,091,216) (2,066,915) (919,885)
Increase (decrease) in accrued interest payable 3,677 (262) 2,945
Proceeds from issuance of senior notes - - 98,223
Repayment of senior notes (17,833) (11,750) (3,000)
(Repayment of ) proceeds from recourse debt borrowings, net (851,771) 252,554 (256,660)
Net proceeds from issuance of stock 30 7,659 42,034
Retirement of common stock (700) (913) -
Dividends paid (9,682) (68,155) (70,520)
--------------- --------------- ---------------
Net cash (used for) provided by financing activities (898,447) (70,603) 1,293,328
--------------- --------------- ---------------
Net increase in cash 18,498 11,601 10,987
Cash at beginning of period 30,103 18,502 7,515
--------------- --------------- ---------------
Cash at end of period $ 48,601 $ 30,103 $ 18,502
=============== =============== ===============
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
December 31, 1999, 1998 and 1997
(amounts in thousands except share data)
NOTE 1 - BASIS OF PRESENTATION
Basis of Presentation 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 accompanying
consolidated statement of operations for 1997 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.
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The financial
statements do not include any adjustments that might result from the outcome of
any uncertainties described herein.
Significant Risks and Uncertainties The Company's business strategy has
historically relied on access to financing sources such as warehouse lines of
credit and repurchase agreements, and the asset-backed securities market, to
finance its activities. During 1999, the Company's access to these sources of
financing was substantially impaired due in part to market perception of
specialty finance companies that resulted from the disruption in the fixed
income market in late 1998. As a result of this environment, the Company sold
both its manufactured housing lending operations and model home
purchase/leaseback business during 1999, and decided not to extend the forward
commitments on commercial mortgage loans. In addition, in lieu of
securitization, the Company decided to sell as whole loans its commercial loans
held in inventory. The sale of the two production operations will significantly
lower the Company's capital requirements and will reduce the need for short-term
financing. As a result of the decision not to extend the forward commitments on
commercial mortgage loans and the related decision to sell (versus securitize)
the commercial mortgage loans in inventory as whole loans, the Company recorded
a writedown in the fourth quarter of 1999 of $54.6 million. On a longer-term
basis, competitive pressures, including competing against larger companies which
generally have significantly lower costs of capital and access to the financing
sources, the lack of ability to obtain critical lending sources to finance its
production operations, and the lack of ability to access the capital markets as
a long-term source of financing in a cost effective manner, are expected to
continue to hamper the Company's ability to compete profitably in the
marketplace for the foreseeable future.
The Company has recourse debt of approximately $537 million as of December
31, 1999, of which $425 million comes due in 2000 (see Note 7, Recourse Debt).
Given the Company's operating performance during 1999 and the recent jury
verdict in the litigation with AutoBond Acceptance Corporation as discussed in
Note 14, Litigation, the Company's access to additional credit has been limited,
and there is generally less willingness of the Company's current lenders to
grant extensions. In addition, the Company is in violation of certain covenants
in two of its warehouse lines of credit and the 1994 Senior Notes, principally
related to minimum senior unsecured ratings and minimum net worth requirements,
and the receipt of a going concern opinion from its auditors. The Company has
not received waivers for these covenant violations, and, as a result, certain
lenders could accelerate the debt as due and payable upon written notice. As of
April 14, 2000, no lender has accelerated such debt.
As of April 14, 2000, the aggregate amount due under the two warehouse
lines of credit was $262.4 million, collateralized by loans with an unpaid
principal balance of $352.2 million, and cash reserves of $8.4 million.
Substantially all collateral pledged under these lines is held for sale. No
assurance can be given, however, that any sales will ultimately be consummated.
The senior unsecured notes due July 2002, with an outstanding balance of
$97.3 million at December 31, 1999, contain covenants which provide for the
acceleration of amounts outstanding should Dynex REIT default under other credit
agreements in amounts in excess of $10 million, and such amounts outstanding
under the other credit agreements are accelerated by the respective lender.
As of April 14, 2000, the Company also has $74.7 million outstanding under
repurchase agreements with substantially one counterparty, which amount is
collateralized with collateral having a current estimated market value of $91.1.
As discussed in Note 14, Litigation, on March 9, 2000, a jury in the
litigation with AutoBond Acceptance Corporation ("AutoBond") returned a verdict
in favor of AutoBond, and awarded $18.7 million in direct lost profits and $50.5
million in lost future profits to AutoBond. On April 17, 2000, based on motions
filed by the Company, the judge presiding over the matter in Travis County
proposed a judgement of approximately $27 million (which includes estimated
prejudgment interest) in lieu of the approximate $69 million jury verdict. As a
result, the Company recorded a litigation provision of $27.0 million. The charge
was reflected in impairment charges and litigation provision in the accompanying
financial statements.
Reclassifications Certain reclassifications have been made to the financial
statements for the years ended December 31, 1998 and 1997 to conform to the
December 31, 1999 presentation.
Stock Splits On May 5, 1997, Dynex REIT completed a two-for-one common
stock split. On July 26, 1999, Dynex REIT completed a one-for-four reverse
common stock split. All references to the per share amounts in the accompanying
consolidated financial statements and related notes have been restated to
reflect both stock splits.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Federal Income Taxes Dynex REIT has elected to be taxed as a real estate
investment trust ("REIT") under the Internal Revenue Code. As a result, Dynex
REIT generally will not be subject to federal income taxation at the corporate
level to the extent that it distributes at least 95 percent of its taxable
income to its shareholders within the proscribed period and complies with
certain other requirements. No provision has been made for income taxes for
Dynex Capital, Inc. and its qualified REIT subsidiaries in the accompanying
consolidated financial statements, as Dynex REIT believes it has met or will
meet the prescribed requirements.
Investments Pursuant to the requirements of Statement of Financial
Accounting Standards No. 115 ("FAS No. 115"), "Accounting for Certain
Investments in Debt and Equity Securities," Dynex REIT is required to classify
certain of its investments as either trading, available-for-sale or
held-to-maturity. Dynex REIT has classified collateral for collateralized bonds
and securities as available-for-sale. These investments are therefore reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as accumulated other comprehensive income. Any decline in the fair
value of an investment below its amortized cost which is deemed to be other than
temporary is charged to earnings. The basis of any securities sold is computed
using the specific identification method. Collateral for collateralized bonds
can be sold only subject to the lien of the respective collateralized bond
indenture, unless the related bonds have been redeemed.
Collateral for Collateralized Bonds. Collateral for collateralized bonds
consists of securities which have been pledged to secure collateralized bonds.
These securities are primarily backed by single family, multifamily and
commercial properties and installment loans on manufactured housing.
Substantially all of the collateral for collateralized bonds is pledged to
secure non-recourse debt in the form of collateralized bonds issued by
limited-purpose finance subsidiaries and is not available for the satisfaction
of general claims of Dynex REIT. As the collateralized bonds are non-recourse to
Dynex REIT, Dynex REIT's exposure to loss on the assets pledged as collateral
for collateralized bonds is generally limited to the amount of collateral
pledged to the collateralized bonds in excess of the amount of the
collateralized bonds issued.
Securities. Securities consist primarily of fixed-rate funding notes and
securities secured by fixed-rate automobile installment contracts originated by
AutoBond ("Funding Notes" and "Securities"), adjustable-rate mortgage ("ARM")
securities, fixed-rate mortgage securities, mortgage derivative securities and
mortgage residual interests.
Other Investments. Other investments consist primarily of property tax
receivables and an installment note receivable received in connection with the
sale of the Company's single family mortgage operations in May 1996. Other
investments are carried at their amortized cost basis.
Loans Held for Sale or Securitization Loans held for sale or securitization
at December 31, 1999 primarily include first mortgage loans secured by
multifamily and commercial properties. These loans are considered held for sale,
and accordingly are carried at the lower of cost or market.
Loans held for sale or securitization at December 31, 1998 included first
mortgage loans secured by multifamily and commercial properties, and installment
loans secured by manufactured housing. At December 31, 1998, these loans were
held for securitization as collateral for collateralized bonds and were carried
at amortized cost. Premiums paid or discounts obtained on these loans were
deferred as an adjustment to the carrying value of the loans. Deferred hedging
gains or losses, if any, were netted against the outstanding asset balances.
Construction loans on multifamily properties are also included in loans
held for sale or securitization. Such loans are carried at the balance funded to
date. Interest earned on these loans is capitalized and included as a component
of the amount funded until construction is completed and the property is
stabilized.
Price Premiums and Discounts Price premiums and discounts on investments
and obligations are amortized into interest income or expense, respectively,
over the life of the related investment or obligation using a method that
approximates the effective yield method.
