Back to GetFilings.com
================================================================================
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, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of (IRS Employer I.D. No.)
incorporation or organization)
4551 Cox Road, Suite 300, 23060
Glen Allen, Virginia (Zip Code)
(Address of principal executive offices)
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:
Title of each class Name of each exchange
on which registered
Series A 9.75% Cumulative Convertible
Preferred Stock, $.01 par value NASDAQ National Market
Series B 9.55% Cumulative Convertible
Preferred Stock, $.01 par value NASDAQ National Market
Series C 9.73% Cumulative Convertible
Preferred Stock, $.01 par value NASDAQ National Market
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 |X| No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
As of March 26, 2002, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $34,470,114 at a closing
price on The New York Stock Exchange of $3.17. Common stock outstanding as of
March 26, 2002 was 10,873,853 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement to be filed pursuant to Regulation
14A within 120 days from December 31, 2001, are incorporated by reference into
Part III.
================================================================================
DYNEX CAPITAL, INC.
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I
Item 1. BUSINESS............................................................1
Item 2. PROPERTIES.........................................................11
Item 3. LEGAL PROCEEDINGS..................................................11
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................11
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..............................................11
Item 6. SELECTED FINANCIAL DATA............................................12
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................13
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.........27
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................28
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.........................................28
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................28
Item 11. EXECUTIVE COMPENSATION.............................................29
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT...................................................29
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................29
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K.....................................................29
SIGNATURES...................................................................31
PART I
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, manufactured housing
installment loans and delinquent property tax receivables. These loans were
funded primarily by the Company's loan production operations or purchased in
bulk in the market. Historically, the Company's loan production operations have
included single-family mortgage lending, which was sold in 1996, commercial
mortgage lending and manufactured housing lending. Through its specialty finance
business, the Company also has provided for the purchase and leaseback of single
family model homes to builders 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 provided
long-term financing for such loans while limiting credit, interest rate and
liquidity risk. The Company 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. Provided that the Company meets all
of the proscribed Internal Revenue Code requirements for a REIT, the Company
will generally not be subject to federal income tax.
Since 1999, as a result of disruptions in the fixed income markets, the
Company has focused its efforts on conserving its capital base and repaying its
outstanding recourse obligations, including both borrowings and letters of
credit. To that end, the Company has not paid a dividend on its common stock
since 1998 and suspended regular dividends on its preferred stock in the third
quarter of 1999. The Company sold both its manufactured housing
lending/servicing operations and its model home purchase/leaseback business
during 1999 and in 2000 the Company phased-out its commercial lending
operations. Since 2000, the Company's business operations have been essentially
limited to the management of its investment portfolio and the active collection
of its portfolio of delinquent property tax receivables. As of December 31,
2001, the Company had paid off all its recourse obligations (borrowings and
letters of credit) except for $58.0 million of its senior notes due July 15,
2002 (the "Senior Notes") and $0.2 million related to a capital lease. Based on
its projected cash flow from its investment portfolio and the projected proceeds
from a securitization the Company is planning in the second quarter of 2002, the
Company projects that it will payoff its Senior Notes and capital lease in
accordance with their contractual terms. At such time, the Company will have no
recourse obligations remaining, and not be subject to any contractual
restrictions on its business or investment activities.
During the fourth quarter of 1999, the board of directors (the "Board")
engaged a financial advisor to analyze and review various alternatives for the
Company. Such effort resulted in the Company entering into a merger agreement in
the fourth quarter of 2000 whereby all of the outstanding equity securities of
the Company would be acquired by a privately owned fund for $90 million. When
the purchaser failed to satisfy various requirements in the merger agreement,
the Company terminated such agreement in January 2001. Since such date, the
Company has received other inquiries for the purchase of all or a portion of its
outstanding equity securities; none of these inquiries were on terms that the
Board felt were adequate and, as a result, were not pursued. The Company is not
actively soliciting merger proposals.
In March 2001, the Company amended the terms of its Senior Notes to
allow for up to $26 million in distributions to holders of its equity
securities. In conjunction with such amendment, the Company also agreed to
purchase $49.6 million of its Senior Notes from certain holders at discounted
prices beginning in March 2001. The Company completed the $49.6 million in
purchases over a ten-month period at a cumulative discount of $4.2 million.
During 2001, the Company completed two tender offers for shares of its preferred
stock having an aggregate liquidation preference of $40.9 million for a total
purchase price of $20.0 million. The Company believes that these tender offers
provided liquidity to those preferred shareholders desiring to sell their
shares, contributed to the improvement in the market prices of both the
Company's preferred and common shares, and improved the book value per common
share. Pursuant to a settlement agreement with an insurance company that
guaranteed a portion of the outstanding Senior Notes, the Company is effectively
precluded from further distributions on its equity securities until the Senior
Notes are paid in full.
The Board continues to evaluate strategies to improve shareholder
value. Given the improvement in the market value of the Company's equity
securities since January 2001, the Board feels that it is unlikely that any
offer will be made by a third party that would be at a level that would be
approved by both the Board and the requisite percentage of shareholders. The
Board has also reviewed possible liquidation scenarios, but the illiquid nature
of many of the Company's remaining assets and the lack of buyers for many of
such assets makes such an alternative impractical over any reasonable time
horizon.
As a result, the Board has requested management of the Company to
analyze various business directions for the Company to pursue on a going forward
basis once the remaining Senior Notes are paid in full, which the Company
expects to be completed on or before July 15, 2002. Based on a review of such
alternatives by the Board in February 2002, the Company has engaged an advisor
to assist it in evaluating the feasibility of the Company forming or acquiring a
depository institution. The Company had taken preliminary steps in that
direction in January 1999 when it visited with and submitted a draft business
plan to the Office of Thrift Supervision ("OTS"). However, the Company was
advised by the OTS that the risk profile of the Company's lines of business at
such time (essentially the origination and securitization of commercial mortgage
loans, manufactured housing loans and sub-prime auto loans) was not compatible
with the regulatory guidelines of the OTS. As a result, the Company did not
formally submit an application for a thrift charter at that time.
The Company sees the benefits of forming or acquiring a depository
institution as follows: (i) as future investments (i.e., loans and/or
securities) would be owned by the depository institution (which has access to
deposits insured by the Federal Deposit Insurance Corporation and to borrowings
from the Federal Home Loan Bank System), there would be reduced liquidity risk
to the Company in the future, a risk that has historically caused considerable
losses to specialty finance companies including the Company; (ii) the depository
institution is not dependent on the public or private markets for funding; (iii)
given that the Company's net operating and capital loss carry-forwards exceed
$180 million in the aggregate (the "NOL"), the fact that depository institutions
are subject to state and federal income taxes should not be a detriment to
financial results for the foreseeable future; (iv) while owning and operating a
depository institution would probably require the Company to give up its REIT
status, the Company will not for the foreseeable future realize any material
benefits from maintaining REIT status (certain of the Company's subsidiaries
will maintain REIT status as required while their respective securitizations are
outstanding); and (v) regulatory guidelines would likely require an investment
strategy that would be of lower risk than the Company's historic investment
strategies.
The Company also sees various drawbacks to forming or acquiring a
depository institution as follows: (i) a depository institution is highly
regulated, and such regulation limits and restricts the activities and
operations of a depository institution; (ii) the Company would become a bank or
thrift holding company and subject to various restrictions and regulations;
(iii) depository institutions operate in a very competitive environment; (iv)
the Company may not be able to achieve a return on the equity invested in a
depository institution that enhances shareholder value relative to other
alternatives for the Company; (v) the Company currently has no experience in
managing a depository institution; and (vi) the annual dividend rate on each of
the three series of preferred stock outstanding would increase by an amount
equal to approximately 0.50%.
To the extent the Company pursues forming or acquiring a depository
institution, the Company would likely use the majority of its cash flow until
the NOL is fully utilized to invest in the depository institution. While subject
to significant uncertainty, the Company projects that the NOL will not be fully
utilized until at least 2010. However, as the Company believes that the two
tender offers and partial dividend on its preferred stock during 2001 did
contribute to the improvement in the liquidity and the market prices of both the
Company's preferred and common shares, it is likely that the Company would
allocate a portion of its cash flow in the future to make distributions on its
preferred stock. Such distributions would be in the form of dividends and/or
periodic tender offers. Any such distributions (and assuming that no equity
securities were issued) would likely delay further the full utilization of the
NOL. The Company is precluded from making any distributions on its common stock
until all dividends are current on its preferred stock. However, if the Company
does pursue forming or acquiring a depository institution, the Company would
most likely minimize any future dividends on its common stock and either retain
earnings or purchase its common stock in an effort to grow earnings per common
share.
At this time, the Company has not developed a business plan for a
depository institution to submit to a regulatory agency. However, the Company
does not anticipate that the Company would encounter the same response from the
regulatory agency as it did in early 1999 because the Company is no longer in
commercial mortgage lending, manufactured housing lending, or sub-prime auto
lending (the Company currently has no loan origination operations). Any business
plan for a depository institution would thus be based on lending or investment
strategies that are compatible with the regulatory requirements. Further, to the
extent the Company does pursue a depository institution, the Board may appoint
additional directors that have recent oversight or operating experience with
depository institutions.
Prior to December 31, 2000, the Company operated the majority of its
lending and servicing activities out of a taxable affiliate, Dynex Holding, Inc.
("DHI"), and its subsidiaries, which were not consolidated for financial
reporting or tax purposes but were accounted for in the Company's financial
statement in a manner similar to the equity method. In December 2000, certain
DHI subsidiaries were sold to Company, and DHI was liquidated into the Company
in a taxable liquidation transaction. Since that time, the surviving assets and
liabilities and operations of DHI have been included in the consolidated
financial results of the Company. Prior to 2000, the consolidated results of DHI
have been included under the equity method of accounting.