Deferred Issuance Costs Costs incurred in connection with the issuance of
collateralized bonds and unsecured notes are deferred and amortized over the
estimated lives of their respective debt obligations using a method that
approximates the effective yield method.
Derivative Financial Instruments 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.
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.
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 these contracts are deferred
as an adjustment to the carrying value of the related loans until the loan has
been funded and accounted for consistent with the accounting of the underlying
loan, or are recognized if the associated forward contract expires or is
otherwise terminated.
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.
Cash Approximately $31,302 and $24,437 of cash at December 31, 1999 and
1998, respectively, is either held as collateral for outstanding letters of
credit; is held in trust to cover losses not otherwise covered by insurance; or
is otherwise restricted for the payment of premiums on various insurance
policies related to certain securities.
Net Income Per Common Share Net income per common share is presented on
both a basic net income per common share and diluted net income per common share
basis. Diluted net income per common share assumes the conversion of the
convertible preferred stock into common stock, using the if-converted method,
and stock appreciation rights, using the treasury stock method, but only if
these items are dilutive. As a result of the two-for-one split in May 1997 and
the one-for-four reverse split in July 1999 of the Dynex REIT's common stock,
the preferred stock is convertible into one share of common stock for two shares
of preferred stock.
Use of Estimates The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reported
period. Actual results could differ from those estimates. The primary estimates
inherent in the accompanying consolidated financial statements are discussed
below.
Fair Value. Dynex REIT 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. Estimates of fair value for
other financial instruments are based primarily on management's judgment. Since
the fair value of Dynex REIT's financial instruments is based on estimates,
actual gains and losses recognized may differ from those estimates recorded in
the consolidated financial statements. The fair value of all on- and off-balance
sheet financial instruments is presented in Note 8.
Allowance for Losses. As discussed in Note 5, Dynex REIT has credit risk on
certain investments in its portfolio. An allowance for losses has been estimated
and established for current expected losses based on management's judgment. The
allowance for losses is evaluated and adjusted periodically by management based
on the actual and projected timing and amount of probable credit losses, as well
as industry loss experience. Provisions made to increase the allowance related
to credit risk are presented as provision for losses in the accompanying
consolidated statements of operations. Dynex REIT's actual credit losses may
differ from those estimates used to establish the allowance.
Derivative and Residual Securities. Income on certain derivative and
residual securities is accrued using the effective yield method based upon
estimates of future cash flows to be received over the estimated remaining lives
of the related securities. Reductions in carrying value are made when the total
projected cash flow is less than the Company's basis, based on either the
dealers' prepayment assumptions or, if it would accelerate such adjustments,
management's expectations of interest rates and future prepayment rates. In some
cases, derivative and residual securities may also be placed on non-accrual
status.
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. In June 1999, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 137, "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133" ("FAS No. 137"). FAS No. 137 amends FAS No. 133 to defer its
effective date to all fiscal quarters of all fiscal years beginning after June
15, 2000. The Company is in the process of determining the impact of adopting
FAS No. 133.
NOTE 3 - COLLATERAL FOR COLLATERALIZED BONDS, SECURITIES AND OTHER INVESTMENTS
<TABLE>
<CAPTION>
The following table summarizes Dynex REIT's amortized cost basis and fair
value of investments classified as available-for-sale, as of December 31, 1999
and 1998, and the related average effective interest rates:
- ----------------------------------------- ------------------------------- ---- -------------------------------
1999 1998
Effective Effective
Fair Value Interest Rate Fair Value Interest Rate
- ----------------------------------------- --------------- --------------- ---- --------------- ---------------
<S> <C> <C> <C> <C>
Collateral for collateralized bonds:
Amortized cost $ 3,752,702 7.8% $ 4,288,520 7.5%
Allowance for losses (15,299) (16,593)
- ----------------------------------------- --------------- --------------- ---- --------------- ---------------
Amortized cost, net 3,737,403 4,271,927
Gross unrealized gains 34,198 67,236
Gross unrealized losses (70,887) (45,635)
- ----------------------------------------- --------------- --------------- ---- --------------- ---------------
$ 3,700,714 $ 4,293,528
- ----------------------------------------- --------------- --------------- ---- --------------- ---------------
Securities:
Funding Notes and Securities $ 94,890 6.8% $ 122,009 8.0%
Adjustable-rate mortgage securities 18,047 7.0% 58,935 6.2%
Fixed-rate mortgage securities 9,861 13.5% 28,851 8.3%
Derivative and residual securities 18,421 1.5% 33,480 2.9%
Other securities - - 28,153 7.5%
- ----------------------------------------- --------------- --------------- ---- --------------- ---------------
141,219 271,428
Allowance for losses (1,690) (2,746)
- ----------------------------------------- --------------- --------------- ---- --------------- ---------------
Amortized cost, net 139,529 268,682
Gross unrealized gains 1,353 1,566
Gross unrealized losses (13,171) (26,264)
- ----------------------------------------- --------------- --------------- ---- --------------- ---------------
$ 127,711 $ 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.
During 1999, Dynex REIT securitized $2.3 billion of collateral, through the
issuance of three series of collateralized bonds. The collateral securitized
primarily included manufactured housing loans, and the resecuritization of
previously securitized single family mortgage loans pursuant to a call feature
in the Company's prior securitizations. The securitizations were 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 retains call
rights which are substantially in excess of a clean-up call as defined by this
accounting standard.
The components of collateral for collateralized bonds at December 31, 1999
and 1998 are as follows:
- -------------------------------------------- --------------- -------------------
1999 1998
- -------------------------------------------- --------------- -------------------
Collateral, net of allowance $ 3,670,570 $ 4,161,000
Funds held by trustees 2,707 1,656
Accrued interest receivable 22,754 27,834
Unamortized premiums and discounts, net 41,372 81,437
Unrealized (loss) gain, net (36,689) 21,601
- -------------------------------------------- --------------- -------------------
$ 3,700,714 $ 4,293,528
- -------------------------------------------- --------------- -------------------
Securities. Securities consist of Funding Notes and Securities as defined
in Notes 2, ARM securities consist of mortgage certificates secured by ARM
loans. Fixed-rate mortgage securities consist of mortgage certificates secured
by mortgage loans that have a fixed rate of interest for at least one year from
the balance sheet date. Derivative securities are classes of collateralized
bonds, mortgage pass-through certificates or mortgage certificates that pay to
the holder substantially all interest (i.e., an interest-only security), or
substantially all principal (i.e., a principal-only security). Residual
interests represent the right to receive the excess of (i) the cash flow from
the collateral pledged to secure related mortgage-backed securities, together
with any reinvestment income thereon, over (ii) the amount required for
principal and interest payments on the mortgage-backed securities or repurchase
arrangements, together with any related administrative expenses. Other
securities primarily consist of a corporate bond at December 31, 1998.
Other investments. Other investments primarily include property tax
receivables and an installment note receivable in connection with the sale of
the Company's single family mortgage operations in May 1996.
Sale of investments. Proceeds from sales of securities totaled $61,415,
$424,338, and $847,339 in 1999, 1998 and 1997, respectively. Gross gains of
$285, $8,481, and $2,743 and gross losses of $9,598, $8,532, and $2,163 were
realized on those sales in 1999, 1998 and 1997, respectively. Net (loss) gain on
sale of investments and trading activities at December 31, 1999 also includes
(i) realized losses of $7,386 related to the sale of $58,724 of commercial loans
during the year ended December, 31, 1999 and (ii) realized gains of $4,176 on
various derivative trading positions entered into during the year ended December
31, 1999. At December 31, 1999, the Company had no open derivative trading
positions outstanding,
In 1999, Dynex REIT recorded an impairment charge of $4,732 relating to the
Funding Notes and Securities held by the Company at December 31, 1999. In 1998,
Dynex REIT recorded an impairment charge of $17,632 relating to the Funding
Notes, a senior unsecured convertible note acquired from AutoBond in June 1998
and certain equity securities of AutoBond held by the Company at December 31,
1998.
NOTE 4 - LOANS HELD FOR SALE OR SECURITIZATION
The following table summarizes Dynex REIT's loans held for sale or
securitization at December 31, 1999 and 1998, respectively.