Business Focus and Strategy
The Company's business plan prior to its redirection in 1999 as
outlined above, was to create a diversified investment portfolio that in the
aggregate generated stable income for the Company in a variety of interest rate
environments and preserved the capital base of the Company. The Company had
historically focused on markets where it believed that it could create
investments for its portfolio at a lower cost than if those investments were
purchased in the secondary market. The markets that the Company has historically
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. During 1998, the Company also
had entered into an arrangement to purchase funding notes secured by sub-prime
auto loans coupled with an option to buy a majority interest in AutoBond
Acceptance Corporation ("AutoBond"), the counter-party on such funding notes. As
previously indicated, the Company has either sold or phased-out its various
lending businesses, terminated its relationship with AutoBond, and is now
primarily focused on collecting its delinquent property tax receivables,
repaying its remaining recourse debt, and improving shareholder value.
The Company's principal source of earnings historically has been its
net interest income from its investment portfolio. The Company had generally
created investments for its portfolio through the issuance of non-recourse
collateralized bonds secured by a pledge of the assets generated or acquired by
its production operations. Commensurate with its shift in its business plan in
1999, the Company's investment portfolio has been declining as the result of
sales and pay-downs, with little additional investment having been made by the
Company over the past two years. The Company's remaining investment portfolio
consists primarily of collateral for collateralized bonds and delinquent
property tax receivables. The Company funds its investment portfolio primarily
through non-recourse collateralized bonds and funds raised from the issuance of
equity. For the portion of the investment portfolio funded with collateralized
bonds or other 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 the 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.
At December 31, 2001, the Company owned the right to call
adjustable-rate and fixed-rate mortgage pass-through securities previously
issued and sold by the Company once the outstanding balance of such securities
reached a call trigger, generally either 10% or less of the original amount
issued or a specified date. The aggregate projected callable balance of such
securities at the time of the projected call is approximately $325 million,
relating to 20 securities. The Company may or may not elect to call one or more
of these securities when eligible to call. During 2001, three securities reached
their call trigger, and the Company did not exercise its right to call any of
the securities. The Company has initiated the call on three securities in 2002
for approximately $31 million, and may initiate the call of eleven additional
securities in 2002 with an estimated balance of $148 million, seven of which the
company owns the call rights and four for which the company expects to purchase
the call rights. The Company may call additional securities in the future.
The Company also owns the right to purchase or redeem generally by
class the collateralized bonds on its balance sheet once the outstanding balance
of such bonds reaches 35% or less of the original amount issued or a specified
date. The Company purchased all the classes of one series of collateralized
bonds during 2001, and re-offered the bonds at a lower effective interest rate.
The Company expects that two series of collateralized bonds will be redeemed in
2002, and that the Company will resecuritize the underlying collateral, which
consists principally of single-family mortgage loans.
Lending Operations
The Company had generally been a vertically integrated lender,
performing the sourcing, underwriting, funding, and servicing of loans to
maximize efficiency and provide superior customer service. The Company had
principally focused on loan products that maximize the advantages of the REIT
tax election and had emphasized direct relationships with the borrower and
minimized, to the extent practical, the use of origination intermediaries. The
Company had 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 Company's funding activity for 2001 included the purchase of
approximately $8.7 million of delinquent property tax receivables under a
previously executed contract to purchase. The Company purchased $7.6 million of
such tax receivables in 2000. The Company's loan funding activity during 2000
also consisted of funding approximately $29.5 million related to prior
multifamily loan commitments. The Company has no remaining commitments to fund
loans or other assets.
Primary Servicing
The Company no longer services, on a primary basis, any of the assets
included in its investment portfolio other than $3.3 million of commercial
mortgage loans currently held for sale and its portfolio of delinquent property
tax receivables. 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
collecting voluntary payments from property owners, and if collection efforts
fail, foreclosing, stabilizing and selling the underlying properties. During
1999, the Company also established a satellite servicing office in Cleveland,
Ohio. As of December 31, 2001, the Company had a servicing portfolio with an
aggregate redemptive value of approximately $138 million of delinquent property
tax receivables in five states, but with the majority in Pennsylvania and Ohio.
The Company plans to offer during 2002 third-party collection services
to taxing jurisdictions for the collection of delinquent property tax
receivables. The Company plans to initially target jurisdictions in Ohio and
Pennsylvania; however, there can no assurance such effort will be successful.
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 of December 31, 2001,
the Company monitored the performance of twelve third-party servicers of single
family loans; the performance of GMAC Commercial Mortgage Corporation as the
servicer of the Company's securitized commercial mortgage loans, and Origen
Financial, LLC as the servicer of the Company's manufactured housing loans.
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, 2001, the
Company master serviced $1.7 billion in securities.
Securitization
Since late 1995, the Company's predominate securitization structure has
been collateralized bonds. Generally, for accounting and tax purposes, the loans
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
loans and the interest and other expenses associated with the collateralized
bond financing. The net interest spread is directly impacted by the credit
performance of the underlying loans, by the level of prepayments of the
underlying loans and, to the extent collateralized bond classes are
variable-rate, may be affected by changes in short-term rates. The Company's
investment in the collateralized bonds is typically referred to as the
over-collateralization. The Company analyzes and values its investment in
collateralized bonds on a "net investment basis" (i.e., the excess of the
collateral pledged over the outstanding collateralized bonds, and the resulting
net cash flow to the Company), as further discussed below.