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------
1999 1998
---------------------------------------------------------------------------------------------------
<S> <C> <C>
Secured by multifamily and commercial properties $ 234,593 $ 160,101
Secured by manufactured homes 2,852 197,076
Secured by single family residential properties 629 1,243
----------------- ----------------
238,074 358,420
Deferred hedging costs 3,496 52,355
Net discount (8,744) (21,014)
Allowance for losses (442) (979)
---------------------------------------------------------------------------------------------------
Total loans held for sale or securitization $ 232,384 $ 388,782
---------------------------------------------------------------------------------------------------
</TABLE>
As of December 31, 1999 approximately 50% of the multifamily and commercial
loans held for sale or securitization are located in Louisiana, Texas,
California and Florida.
The Company funded loans with an aggregate principal balance of $706,636
and $1,150,271 during 1999, and 1998, respectively. Included in these amounts
are $136,682, and $228,613 of multifamily construction loans and tax exempt
bonds closed during the years ended December 31, 1999, and 1998, respectively.
Only the amount drawn on the construction loans of $115,515 and $46,146 is
included in the balance of the loans held for sale or securitization at December
31, 1999 and 1998, respectively. Additionally, Dynex REIT purchased loans on a
bulk basis, principally single family ARM loans, totaling $562,045 in 1998. The
Company made no bulk loan purchases in 1999.
In the fourth quarter of 1999, the Company decided not to extend the
forward commitments on commercial mortgage loans and to sell (versus securitize)
the commercial mortgage loans held in inventory as whole loans. Accordingly, the
Company reclassified loans with a principal balance of $261,925 from held for
securitization to held for sale, and recognized a loss of $31,597 to adjust the
carrying value of these loans to the lower of cost or market. The
reclassification was necessary as the Company no longer had the intent nor the
ability to hold such loans to maturity. The Company wrote-off $28,365 of
previously deferred hedging costs related to the expiration of the forward
commitments to fund $255,577 of multifamily and commercial and multifamily
loans. The Company currently has commitments outstanding to fund multifamily
loans of $17.7 million, and has remaining construction draw commitments of $8.3
million. The charges relating to exiting these operations have been included in
"writedowns associated with commercial production operations" in the
accompanying financial statements.
NOTE 5 - ALLOWANCE FOR LOSSES
The following table summarizes the activity for the allowance for losses on
investments for the years ended December 31, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
- ---------------------------------------------- --------------- --------------- ---------------
1999 1998 1997
- ---------------------------------------------- --------------- --------------- ---------------
<S> <C> <C> <C>
Allowance at beginning of year $ 20,370 $ 30,270 $ 39,781
Provision for losses 16,154 6,421 4,933
Credit losses, net of recoveries (19,040) (16,321) (14,444)
- ---------------------------------------------- --------------- --------------- ---------------
Allowance at end of year $ 17,484 $ 20,370 $ 30,270
- ---------------------------------------------- --------------- --------------- ---------------
</TABLE>
Collateral for collateralized bonds. Dynex REIT has exposure to credit risk
retained on loans that it has securitized through the issuance of collateralized
bonds. The aggregate loss exposure is generally limited to the amount of
collateral in excess of the related investment-grade collateralized bonds issued
(commonly referred to as "overcollateralization"), excluding price premiums and
discounts and hedge gains and losses. The allowance for losses on the
overcollateralization totaled $15,299 and $16,593 at December 31, 1999 and 1998
respectively, and is included in collateral for collateralized bonds in the
accompanying consolidated balance sheets. Overcollateralization amounted to
$229,328 and $206,779 at December 31, 1999 and 1998, respectively, and $179,438
and $152,248, at December 31, 1999 and 1998, respectively, net of the allowance
for losses, collateral discounts, and third party loss reimbursement guarantees.
Securities. On certain securities collateralized by mortgage loans
purchased by Dynex REIT for which mortgage pool insurance is used as the primary
source of credit enhancement, Dynex REIT has limited exposure to certain credit
risks such as fraud in the origination and special hazards not covered by such
insurance. An allowance was established based on the estimate of losses at the
time of securitization. The allowance for losses for securities is $1,690 and
$2,746 at December 31, 1999 and 1998, respectively, and is included in
securities in the accompanying consolidated balance sheets.
Other investments. Dynex REIT has established reserves for potential losses
for property tax receivables totaling $53 at both December 31, 1999 and 1998.
This amount excludes the difference between what the respective property owners
owe satisfy their tax obligation, and the Company's basis in such property tax
receivables. Such differences were $6,968 and $89 at December 31, 1999 and 1998,
respectively.
Loans held for sale or securitization. Dynex REIT has established reserves
for potential losses for the loans held for sale or securitization totaling $442
and $979 at December 31, 1999 and 1998, respectively.
NOTE 6 - NON-RECOURSE DEBT
Dynex REIT, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds. Each series of
collateralized bonds may consist of various classes of bonds, either at fixed or
variable rates of interest. Payments received on the collateral for
collateralized bonds and any reinvestment income thereon are used to make
payments on the collateralized bonds (see Note 3). The obligations under the
collateralized bonds are payable solely from the collateral for collateralized
bonds and are otherwise non-recourse to Dynex REIT. The maturity of each class
is directly affected by the rate of principal prepayments on the related
collateral. Each series is also subject to redemption according to specific
terms of the respective indentures, generally when the remaining balance of the
bonds equals 35% or less of the original principal balance of the bonds. As a
result, the actual maturity of any class of a collateralized bonds series is
likely to occur earlier than its stated maturity.
Dynex REIT may retain certain classes of collateralized bonds issued,
financing these retained collateralized bonds through a combination of
repurchase agreements and equity. Total retained bonds at December 31, 1999 and
1998 were $239,079 and $375,108, respectively.
The components of collateralized bonds along with certain other information
at December 31, 1999 and 1998 are summarized
as follows:
<TABLE>
<CAPTION>
- ------------------------------ ------------------------------------ --- ----------------------------------
1999 1998
- ------------------------------ ------------------------------------ --- ----------------------------------
Bonds Outstanding Range of Bonds Range of
Interest Rates Outstanding Interest Rates
- ------------------------------ ------------------- ---------------- --- ----------------- ----------------
<S> <C> <C> <C> <C>
Variable-rate classes $ 1,968,915 5.8% - 9.1% $ 3,028,108 5.1% - 7.0%
Fixed-rate classes 1,315,944 6.2% - 11.5% 630,074 6.3% - 11.5%
Accrued interest payable 9,364 5,687
Deferred bond issuance costs (10,818) (6,880)
Unamortized net (discount)
premium (1,027) 8,327
- ------------------------------ ------------------- ---------------- --- ----------------- ----------------
$ 3,282,378 $ 3,665,316
- ------------------------------ ------------------- ---------------- --- ----------------- ----------------
Range of stated maturities 2009-2033 2009-2032
Number of series 27 33
- ------------------------------ ------------------- ---------------- --- ----------------- ----------------
</TABLE>
The variable rate classes are based on one-month London InterBank Offered
Rate (LIBOR). The average effective rate of interest expense for non-recourse
debt was 6.2%, 6.4%, and 6.7% for the years ended December 31, 1999, 1998 and
1997, respectively.
NOTE 7 - RECOURSE DEBT
Dynex REIT utilizes repurchase agreements, notes payable and secured credit
facilities (together, "recourse debt") to finance certain of its investments.
The following table summarizes Dynex REIT's recourse debt outstanding and the
weighted-average annual rates at December 31, 1999 and 1998:
<TABLE>
<CAPTION>
- ----------------------------------------- ----------------------------------------- - -----------------------------------------
1999 1998
- ----------------------------------------- ----------------------------------------- - -----------------------------------------
Weighted-Average Weighted-Average
Annual Rate Market Value Annual Rate Market
Amount of Collateral Amount Value of
Outstanding Outstanding Collateral
- ----------------------------------------- ------------- ------------ -------------- - -------------- ------------ -------------
Recourse debt secured by:
<S> <C> <C> <C> <C> <C> <C>
Collateralized bonds $ 144,746 6.68% $ 173,278 $ 298,695 6.01% $ 348,494
Securities 66,090 8.70% 114,641 192,706 6.53% 245,375
Other investments 31,498 8.47% 36,614 142,883 6.20% 159,377
Loans held for sale or securitization 183,901 7.93% 257,739 250,589 7.19% 334,855
Other assets 990 7.42% 895 2,557 7.46% 4,520
------------- -------------- -------------- -------------
427,225 583,167 887,430 1,092,621
Unsecured debt:
7.875% senior notes 96,361 7.88% - 98,718 7.88% -
Series B 10.03% senior notes 13,512 10.03% - 26,116 10.03% -
Series A 9.56% senior notes - - - 2,969 9.56% -
Bank credit facility - - - 17,500 8.03% -
- ----------------------------------------- ------------- ------------ -------------- - -------------- ------------ -------------
$ 537,098 $ 583,167 $1,032,733 $ 1,092,621
- ----------------------------------------- ------------- ------------ -------------- - -------------- ------------ -------------
</TABLE>
Secured Debt. At December 31, 1999 and 1998, recourse debt consisted of
$163,045 and $529,067, respectively, of repurchase agreements secured by
investments, $263,190 and $355,805, respectively, outstanding under secured
credit facilities which are secured by loans held for sale or securitization,
securities and other investments, and $990 and $2,557, respectively, of amounts
outstanding under a capital lease. At December 31, 1999, substantially all
recourse debt in the form of repurchase agreements had maturities within sixty
days and bear interest at rates indexed to LIBOR. If the counterparty to the
repurchase agreement fails to return the collateral, the ultimate realization of
the security by Dynex REIT may be delayed or limited. The excess market value of
the assets securing Dynex REIT's repurchase obligations at December 31, 1999 did
not exceed 10% of shareholders' equity for any of the individual counterparties
with whom Dynex REIT had contracted these agreements.