Investment Portfolio
Composition. The following table presents the balance sheet composition
of the investment portfolio by investment type and the percentage of the total
investments as of December 31, 2001 and 2000. Collateral for collateralized
bonds and securities are presented at estimated fair value, other investments
are presented at amortized cost, and loans held for sale are presented at the
lower of cost or market.
- --------------------------------------------- ---------------------------------------------------------------
As of December 31,
2001 2000
------------------------------- -------------------------------
(amounts in thousands) Balance % of Total Balance % of Total
- --------------------------------------------- ----------------- ------------- ----------------- -------------
Investments:
Collateral for collateralized bonds $2,404,157 96.9% $3,042,158 97.8%
Securities:
Adjustable-rate mortgage securities 1,740 0.1 4,266 0.1
Fixed-rate mortgage securities 1,245 0.1 1,400 0.0
Derivative and residual securities 2,523 0.1 3,698 0.1
Other investments 63,553 2.6 42,284 1.4
Loans 7,315 0.2 19,102 0.6
- --------------------------------------------- ----------------- ------------- ----------------- -------------
Total investments $2,480,533 100% $3,112,908 100%
- --------------------------------------------- ----------------- ------------- ----------------- -------------
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 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, 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 in the past has pledged such classes as
collateral for repurchase agreements.
ARM securities. Another segment of the Company's portfolio is the
investments in adjustable-rate mortgage ("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.
Fixed-rate mortgage securities. Fixed-rate mortgage securities consist
of securities that have a fixed-rate of interest over their remaining life. The
Company's yields on these securities are primarily affected by changes in
prepayment rates.
Derivative and residual securities. Derivative and residual securities
consist primarily of interest-only securities ("I/Os"), principal-only
securities ("P/Os") and residual interests that were generally created as a
result of the Company's securitizations. 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 substantially all principal to the holder.
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.
The yields on these securities are affected primarily by changes in prepayment
rates and by changes in short-term interest rates.
Other investments. Other investments consist primarily of delinquent
property tax receivables. For December 31, 2000, other investments also includes
a $9.5 million installment note receivable received in connection with the sale
of the Company's single family mortgage operations in May 1996. One pool of the
delinquent property tax receivables was previously pledged as collateral for
collateralized bonds, and in 2001 was reclassified to other investments
commensurate with the repayment of the associated collateralized bonds
outstanding to third parties. During 2001, the Company collected approximately
$16.8 million on its delinquent property tax receivables, with collections of
$8.3 million relating to Allegheny County, Pennsylvania, $7.5 million related to
Cuyahoga County, Ohio and $1.0 million relating to various other jurisdictions.
Loans. As of December 31, 2001, loans consist principally of consumer
installment loans that were previously securitized, mezzanine loans secured by
healthcare properties, and participation in first mortgage loans secured by
multifamily and commercial mortgage loans. As of December 31, 2000, loans
consisted primarily of multifamily permanent and construction mortgage loans and
mezzanine loans secured by healthcare properties. As of December 31, 2001 and
2000, loans with a carrying value of $3.7 million and $19.1 million,
respectively, are considered held for sale and are carried at the lower of cost
or market.
Collateralized Bond Securities
The Company analyzes and values its investment in collateral for
collateralized bonds on a net investment basis. The Company, through its
subsidiaries, pledges collateral (i.e., single-family mortgage loans,
manufactured housing mortgage loans, or commercial mortgage loans) for
collateralized bond obligations that are issued based on the pledge of such
collateral. These collateralized bonds are recourse only to the collateral
pledged, and not to the Company. The structure created by the pledge of
collateral and sale of the associated collateralized bonds is referred to
hereafter as a "collateralized bond security". The "net investment in
collateralized bond securities" generally represents the principal balance of
the collateral pledged (plus any premiums and related costs and less any
discounts) less the outstanding balance of the associated collateralized bonds
owned by third parties. The Company generally has sold the investment grade
classes of the collateralized bonds to third parties, and has retained the
portion of the collateralized bond security that is below investment grade. The
Company estimates the fair value of its net investment in collateralized bond
securities as the present value of the projected cash flow from the collateral,
adjusted for the impact of and assumed level of future prepayments and credit
losses, less the projected principal and interest due on the bonds owned by
third parties. Below is a summary as of December 31, 2001, by each series where
the fair value exceeds $0.5 million of the Company's net investment in
collateralized bond securities. As previously indicated the Company master
services the majority of its collateralized bond securities. Monthly payment
reports for those securities master-serviced by the Company may be found on the
Company's website at www.dynexcapital.com.
- ----------------------------------------------------------------------------------------------------------------------
(amounts in Principal
thousands) Principal balance of Principal Amortized Cost
balance of collateralized Balance of Basis of Net
Collateralized Bond Collateral Type collateral bonds Net Investment Investment
Series (1) pledged outstanding to
third parties
- ----------------------------------------------------------------------------------------------------------------------
MERIT Series 11A Single-family loans ;
manufactured housing loans $ 454,982 $ 405,075 $ 49,907 $54,937
MERIT Series 12-1 Manufactured housing loans 283,666 254,087 29,579 27,545
MERIT Series 12-2 Single-family loans 400,259 375,374 24,885 36,466
MERIT Series 13 Manufactured housing loans 344,545 300,379 44,166 39,768
MERIT Series 14-1 Single-family loans 158,443 157,524 919 4,554
MERIT Series 14-2 Single-family loans 3,136 - 3,136 3,192
MCA One Series 1 Commercial mortgage loans 88,097 83,354 4,743 (517)
CCA One Series 2 Commercial mortgage loans 300,033 277,930 22,103 8,551
CCA One Series 3 Commercial mortgage loans 415,169 369,881 45,288 58,430
- ----------------------------------------------------------------------------------------------------------------------
2,448,330 2,223,604 224,726 232,926
On-balance sheet reserves for credit losses (27,163) (27,163)
- ----------------------------------------------------------------------------------------------------------------------
$2,448,330 $2,223,604 $197,563 $205,763
- ----------------------------------------------------------------------------------------------------------------------
(1) MERIT stands for MERIT Securities Corporation; MCA stands for Multifamily
Capital Access One, Inc. (now known as Commercial Capital Access One, Inc.); and
CCA stands for Commercial Capital Access One, Inc. Each such entity is a wholly
owned limited purpose subsidiary of the Company.
The following table summarizes the fair value of the Company's net
investment in collateralized bond securities, the various assumptions made in
estimating value, the unrealized gain (loss) on the Company's net investment and
the cash flow received from such net investment during 2001.
- -----------------------------------------------------------------------------------------------------------------------------
Fair Value Assumptions ($ in thousands)
------------------------------------------------------------
Cash flows
Weighted-average Projected cash Fair value of Unrealized received in
Collateralized Bond prepayment speeds Losses flow termination net gain (loss) 2001, net (2)
Series date investment (1)
- -----------------------------------------------------------------------------------------------------------------------------
MERIT Series 11A 40%-60% CPR on SF
loans; 10% CPR 3.5% annually on Anticipated
on MH loans MH loans final maturity $ 52,416 $ (2,521) $22,042
in 2025
MERIT Series 12-1 9% CPR 2.8% annually on MH Anticipated
Loans final maturity 3,492 (24,053) 794
in 2027
MERIT Series 12-2 35% CPR 0.55% annually Anticipated
call date in 2002 39,565 3,099 19,814
MERIT Series 13 10% CPR 4.0% annually Anticipated
final maturity 4,027 (35,742) 926
in 2026
MERIT Series 14-1 35% CPR 0.2% annually Anticipated
call date in 2002 7,311 2,757 7,207
MERIT Series 14-2 50% CPR 10.0% annually Anticipated
call date in 2002 2,959 (233) 2,717
MCA One Series 1 (3) Losses of $2,096 in Anticipated
2004, $1,500 in final maturity 1,466 1,983 63
2006 and $1,000 in in 2018
2008
CCA One Series 2 (4) 0.60% annually Anticipated
beginning in 2003 call date in 2012 8,113 (438) 1,724
CCA One Series 3 (4) 0.60% annually Anticipated
beginning in 2004 call date in 2009 20,556 (37,875) 2,778
- -----------------------------------------------------------------------------------------------------------------------------
139,905 (93,023) 58,065
On-balance sheet reserves for credit losses 27,163
- -----------------------------------------------------------------------------------------------------------------------------
$139,905 $(65,860) $58,065
- -----------------------------------------------------------------------------------------------------------------------------
(1) Calculated as the net present value of expected future cash flows,
discounted at 16%. Expected cash flows were based on the level of interest rates
as of December 31, 2001, and incorporates the resetting of the interest rates on
the adjustable rate assets to a level consistent with the respective index level
as of December 31, 2001. Increases or decreases in interest rates and index
levels from December 31, 2001 would impact the calculation of fair value, as
would differences in actual prepayment speeds and credit losses versus the
assumptions set forth above.
(2) Cash flows received by the Company during the year, equal to the excess
of the cash flows received on the collateral pledged, over the cash flow
requirements of the collateralized bond security
(3) Computed at 0% CPR through June 2008, then 20% CPR thereafter
(4) Computed at 0% CPR until the respective call 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 its net
investment in the collateralized bond structure (also know as
over-collateralization) and subordinated securities that it may retain from the
securitization. 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 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. For its securitized loans, the Company
considers its credit exposure to include over-collateralization and subordinated
securities retained from a securitization. As of December 31, 2001, the
Company's credit exposure on subordinated securities retained or as to
over-collateralization was $233.0 million. The Company has reserves and
discounts of $79.5 million relative to this credit exposure.