At December 31, 1999, Dynex REIT had four committed secured credit
facilities aggregating $698,662 to finance the funding of loans and securities,
which expire prior to December 31, 2000. The following table summarizes the
material terms of these facilities:
<TABLE>
<CAPTION>
- ---------------------------------------- --------------- ----- ------------------ -------------------- --------------------
Outstanding Range of Interest
Facility Balance Maturity Date Eligible Collateral Rates
- ---------------------------------------- --------------- ----- ------------------ -------------------- --------------------
<S> <C> <C> <C> <C>
$195,000 secured credit facility $ 111,600 (1) May 29, 2000 Loans held for Various, ranging
agented by Chase Bank of Texas sale, property tax from LIBOR plus
receivables 1.375%-2.50%
$400,000 secured credit facility with 83,600 April 28, 2000 Loans held for sale LIBOR plus 1.25%
Morgan Stanley Mortgage Capital, Inc. and 1.50%
$100,000 secured credit facility with 47,800 May 10, 2000 Funding Notes and LIBOR plus 3.00%
Daiwa Finance Corp. Securities
$3,700 secured credit facility with 3,700 December 15, 2000 Other investments LIBOR plus 2.50%
Residential Funding Corporation
- ---------------------------------------- --------------- ----- ------------------ -------------------- --------------------
$ 246,700
- ---------------------------------------- --------------- ----- ------------------ -------------------- --------------------
<FN>
(1) The $195,000 secured credit facility agented by Chase Bank of Texas includes a subline in the amount of $79,052 for
the issuance of letters of credit to facilitate the issuance of tax-exempt multifamily housing bonds as discussed in
Note 13. As of December 31, 1999, $79,052 of letters of credit had been issued under the subline. Such amount is not
included in the $111,600 balance outstanding included in the table above.
</FN>
</TABLE>
For the credit lines expiring on April 28, 2000 and May 29, 2000, Dynex
REIT is seeking to sell a substantial portion of the associated collateral by
the respective maturity dates. However, it is unlikely that Dynex REIT will be
able to payoff such credit lines by the respective maturity dates, and there can
be no assurances that the lenders will agree to any extensions. In the event
that the lenders declare an Event of Default, the underlying credit line
agreements provide for the liquidation of the pledged collateral. In such a
scenario it is likely that the Company will suffer substantial losses on the
sale of the collateral. For the credit line expiring May 10, 2000, Dynex REIT
and the lender executed a letter of intent dated April 10, 2000 whereby the
collateral currently pledged to the line is instead pledged to a
senior/subordinate security structure. Under the terms of the letter, the lender
will "purchase" the senior security, the proceeds of which are used to repay the
remaining amount outstanding under the credit line. Dynex REIT will retain the
subordinate class. The security will provide for the full amortization of the
senior class before any cash flow is paid on the subordinate class. The above
lines of credit include various representations and covenants. Dynex REIT has
violated certain covenants on credit lines expiring on April 28, 2000 and May
29, 2000 relating primarily to minimum net worth, minimum senior unsecured
ratings requirements and the receipt of a going concern opinion from its
auditors. Dynex REIT has received waivers from the investment bank on the credit
line expiring on April 28, 2000 for the minimum senior unsecured ratings and
minimum net worth requirements. Dynex REIT has not received a waiver for the
uncured covenant violation for the receipt of the going concern opinion. The
investment bank has not notified the Company formally in writing as required by
the loan agreement that it has (i) terminated its commitments to lend or (ii)
declared all or a portion of the loan due and payable. Dynex REIT has not
received waivers for any uncured covenant violations from the bank syndicate on
the credit line expiring on May 29, 2000. The bank syndicate has not formally
notified Dynex REIT in writing as required by the loan documentation, that it
has (i) terminated its commitment to lend or (ii) declared all or a portion of
the loan due and payable. The Company's recourse credit facilities generally
contain cross-default provisions whereby a default under any one credit facility
is a default under each of the other credit facilities.
In 1997, Dynex REIT entered into capital leases for financing its furniture
and computer equipment. Interest expense on these capital leases was $177, $274
and $52 for the years ended December 31, 1999, 1998 and 1997, respectively. The
leases expire in 2002. The aggregate payments due under the capital leases for
remaining three years after December 31, 1999 are $573, $317 and $255,
respectively.
Unsecured Debt. Since 1994, Dynex REIT has issued three series of unsecured
notes payable totaling $150 million. These notes payable had an outstanding
balance at December 31, 1999 of $110.8 million. The Company has $97.3 million
outstanding of its July 2002 senior notes (the "2002 Notes") and $13.5 million
outstanding on notes issued in September 1994 (the "1994 Notes"). During the
year ended December 31, 1999, Dynex REIT extinguished $2.75 million of the 2002
Notes resulting in a $0.6 million extraordinary gain. Effective May 15, 1999,
the Company amended the 1994 Notes. In return for certain covenant relief
related to the fixed-charge coverage requirements of the 1994 Notes, the Company
agreed to (i) convert the principal amortization of the 1994 Notes from annual
to monthly and (ii) shorten the remaining principal amortization period from 30
months to 16 months. Monthly amortization for the 1994 Notes through August 2000
approximates $1.7 million per month. The Company is in violation of certain
covenants in the 1994 Notes including the minimum net worth requirement and the
covenant requiring an unqualified audit opinion. The Company has not received
waivers for these defaults; however, the holders of the 1994 Notes have not
accelerated the remaining amounts due.
The 2002 Notes contain covenants which provide for the acceleration of
amounts outstanding under the 2002 Notes should Dynex REIT default under other
credit agreements in amounts in excess of $10 million, and such amounts
outstanding under the other credit agreements are accelerated by the respective
lender.
NOTE 8 - FAIR VALUE AND ADDITIONAL INFORMATION ABOUT FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standard No. 107, "Disclosures about Fair
Value of Financial Instruments" ("FAS No. 107") requires the disclosure of the
estimated fair value of on-and off-balance-sheet financial instruments. The
following table presents the amortized cost and estimated fair values of Dynex
REIT's financial instruments as of December 31, 1999 and 1998:
<TABLE>
<CAPTION>
- ----------------------------------------- ---------------------------------------- ----------------------------------------
1999 1998
---------------------------------------- ----------------------------------------
Notional Amortized Fair Notional Amortized Fair
Recorded financial instruments: Amount Cost Value Amount Cost Value
- ----------------------------------------- ------------ ------------- ------------- ------------ ------------- -------------
Assets:
<S> <C> <C> <C> <C> <C> <C>
Collateral for collateralized bonds $ - $3,734,310 $3,699,829 $ - $4,267,268 $4,293,159
Securities - 135,431 126,675 - 263,708 243,589
Other investments - 48,927 48,752 - 30,371 29,249
Loans held for sale or securitization - 236,332 237,192 - 356,895 354,102
Interest rate cap agreements 1,364,000 7,190 1,920 1,599,000 9,634 764
Liabilities:
Non-recourse debt - 3,282,378 3,282,378 - 3,665,316 3,665,316
Recourse debt:
Secured by collateralized bonds
retained - 144,746 144,746 - 298,695 298,695
Secured by investments - 282,479 282,479 - 588,735 588,735
Unsecured - 109,873 80,747 - 145,303 105,205
Off-balance sheet financial
instruments:
- ----------------------------------------- ------------ ------------- ------------- ------------ ------------- -------------
Options on futures contracts - - - 700,000 4,589 2,441
Interest rate swap agreements 1,020,000 - (1,259) 1,139,863 - (3,699)
Commitments to fund loans 54,668 (3,948) 49,066 823,030 27,908 849,713
- ----------------------------------------- ------------ ------------- ------------- ------------ ------------- -------------
</TABLE>
The fair value of collateral for collateralized bonds, securities, other
investments, loans held for sale or securitization and interest rate cap
agreements is based on actual market price quotes, or by determining the present
value of the projected future cash flows using appropriate discount rates,
credit losses and prepayment assumptions. Non-recourse debt and secured recourse
debt are short-term borrowings that reprice frequently. Therefore, the carrying
value approximates the fair value. For unsecured debt maturing in less than one
year, carrying value approximates fair value. For unsecured debt with a maturity
of greater than one year, the fair value was determined by calculating the
present value of the projected cash flows using appropriate discount rates. The
fair value of the off-balance sheet financial instruments excluding the
commitments to fund loans was determined from actual market quotes. The fair
value of the commitments to fund loans was estimated assuming the loans were
securitized at current market rates.