The Company also has various other forms of credit enhancement which,
based upon the performance of the underlying loans, may provide additional
protection against losses. Specifically, $169.0 million and $139.3 million of
the commercial mortgage loans are subject to guarantees of $14.3 million and
$14.4 million, respectively, whereby losses on such loans would need to exceed
the respective guarantee amount before the Company would incur credit losses;
$308 million of the single family mortgage loans in various pools are subject to
various mortgage pool insurance policies whereby losses would need to exceed the
remaining stop loss of at least 6% on such policies before the Company would
incur losses; and $122.1 million of the single family mortgage loans are subject
to various loss reimbursement agreements totaling $30.3 million with a remaining
aggregate deductible of approximately $1.6 million. The Company is currently in
dispute with the counter-party on the loss reimbursement agreements as to what
constitutes qualifying losses. This matter is being pursued through
court-ordered arbitration scheduled to begin in May 2002.
The Company also has credit risk on the entire amount of investments
that are not securitized. Such investments include loans and other investments
that aggregated $70.9 million at December 31, 2001.
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
could increase more rapidly than the interest earned on the associated asset
financed. The Company's floating-rate funding sources are substantially based on
the one-month London InterBank Offered Rate ("LIBOR") and reprice at least
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. Additionally, the Company has approximately $184 million of
fixed-rate assets financed with floating-rate collateralized bond liabilities.
In a declining rate environment, net interest margin may be enhanced for the
opposite reasons. In a period of declining interest rates, however, 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 security and the
yield on the ten-year Treasury security is less than 1.0%), single-family
adjustable rate mortgage ("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.
FEDERAL INCOME TAX CONSIDERATIONS
General
The Company believes it has complied with the requirements for
qualification as a REIT under the Internal Revenue Code (the "Code"). To the
extent the Company 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 as dividends to shareholders. While they were still
in existence, DHI and its subsidiaries were not qualified REIT subsidiaries and
were not consolidated with the Company for either tax or financial reporting
purposes.
DHI was liquidated pursuant to a plan of liquidation on December 31,
2000 under Sections 331 and 336 of the Code. The liquidation of DHI resulted in
the recognition of an estimated $17.5 million in capital gains for the Company,
which was wholly offset by the Company's capital loss carry-forwards. The
Company is in the process of completing its income tax return for 2001, and it
currently estimates that it has a net operating loss carry-forward of
approximately $125 million and capital loss carry-forwards of approximately $61
million at December 31, 2001. Substantially all of the $125 million in net
operating losses carry-forwards expire in 2014 and 2015, and of the $61 million
of capital loss carry-forwards, $33 million expires in 2003 and $28 million
expires in 2004.
The REIT rules generally require that a REIT invest primarily in real
estate-related assets, that its activities be passive rather than active and
that it distribute annually to its shareholders substantially all of its taxable
income. The Company could be subject to income tax if it failed to satisfy those
requirements or if it acquired certain types of income-producing real property.
Although no complete assurances can be given, the Company does not expect that
it will be subject to material amounts of such taxes.
Failure to satisfy certain Code requirements could cause the Company to
lose its status as a REIT. If the Company 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. The Company could utilize
loss carry-forwards to offset any taxable income. In addition, given the size of
its tax loss carry-forwards, the Company could pursue a business plan in the
future whereby the Company would voluntarily forego its REIT status. Once the
Company loses its status as REIT, the Company could not elect REIT status again
for five years.
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 to the ability of
REITs to own a 100% interest in taxable REIT subsidiaries. The Company had one
taxable REIT subsidiary at December 31, 2001.
Qualification of the Company as a REIT
Qualification as a REIT requires that the Company 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, the Company 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 the
Company 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% of the Company'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 the Company 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 the Company
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 the Company. Under the 75% asset test,
at least 75% of the value of the Company's total assets must represent cash or
cash items (including receivables), government securities or real estate assets.
Under the "10% asset test", the Company may not own more than 10% of the
outstanding voting securities of any single non-governmental issuer, provided
such securities do not qualify under the 75% asset test or relate to taxable
REIT subsidiaries. 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 the Company.
If the Company 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 the Company'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, the
Company 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, the Company generally must distribute to its shareholders an
amount at least equal to 90% 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 non-cash income" (the "90% distribution
requirement"). The Code provides that in certain circumstances distributions
relating to a particular year may be made in the following year for purposes of
the 90% distribution requirement. The Company will balance the benefit to the
shareholders of making these distributions and maintaining REIT status against
their impact on the liquidity of the Company. In certain situations, it may
benefit the shareholders if the Company retained cash to preserve liquidity and
thereby lose REIT status.
Ownership. In order to maintain its REIT status, the Company 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 the
Company's outstanding shares be owned by five or fewer persons at anytime during
the last half of the Company's taxable year. The more than 100 shareholders rule
requires that the Company have at least 100 shareholders for 335 days of a
twelve-month taxable year. In the event that the Company failed to satisfy the
ownership requirements the Company would be subject to fines and required taking
curative action to meet the ownership requirements in order to maintain its REIT
status.
For federal income tax purposes, the Company 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 the Company. The nature of the Company's investments,
coupled with its tax loss carry-forwards, is such that the Company expects to
have sufficient assets to meet federal income tax distribution requirements.