Derivative Financial Instruments Used for Interest Rate Risk Management
Dynex REIT may engage in derivative financial instrument activities for the
purpose of interest rate risk management and yield enhancement. As of December
31, 1999, all of Dynex REIT's outstanding derivative financial positions were
for interest rate risk management. For all derivative financial instruments,
Dynex REIT has credit risk to the extent that the counterparties do not perform
their obligation under the agreements. If one of the counterparties does not
perform, Dynex REIT would not receive the cash to which it would otherwise be
entitled under the conditions of the agreement.
Interest rate cap agreements. Dynex REIT has LIBOR and one-year Constant
Maturity Treasury (CMT) index based interest rate cap agreements to limit its
exposure to the lifetime interest rate caps on certain of its ARM securities and
collateral for collateralized bonds. Under these agreements, the Company will
receive additional cash flow should the related index increase above the
contracted rates. Contract rates on these cap agreements range from 9.0% to
11.5%, with expiration dates ranging from 2001 to 2004.
Financial futures, forwards and options contracts. Dynex REIT may use
financial futures, forward and option contracts to reduce exposure to the effect
of changes in interest rates on funded loans, as well as those loans that Dynex
REIT has committed to fund. As of December 31, 1999, Dynex REIT had outstanding
commitments to fund multifamily and commercial loans of $26,005 at fixed
interest rates ranging from 6.69% to 7.90%. The multifamily and commercial
commitments had original terms of not more than 18 months. Dynex REIT has
deferred net hedging losses of $186 at December 31, 1999. At December 31, 1999,
there were no open financial futures, forward or options contracts to reduce
exposure to the effect of changes in interest rates on these commitments.
Interest rate swap agreements. Dynex REIT may enter into various interest
rate swap agreements to limit its exposure to changes in financing rates of
collateral for collateralized bonds and certain securities. Dynex REIT has
entered into a series of interest rate swap agreements which limits the increase
in borrowing costs in any six-month period to 1% for $1,020,000 notional amount
of short-term borrowings. Pursuant to the terms of this agreement, Dynex REIT
pays the lesser of current six-month LIBOR, or six-month LIBOR in effect
180-days prior plus 1%, and receives current 6-month LIBOR. These agreements
expire in 2001.
During 1999, Dynex REIT terminated interest rate swap agreements with a
notional value of $102,198. These interest rate swap agreements related to Prime
rate-based ARM loans financed with LIBOR-based variable-rate collateralized
bonds. Under the terms of the agreement, the Company received one-month LIBOR
plus 2.65% and paid one-month average Prime rate in effect three months prior.
The cost of terminating this agreement was $750, which was deferred and is being
recognized as a yield adjustment over the remaining life of the underlying
collateral.
During 1998 and 1997, Dynex REIT entered into interest rate swap agreements
with a notional balance of $73,000 and $25,134, respectively, related to
tax-exempt bonds for which Dynex REIT facilitates the issuance. As the
facilitator of the issuance of the bonds, Dynex REIT is required to pay interest
due to the bondholders in excess of a fixed rate. The bonds are floating-rate
based on the current weekly Bond Market Association ("BMA") index. During the
fourth quarter of 1998, Dynex REIT terminated all of these agreements. The cost
of terminating these agreements was $3,419. The cost was deferred and is being
amortized over the remaining life of the tax-exempt bonds. The amount remaining
to be amortized at December 31, 1999 was $3,310.
Derivative Financial Instruments Used for Other Than Risk Rate Management
Purposes The Company may enter into financial futures, forwards and options
contracts to enhance the overall yield on its investment portfolio. Such
derivative contracts are accounted for as trading positions, and generally are
for terms of less than three months. The Company realized gross gains of $4,160
and $4,136 from these contracts in 1999 and 1998, respectively, primarily from
premium income received on options contracts written. The Company realized gross
losses of $14 and $5,565 from these contracts in 1999 and 1998, respectively.
There were no open trading positions at December 31, 1999 and 1998.
NOTE 9 - SALE OF LOAN PRODUCTION OPERATIONS
On December 20, 1999, the Company sold its manufactured housing lending
operations, which was operated through its affiliate, Dynex Financial, Inc., to
a subsidiary of Bingham Financial Services Corporation (NYSE: BFSC) ("Bingham")
for $18,602. Under the terms of the sale, Bingham purchased all of the
outstanding stock of Dynex Financial, Inc. and assets that constitute the
manufactured housing lending and servicing operations, as well as unsecuritized
loans which had been held in warehouse at the time of the sale. As a result of
the sale, the Company recorded a net gain of $1,540.
On November 10, 1999, the Company sold its model home purchase/leaseback
operations and related assets, which were operated through its affiliate, Dynex
Residential, Inc., to Residential Funding Corporation, an indirect subsidiary of
General Motors Corporation for $194,989. As a result of the sale, the Company
recorded a net gain of $6,136. The provisions of the sale included
indemnification escrows and reserves amounting to $3,000. These escrows and
reserves will be released to the Company pursuant to various terms in the
agreement over a period not to exceed 24 months.
NOTE 10 - EARNINGS PER SHARE
The following table reconciles the numerator and denominator for both the
basic and diluted EPS for the years ended December 31, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
- ----------------------------------- --------------------------- -- ---------------------------- -- ----------------------------
1999 1998 1997
--------------------------- -- ---------------------------- -- ----------------------------
- -----------------------------------
Weighted-Average Weighted-Average Weighted-Average
Number of Number of Number of
Shares Shares Shares
Income Income Income
- ----------------------------------- ---------- --- ------------ -- ----------- -- ------------- -- ----------- -- ------------
<S> <C> <C> <C> <C> <C> <C>
Income before extraordinary item $(73,618) $ 20,148 $ 73,998
Extraordinary item - loss on
extinguishment of debt (1,517) (571) -
---------- ----------- -----------
Net income after extraordinary (75,135) 19,577 73,998
item
Less: Dividends paid to preferred (12,910) (13,019) - (14,820)
stock
---------- ------------ ----------- ------------- ----------- ------------
------------ ------------- ------------
Basic (88,045) 11,483,977 6,558 11,436,599 59,178 10,757,845
Effect of dividends and additional shares
of preferred stock:
Series A - - - - 3,948 738,353
Series B - - - - 5,500 1,034,737
Series C - - - - - -
========== =========== =========== ============ =========== ============
Diluted $(88,045) 11,483,977 $ 6,558 11,436,599 $ 68,626 12,530,935
========== =========== =========== ============ =========== ============
Earnings per share before extraordinary
item:
Basic EPS ($7.53) $0.62 $5.50
=========== ============ ============
Diluted EPS ($7.53) $0.62 $5.48
=========== ============ ============
Earnings per share after extraordinary
item:
Basic EPS ($7.67) $0.57 $5.50
=========== ============ ============
Diluted EPS ($7.67) $0.57 $5.48
=========== ============ ============
Reconciliation of anti-dilutive
shares:
Dividends and additional shares
of preferred stock:
Series A $ 3,063 654,531 $ 3,111 660,812 $ - -
Series B 4,475 956,217 4,535 959,282 - -
Series C 5,372 920,000 5,373 920,000 5,372 919,868
Expense and incremental shares
of stock appreciation rights - 28,931 929 15,226 2,019 51,849
========== =========== =========== ============ =========== ============
$ 12,910 2,559,679 $ 13,948 2,555,320 $ 7,391 971,717
========== =========== =========== ============ =========== ============
- ----------------------------------- ---------- ---- ----------- -- ----------- --- ------------ -- ----------- -- ------------
</TABLE>
During 1999, Dynex REIT exercised its call rights on two series of
previously issued collateralized bonds and re-securitized these two series along
with six series of previously issued collateralized bonds redeemed in 1998. This
re-securitization resulted in $2,114 of additional costs in 1999. During 1998,
Dynex REIT redeemed six series of previously issued collateralized bonds, which
resulted in $571 of additional costs related to such redemptions. In addition,
Dynex REIT purchased $2,750 of the 2002 Notes during 1999, which resulted in an
extraordinary gain of $597. As a result of these early redemptions, both the
basic and diluted earnings per share were reduced by $0.14 during 1999.