Taxation of Distributions by the Company
Assuming that the Company 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 capital gains, regardless of how
long a shareholder has owned his shares. Any other distributions out of the
Company's current or accumulated earnings and profits will be dividends taxable
as ordinary income. Distributions in excess of the Company'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 the Company's ordinary or capital
losses. Distributions to shareholders attributable to "excess inclusion income"'
of the Company will be characterized as excess inclusion income in the hands of
the shareholders. Excess inclusion income can arise from the Company'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 event that the Company's excess inclusion income is greater
than its taxable income, the Company's distribution requirement would be based
on the Company's excess inclusion income. Dividends paid by the Company 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 the Company was financed by "acquisition
indebtedness" or (ii) such dividends constitute excess inclusion income. In
2001, the Company paid a dividend on its preferred stocks equal to approximately
$1.6 million, representing the Company's excess inclusion income in 2000. The
Company estimates that excess inclusion income for 2001 was $1.1 million.
Taxable Income
The Company 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.
The Company's estimated taxable income for 2001, excluding net operating losses
carried forward from prior years, was $16.9 million, comprised of $7.4 million
in ordinary income and $9.5 million of capital gain income. Such amounts were
fully offset by loss carry-forwards of a similar amount.
REGULATION
The Company's existing consumer-related servicing activities consist of
collections on the delinquent property tax receivables. The Company believes
that 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 and a
lower cost of capital than the Company.
EMPLOYEES
As of December 31, 2001, the Company had 73 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 11,194 square feet. The address is 4551 Cox Road, Suite
300, Glen Allen, Virginia 23060. The lease expires in 2005. The Company also
occupies space located in Cleveland, Ohio, and the Pittsburgh, Pennsylvania
metropolitan area. These locations consist of approximately 16,384 square feet,
and the leases associated with these properties expire in 2004.
Item 3. LEGAL PROCEEDINGS
The Company is subject to 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 effect 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
3,662 holders of record as of February 28, 2002. 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
- ---------------------------------------------- ------------- -------------- --------------
2001:
First quarter $ 1.30 $ 0.64 $ -
Second quarter 2.45 0.89 -
Third quarter 2.48 1.91 -
Fourth quarter 2.45 1.86 -
2000:
First quarter $ 9.56 $ 3.38 $ -
Second quarter 5.25 1.19 -
Third quarter 1.88 0.47 -
Fourth quarter 1.75 0.63 -
- ---------------------------------------------- ------------- -------------- --------------
Item 6. SELECTED FINANCIAL DATA
(amounts in thousands except share data)
- ------------------------------------------------------------------------------------------------------------------------------
Years ended December 31, 2001 2000 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------
Net interest margin $ 12,570 $ (3,146) $ 48,015 $ 66,538 $ 83,454
Net (loss) gain on sales, write-downs, and impairment (5,114) (78,516) (100,876) (20,346) 11,584
charges
Equity in net (loss) earnings of Dynex Holding, Inc. - (680) (1,923) 2,456 (1,109)
Other income (expense) 104 (428) 1,673 2,852 1,716
General and administrative expenses (10,526) (8,712) (7,740) (8,973) (9,531)
Net administrative fees and expenses to Dynex - (381) (16,943) (22,379) (12,116)
Holding, Inc.
Extraordinary item - gain (loss) on extinguishment of 2,972 - (1,517) (571) -
debt
- -------------------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (3,085) $ (91,863) $ (75,135) $ 19,577 $ 73,998
------------------------------------------------------------------------------------------------------------------------------
Net income (loss) available to common shareholders $ 6,246 $ (104,774) $ (88,045) $ 6,558 $ 59,178
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 225,836 $ 291,160 $ 347,298 $ 410,821 $ 346,859
- -------------------------------------------------------------------------------------------------------------------------------
Total expenses $ 228,921 $ 383,023 $ 422,433 $ 391,244 $ 272,861
- -------------------------------------------------------------------------------------------------------------------------------
Income (loss) per common share before
extraordinary item:
Basic(1) $ 0.29 $ (9.15) $ (7.53) $ 0.62 $ 5.50
Diluted(1) $ 0.29 $ (9.15 $ (7.53) $ 0.62 $ 5.50
Net income (loss) per common share after
extraordinary item:
Basic(1) $ 0.55 $ (9.15) $ (7.67) $ 0.57 $ 5.50
Diluted(1) $ 0.55 $ (9.15) $ (7.67) $ 0.57 $ 5.50
Dividends declared per share:
Common (1) $ - $ - $ - $ 3.40 $ 5.42
Series A Preferred 0.2925 - 1.17 2.37 2.71
Series B Preferred 0.2925 - 1.17 2.37 2.71
Series C Preferred 0.3649 - 1.46 2.92 2.92
- ----------------------------------------------------------------------------------------------------------------------------
December 31, 2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------
Investments (2) $ 2,480,533 $ 3,112,908 $ 4,109,736 $ 4,956,665 $ 5,211,009
Total assets 2,500,812 3,159,596 4,192,516 5,178,848 5,367,413
Non-recourse debt 2,264,213 2,856,728 3,282,378 3,665,316 3,632,079
Recourse debt 58,134 134,168 537,098 1,032,733 1,133,536
Total liabilities 2,327,749 3,002,465 3,867,444 4,726,044 4,806,504
Shareholders' equity 173,063 157,131 325,072 452,804 560,909
Number of common shares outstanding 10,873,853 11,446,206 11,444,099 46,027,426 45,146,242
Average number of common shares (1) 11,430,471 11,445,236 11,483,977 11,436,599 10,757,845
Book value per common share (1) $ 4.71 $ 0.37 $ 16.18 $ 27.75 $ 37.59
- ----------------------------------------------------------------------------------------------------------------------------
(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, and are
inclusive of the liquidation preference on the Company's preferred stock. (2)
Investments classified as available for sale are shown at fair value.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company is a financial services company that 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 prior loan production
operations or purchased in bulk in the market. Loans funded through the
Company's prior 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.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the Company's financial condition and
results of operations are based in large part upon its consolidated financial
statements, which have been prepared in conformity with accounting principles
generally accepted in the United States of America. The preparation of the
financial statements 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.