NOTE 11 - PREFERRED STOCK
The following table presents a summary of Dynex REIT's issued and
outstanding preferred stock:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Liquidation Dividends
Preference Per Share
------------------------------------
Per Share 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Series A 9.75% Cumulative Convertible Preferred Stock ("Series A") $24.00 $ 1.17 $ 2.37 $ 2.71
Series B 9.55% Cumulative Convertible Preferred Stock ("Series B") 24.50 1.17 2.37 2.71
Series C 9.73% Cumulative Convertible Preferred Stock ("Series C") 30.00 1.46 2.92 2.92
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
Dynex REIT is authorized to issue up to 50,000,000 shares of preferred
stock. For all series issued, dividends are cumulative from the date of issue
and are payable quarterly in arrears. The dividends are equal, per share, to the
greater of (i) the per quarter base rate of $0.585 for Series A and Series B,
and $0.73 for Series C, or (ii) one half times the quarterly dividend declared
on Dynex REIT's common stock. Two shares of Series A, Series B and Series C are
convertible at any time at the option of the holder into one share of common
stock. Each series is redeemable by Dynex REIT at any time, in whole or in part,
(i) two shares of preferred stock for one share of common stock, plus accrued
and unpaid dividends, provided that for 20 trading days within any period of 30
consecutive trading days, the closing price of the common stock equals or
exceeds one-half of the issue price, or (ii) for cash at the issue price, plus
any accrued and unpaid dividends.
In the event of liquidation, the holders of all series of preferred stock
will be entitled to receive out of the assets of Dynex REIT, prior to any such
distribution to the common shareholders, the issue price per share in cash, plus
any accrued and unpaid dividends.
No shares of Series A, B or C preferred stock were converted during 1999.
The Company did not declare a dividend on its preferred stock during the
third or fourth quarter of 1999. As of December 31, 1999, the total amount of
dividends in arrears was $6,456. Individually, the amount of dividends in
arrears on the Series A, the Series B and the Series C was $1,532 ( $1.17 per
Series A share), $2,238 ($1.17 per Series B share) and $2,686 ($1.46 per Series
C share), respectively.
NOTE 12 - EMPLOYEE BENEFITS
Stock Incentive Plan Pursuant to the Company's 1992 Stock Incentive Plan,
as amended on April 24, 1997 (the "Employee Incentive Plan"), the Company may
grant to eligible employees stock options, stock appreciation rights ("SARs")
and restricted stock awards. An aggregate of 2,400,000 shares of common stock is
available for distribution pursuant to the Employee Incentive Plan. The Company
may also grant dividend equivalent rights ("DERs") in connection with the grant
of options or SARs. These SARs and related DERs generally become exercisable as
to 20 percent of the granted amounts each year after the date of the grant. The
Company expensed $1,830 for SARs and DERs related to the Employee Incentive Plan
during 1997, and there was no expense during 1999 and 1998. There were no stock
options outstanding as of December 31, 1999, 1998 and 1997.
Stock Incentive Plan for Outside Directors In 1995, Dynex REIT adopted a
Stock Incentive Plan for its Board of Directors (the "Board Incentive Plan")
with terms similar to the Employee Incentive Plan. On May 1, 1995, the date of
the initial date of grant under the Board Incentive Plan, each member of the
Board of Directors was granted 14,000 SARs. Each Board member has subsequently
received a grant of 2,000 SARs on May 1, 1996, 1997, 1998 and 1999. The SARs
granted on May 1, 1995 were fully vested on May 1, 1998. Each successive award
will become exercisable as to 20% of the granted amounts each year after the
date of grant. The maximum period in which any SAR may be exercised is 73 months
from the date of grant. The maximum number of shares of common stock encompassed
by the SARs granted under the Board Incentive Plan is 200,000. Dynex REIT
expensed $189 for SARs and DERs related to the Board Incentive Plan during 1997
and there was no expense during 1999 and 1998.
The following table presents a summary of the SARs activity for both the
Employee Incentive Plan and the Board Incentive Plan.
<TABLE>
<CAPTION>
-------------------------------- --------------------------------------------------------------------------------------
Years ended December 31,
--------------------------------------------------------------------------------------
--------------------------------
1999 1998 1997
------------------------ ----- ------------------------ ---- -------------------------
-------------------------------- ------------- ---------- ----- ------------ ----------- ---- ------------- -----------
Weighted-Average Weighted-Average Weighted-Average
Exercise Exercise Exercise
Number of Price Number of Price Number of Price
Shares Shares Shares
-------------------------------- ------------- ---------- ----- ------------ ----------- ---- ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
SARs outstanding at beginning
of year 219,695 $44.72 173,723 $43.48 157,955 $35.92
SARs granted 111,858 14.00 64,775 47.00 52,075 55.00
SARs forfeited (33,316) 34.15 (5,303) 48.48 - -
SARs exercised (19,525) 10.86 (13,500) 28.16 (36,307) 27.28
----------
-------------------------------- ------------- ----- ------------ ----------- ---- ------------- -----------
SARs outstanding at end of 278,712 33.33 219,695 $44.72 173,723 $43.48
year
-------------------------------- ------------- ----- ------------ ----------- ---- ------------- -----------
----------
SARs vested and exercisable 103,458 42.41 85,120 $41.52 55,910 $38.84
-------------------------------- ------------- ---------- ----- ------------ ----------- ---- ------------- -----------
</TABLE>
The Company adopted the disclosure-only option under Statement of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("FAS No.
123"). If the fair value accounting provisions of FAS No. 123 had been adopted
as of January 1, 1996 the pro forma effect on the 1999, 1998 and 1997 results
would have been immaterial. The exercise price range for the SARs outstanding at
December 31, 1999 was $14.00-$58.00 with a weighted-average exercise price of
$33.33 and a weighted-average contractual remaining life of 3 years.
Employee Savings Plan The Company provides an Employee Savings Plan under
Section 401(k) of the Internal Revenue Code. The Employee Savings Plan allows
eligible employees to defer up to 12% of their income on a pretax basis. The
Company matches the employees' contribution, up to 6% of the employees' eligible
compensation. The Company may also make discretionary contributions based on the
profitability of the Company. The total expense related to the Company's
matching and discretionary contributions in 1999, 1998 and 1997 was $541, $497,
and $424, respectively. The Company does not provide post employment or post
retirement benefits to its employees.
401(k) Overflow Plan During 1997, the Company adopted a non-qualifying
overflow plan which covers employees who have contributed to the Employee
Savings Plan the maximum amount allowed under the Internal Revenue Code. The
excess contributions are made to the overflow plan on an after-tax basis.
However, the Company partially reimburses employees for the effect of the
contributions being made on an after-tax basis. The Company matches the
employee's contribution up to 6% of the employee's eligible compensation. The
total expense related to the Company's reimbursements in 1999, 1998 and 1997 was
$60, $56 and $17, respectively.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
The Company makes various representations and warranties relating to the
sale or securitization of loans. To the extent the Company were to breach any of
these representations or warranties, and such breach could not be cured within
the allowable time period, the Company would be required to repurchase such
loans, and could incur losses. In the opinion of management, no material losses
are expected to result from any such representations and warranties.
The Company has made various representations and warranties relating to the
sale of various production operations. 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 cover any
loss and expenses up to certain limits. 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 construction or moderate
rehabilitation mortgage loans on multifamily properties. These tax-exempt bonds
are sold to third party investors. Dynex REIT enters into various standby
commitment and similar agreements whereby Dynex REIT is required to pay
principal and interest to the bondholders in the event there is a payment
shortfall from the construction proceeds, and is required to repurchase bonds if
the bonds cannot be successfully marketed. Dynex REIT provided letters of credit
to support its obligations in amounts equal $95,730 and $144,216 at December 31,
1999 and 1998, respectively. Dynex REIT is also party to various conditional
bond repurchase obligation agreements which require Dynex REIT to repurchase
bonds in the aggregate notional amount of $167,700 by June 15, 2000. As support
for its obligation to repurchase, Dynex REIT has posted fully
cash-collateralized letters of credit totaling $16,678, and esrowed cash of an
additional $15,832 and posted a $5,000 sight draft surety bond. Such amounts are
at risk should the Company fail on its repurchase obligation.
As of December 31, 1999, Dynex REIT is obligated under noncancelable
operating leases with expiration dates through 2004. Rent expense under those
leases was $278, $336, and $295, respectively in 1999, 1998 and 1997. The future
minimum lease payments under these noncancelable leases are as follows:
2000--$642; 2001--$659; 2002--$677; 2003--$696 and 2004--$9.
NOTE 14 - LITIGATION
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 the Credit Agreement, dated June 9, 1998, by and
among AutoBond, Funding and the Company. The terms of the Credit Agreement
provided for the purchase by the Company of funding notes issued by Funding, and
collateralized by automobile installment contracts ("Auto Contracts") acquired
by AutoBond. The Company suspended purchasing the funding notes in February 1999
on grounds that AutoBond and Funding had violated certain provisions of the
Credit Agreement. The Plaintiffs also alleged 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.
On August 26, 1999, the District Court of Travis County ordered AutoBond
and Funding, through a temporary injunction action, to cooperate with the
Company and permit the transfer of the servicing of the Auto Contracts from
AutoBond to a third party servicer selected by the Company. The servicing was
transferred on September 3, 1999.
On March 9, 2000, a jury in the AutoBond action returned a verdict in favor
of the Plaintiffs, and awarded AutoBond and Funding $18.7 million in direct lost
profits and $50.5 million in lost future profits, for a total of $69.2 million.
The Company filed on March 24, 2000 with the Court motions to set aside the
verdict and to reduce the amount of the verdict, and on the same date, AutoBond
filed a motion to the court to enter judgment. On April 17, 2000, in response to
the various motions filed, the judge presiding over the matter in Travis County
reduced the $69.2 million verdict awarded by the jury to approximately $27
million (which includes estimated prejudgment interest). As a result, the
Company recorded a litigation provision of $27.0 million for the amount of the
reduced judgment. Should AutoBond not accept the proposed judgment, the judge
has indicated that he will grant Dynex a new trial. Should AutoBond accept the
judgment, the Company is evaluating its options in the matter, which may include
the appeal of the verdict and the resulting judgment. Factors for the Company to
consider include the potential inability of the Company to post the amount of
appeal bond necessary to secure an appeal. Should Dynex REIT not be able to
secure an appeal bond for the full amount of the proposed judgement of $27
million, Texas State law would allow for Dynex REIT to present evidence to
reduce the required amount of the appeal bond or to provide other collateral for
the appeal. There can be no assurance that Dynex REIT will be allowed to post a
reduced bond.
The Company is also subject to other lawsuits or claims which arise in the
ordinary course of its business, some of which seek damages in amounts which
could be material to the financial statements. Although no assurance can be
given with respect to the ultimate outcome of any such litigation or claim, the
Company believes the resolution of such lawsuits or claims will not have a
material affect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
NOTE 15 - SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS INFORMATION
<TABLE>
<CAPTION>
- ------------------------------------------------------ -----------------------------------------------------
Years ended December 31,
- ------------------------------------------------------ -----------------------------------------------------
1999 1998 1997
-------------- --------------- ---------------
<S> <C> <C> <C>
Cash paid for interest $ 264,130 $ 319,626 $ 232,598
Supplemental disclosure of non-cash activities:
Collateral for collateralized bonds owned
subsequently securitized $ 1,607,891 $ - $ 65,537
Securities owned subsequently securitized $ 4,986 $ 257,959 $ 311,117
Other investments owned subsequently securitized $ - $ 37,221 $ -
- ---------------------------------------------------------- -------------- -- --------------- -- ---------------
</TABLE>
NOTE 16 - 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 December 31, 1999 and 1998, net
borrowings due to DHI under this agreement totaled $26,720 and $8,583,
respectively. Net interest expense under this agreement was $706, $992 and $462
for the years ended December 31, 1999, 1998 and 1997, respectively.
Dynex REIT also had a loan funding agreement with Dynex Financial, Inc.
("DFI"), an operating subsidiary of DHI, whereby Dynex REIT paid DFI on a fee
plus cost basis for the origination of manufactured housing loans on behalf of
Dynex REIT. During 1999, 1998 and 1997, Dynex REIT paid DFI $12,369, $15,771 and
$9,722, respectively under such agreement. This agreement was terminated as a
result of the sale of the manufactured housing operations during 1999.
Dynex REIT had a funding agreement with Dynex Commercial, Inc. ("DCI"), an
operating subsidiary of DHI, whereby Dynex REIT pays DCI a fee per loan
purchased by Dynex REIT from DCI. Dynex REIT paid DCI $2,147, $4,753 and 1,694,
respectively under this agreement for the years ended December 31, 1999, 1998
and 1997.
Dynex REIT had note agreements with Dynex Residential, Inc. ("DRI"), an
operating subsidiary of DHI, whereby DRI and its subsidiaries could 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 note was
adjustable and was based on 30-day LIBOR plus 2.875%. During 1999, $4,577 of the
notes was assumed by SMFC Funding Corporation ("SMFC"), a subsidiary of DHI. The
remainder of the notes were paid off at the time of the sale of DRI on November
10, 1999. The outstanding balance of the notes as of December 31, 1999 and 1998
was $4,274 and $159,377, respectively. Interest income recorded by Dynex REIT
for the years ended December 31, 1999, 1998 and 1997 was $12,793, $11,971 and
$6,354, respectively.
Dynex REIT has entered into subservicing agreements with DCI, Dynex
Commercial Services, Inc. ("DCSI"), DFI and GLS Capital Services, Inc. ("GLS")
to service commercial, single family, consumer, manufactured housing loans and
property tax receivables. For servicing the commercial loans, DCI or DCSI, as
applicable, received 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 received annual fees ranging from
sixty dollars ($60) to one hundred forty-four dollars ($144) per loan and
certain incentive fees. The subservicing agreement with DFI was terminated due
to the sale of DFI on December 20, 1999. For servicing the property tax
receivables, GLS receives an annual servicing fee of 0.72% of the aggregate
unpaid principal balance of the property tax receivables. Servicing fees paid by
Dynex REIT under such agreements were $2,873, $1,061 and $321 in 1999, 1998 and
1997, respectively.
NOTE 17- INVESTMENT IN AND ADVANCES TO DYNEX HOLDING, INC.
In 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 1997 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 $4,814 and $169,384 at December 31, 1999 and 1998,
respectively. The results of operations and financial position of DHI are
summarized below:
<TABLE>
<CAPTION>
- ------------------------------------------------------ ------------------------------------------------------
Condensed Income Statement Information Years ended December 31,
- ------------------------------------------------------ ------------------------------------------------------
1999 1998 1997
- ---------------------------------------------------------- -------------- -- --------------- -- ----------------
<S> <C> <C> <C>
Total revenues $ 40,710 $ 30,126 $ 17,338
Total expenses 42,653 27,645 18,458
Net income (loss) (1,943) 2,481 (1,120)
</TABLE>
- ---------------------------------------------- ---------------------------------
Condensed Balance Sheet Information December 31,
- ---------------------------------------------- ---------------------------------
1999 1998
- -------------------------------------------------- -------------- -- -----------
Total assets $ 36,822 $ 196,324
Total liabilities 9,075 177,050
Total equity 27,747 19,274
- -------------------------------------------------- -------------- -- -----------
NOTE 18- OTHER MATTERS
During the year ended December 31, 1999, the Company issued 2,084 shares of
its common stock pursuant to its dividend
reinvestment program for net proceeds of $30.
The Company repurchased 66,100 shares of its common stock outstanding at an
aggregate purchase price of $700, or $10.59 per share, during the year ended
December 31, 1999. The Company has authorization to purchase an additional
848,900 shares of its common stock.
At the special meeting of shareholders, held on July 26, 1999, the
shareholders approved an amendment to the Articles of Incorporation to effect a
one-for-four reverse split of the issued and outstanding shares of the Company's
$0.01 par value common stock to holders of record on August 2, 1999. All
references in the accompanying financial statements to the per share amounts and
the number of shares of common stock, except for shares authorized, issued and
outstanding for 1998 have been restated to reflect the reverse stock split.
DYNEX CAPITAL, INC.
SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE
December 31, 1999
(amounts in thousands except number of loans)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
Principal
Amount of
Carrying Loans
Final Periodic Face Amount of Subject to
Interest Maturity Payment Prior Amount of Mortgage Delinquent
Description Rate Date Terms Liens Mortgages Loans Principal or
Interest
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
First mortgage loans:
Single family residential
18 mortgages, original 7.25% - Varies - $ $ $ 1,493 $ 69
loan amounts ranging from 10.25% - -
$46 to $216
Commercial
Office Building
St. Paul, Minnesota (1) 6.96% October Interest - 41,500 14,729 -
1, 2008 and
principal
monthly
Denver, Colorado (1) 8.30% October Interest - 30,000 6,870 -
1, 2012 and
principal
monthly
New Orleans, Louisiana 9.70% April 1, Interest - 8,200 8,200 -
2001 monthly
New Orleans, Louisiana 9.70% April 1, Interest - 7,400 7,400 -
2001 monthly
New Orleans, Louisiana 8.70% April 1, Interest - 15,000 15,000 -
2001 monthly
Multifamily Residential
Baton Rouge, Louisiana 7.75% March, 1 Interest - 8,075 7,297 -
2016 and
principal
monthly
Baton Rouge, Louisiana 7.75% March, 1 Interest - 8,075 6,851 -
2016 and
principal
monthly
Garland, Texas 7.95% May, 1 Interest - 11,750 11,693 -
2017 and
principal
monthly
Fredricksburg, Virginia 7.95% August, 1 Interest - 5,290 5,276 -
2017 and
principal
monthly
DYNEX CAPITAL, INC.
SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE (CONTINUED)
December 31, 1999
(amounts in thousands except number of loans)
- ----------------------------------------------------------------------------------------------------------------------------
Principal
Amount of
Carrying Loans
Final Periodic Face Amount of Subject to
Interest Maturity Payment Prior Amount of Mortgage Loans Delinquent
Description Rate Date Terms Liens Mortgages Principal or
Interest
- ----------------------------------------------------------------------------------------------------------------------------
Columbia, South Carolina 7.75% January, 1 - 4,876 4,837 -
2009 Interest
and
principal
monthly
Arvada, Colorado 7.95% January, 1 - 3,887 3,887 -
2018 Interest
and
principal
monthly
Concord, North Carolina 7.95% June, 1 2017 - 3,795 3,779 -
Interest
and
principal
monthly
Austin, Texas 8.15% September, 1 - 3,600 3,591 -
2017 Interest
and
principal
monthly
Oceanside, California 8.00% April, 1 2009 - 7,000 3,640 -
Interest
monthly
22 mortgages, original loan 6.79%- Varies - - - 30,524 -
amounts ranging from $115 to 8.75%
$3,034
- -------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
135,067
Write-down to lower of
cost or market (14,221)
Net premium/discount (2,581)
Allowance for loan losses (26)
- ------------------------------------------------------------------------------------------------------------------------------
Total mortgage loans on real $ 118,239
estate
- ------------------------------------------------------------------------------------------------------------------------------
<FN>
(1) The Company owns a participation in this loan. The remaining amount of the loan was securitized in a commercial
securitization completed by the Company in December 1998.
</FN>
</TABLE>
The loans in the table above are conventional mortgage loans secured by
either single family and/or commercial properties with initial maturities
ranging from 3 to 30 years. All of the loans above are fixed-rate. The Company
believes that its mortgage pool insurance and allowance of $26 are adequate to
cover any exposure on delinquent mortgage loans. A summary of activity of the
single family and commercial mortgage loans for the years ended December 31,
1999, 1998 and 1997 is as follows:
Balance at December 31, 1996 $ 238,428
Mortgage loans funded 1,526,229
Collection of principal (61,188)
Mortgage loans sold or securitized (1,544,844)
-------------------------------------- -------------- ----------------
Balance at December 31, 1997 158,625
Mortgage loans funded or purchased 1,164,512
Collection of principal (118,583)
Mortgage loans securitized (1,070,186)
-------------------------------------- -------------- ----------------
Balance at December 31, 1998 134,368
Mortgage loans funded or purchased 183,386
Collection of principal (16,642)
Mortgage loans sold or securitized (168,652)
Write-down of loans to lower of cost
or market (14,221)
-------------------------------------- -------------- ----------------
Balance at December 31, 1999 $ 118,239
-------------------------------------- -------------- ----------------
The geographic distribution of the Company's single family and commercial
loans held for sale or securitization at December 31, 1999 is as follows:
Number of Loans Principal
State Amount
------------------------- ------ ------------------ ----------------------
California 2 $
3,798
Colorado 2 10,766
Georgia 1 115
Kansas 1 1,233
Kentucky 1 115
Louisiana 6 47,381
Michigan 3 4,901
Minnesota 4 17,116
Mississippi 1 434
North Carolina 9 6,348
Nebraska 1 1,538
New York 2 4,753
Oregon 1 78
South Carolina 3 6,626
Tennessee 6 4,561
Texas 4 17,799
Utah 1 1,357
Virginia 4 5,505
Wisconsin 1 573
West Virginia 1 70
---------------------------------- --- ------- ------------------------ --
Total 135,067
Write-down to lower of cost or
market (14,221 )
Net premium/discount (2,581 )
Allowance for loan losses (26 )
---------------------------------- --- ------- ------------------------ --
$
118,239
---------------------------------- --- ------- ------------------------- --
EXHIBIT INDEX
Sequentially
Exhibit Numbered Page
21.1 List of consolidated entities I
23.1 Consent of Deloitte & Touche LLP II
23.2 Consent of KPMG LLP III
Exhibit 21.1
Dynex Capital, Inc.
List of Consolidated Entities
As of December 31, 1999
MSC 1 L.P.
Merit Auto Finance Corporation
Dynex Healthcare Capital, Inc.
Issuer Holding Corp.
Commercial Capital Access One, Inc.
Resource Finance Co. One
Resource Finance Co. Two
ND Holding Co.
Merit Securities Corporation
GLS Capital, Inc.
GLS Capital Marlborough, Inc.
GLS Capital - Cuyahoga, Inc.
SHF Corp.
Dynex Holding, Inc.
Dynex Commercial, Inc.
Dynex Healthcare, Inc.
Dynex Commercial Services, Inc.
GLS Capital Services, Inc.
GLS Development, Inc.
SMFC Funding Corporation
Dynex Securities Corporation
Dynex Bank Holding Corporation
Dynex Home Loan, Inc.
Financial Asset Securitization, Inc.
NOTE: All companies were incorporated in Virginia except for Dynex Holding,
Inc. (Delaware).
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Dynex Capital, Inc.:
We consent to the incorporation by reference in the Registration Statements
Nos. 333-22859, 333-10783, 333-10587 and 333-35769 of Dynex Capital, Inc. on
Form S-3 and Registration Statement No. 333-32663 of Dynex Capital, Inc. on Form
S-8 of our report dated April 17, 2000, appearing in this Annual Report on Form
10-K of Dynex Capital, Inc. for the year ended December 31, 1999.
DELOITTE & TOUCHE LLP
Richmond, Virginia
April 17, 2000
Exhibit 23.2
Consent of Independent Auditors
The Board of Directors
Dynex Capital, Inc.:
We consent to incorporation by reference in Registration Statements Nos.
333-22859, 333-10783, 333-10587 and 333-35769 of Dynex Capital, Inc. on Form S-3
and Registration Statement No. 333-32663 of Dynex Capital, Inc. on Form S-8 of
our report dated February 4, 1998, except as to the 1997 information contained
in note 17, which is as of April 14, 1999, relating to the consolidated
statements of operations, shareholders' equity and cash flows of Dynex Capital,
Inc. and subsidiaries for the year ended December 31, 1997, which report appears
in the December 31, 1999 annual report on Form 10-K of Dynex Capital, Inc.
KPMG LLP
Richmond, Virginia
April 14, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000826675
<NAME> Dynex Capital, Inc.
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-mos
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-START> Jan-1-1999
<PERIOD-END> Dec-31-1999
<CASH> 48,601
<SECURITIES> 3,877,352
<RECEIVABLES> 2,208
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0 <F1>
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 4,190,896
<CURRENT-LIABILITIES> 0 <F1>
<BONDS> 3,282,378
0
127,407
<COMMON> 114
<OTHER-SE> 197,551
<TOTAL-LIABILITY-AND-EQUITY> 4,190,896
<SALES> 0
<TOTAL-REVENUES> 350,798
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 150,472
<LOSS-PROVISION> 16,154
<INTEREST-EXPENSE> 270,700
<INCOME-PRETAX> (86,528)
<INCOME-TAX> 0
<INCOME-CONTINUING> (86,528)
<DISCONTINUED> 0
<EXTRAORDINARY> (1,517)
<CHANGES> 0
<NET-INCOME> (88,045)
<EPS-BASIC> (7.67)
<EPS-DILUTED> (7.67)
</TABLE>