Critical accounting policies are defined as those that are reflective
of significant judgements or uncertainties, and which may result in materially
different results under different assumptions and conditions, or by application
of which may have a material impact on the Company's financial statements. The
following are the Company's critical accounting policies, excerpt from Footnote
2 to the consolidated financial statements.
Interest Income. Interest income is recognized when earned according to
the terms of the underlying investment and when, in the opinion of management,
it is collectible. The accrual of interest on investments is discontinued or the
rate on which interest is accrued is reduced at the time the collection of
interest is considered doubtful. All interest accrued but not collected for
investments that are placed on non-accrual status or charged-off is reversed
against interest income. Interest on these investments is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual.
Investments are returned to accrual status when all the principal and interest
amounts contractually due are brought current and future payments are reasonably
assured.
Fair Value. The Company uses estimates in establishing fair value for
its financial instruments. Estimates of fair value for financial instruments may
be based on market prices provided by certain dealers. Estimates of fair value
for certain other financial instruments are determined by calculating the
present value of the projected cash flows of the instruments using appropriate
discount rates, prepayment rates and credit loss assumptions. Collateral for
collateralized bonds make up a significant portion of the Company's investments.
The estimate of fair value for collateral for collateralized bonds is determined
by calculating the present value of the projected cash flows of the instruments,
using discount rates, prepayment rate assumptions and credit loss assumptions
established by management. The discount rate used in the determination of fair
value of the collateral for collateralized bonds was 16% at December 31, 2001
and 2000. Prepayment rate assumptions at December 31, 2001 and 2000 were
generally at a "constant prepayment rate," or CPR, ranging from 35%-60% for
2001, and 28% for 2000, respectively, for collateral for collateralized bonds
consisting of single-family mortgage loans, and a CPR equivalent ranging from
9%-10% for 2001 and 7% for 2000, respectively for collateral for collateralized
bonds consisting of manufactured housing loan collateral. Commercial mortgage
loan collateral was generally assumed to repay in accordance with their
contractual terms. CPR assumptions for each year are based in part on the actual
prepayment rates experienced for the prior six-month period and in part on
management's estimate of future prepayment activity. The loss assumptions
utilized vary for each series of collateral for collateralized bonds, depending
on the collateral pledged. The cash flows for the collateral for collateralized
bonds were projected to the estimated date that the security could be called and
retired by the Company if there is economic value to the Company in calling and
retiring the security. Such call date is typically triggered on the earlier of a
specified date or when the remaining security balance equals 35% of the original
balance (the "Call Date"). The Company estimates anticipated market prices of
the underlying collateral at the Call Date.
The Company estimated the fair value of certain other investments as
the present value of expected future cash flows, less costs to service such
investments, discounted at a rate of 12%.
Allowance for Losses. The Company 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. The Company's actual credit losses may
differ from those estimates used to establish the allowance.
FINANCIAL CONDITION
Below is a discussion of the Company's financial condition.
- ------------------------------------------------------ -----------------------------------------
December 31,
(amounts in thousands except per share data) 2001 2000
- ------------------------------------------------------ -------------------- --------------------
Investments:
Collateral for collateralized bonds $2,404,157 $3,042,158
Securities 5,508 9,364
Other investments 63,553 42,284
Loans 7,315 19,102
Non-recourse debt - collateralized bonds 2,264,213 2,856,728
Recourse debt 58,134 134,168
Shareholders' equity 173,063 157,131
Book value per common share (inclusive of preferred
stock liquidation preference) $ 4.71 $ 0.37
- ------------------------------------------------------ -------------------- --------------------
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, and manufactured housing installment
loans secured by either a UCC filing or a motor vehicle title. Collateral for
collateralized bonds in 2000 also included delinquent property tax receivables.
As of December 31, 2001, the Company had 23 series of collateralized bonds
outstanding. Collateral for collateralized bonds are considered available for
sale, and are therefore carried at estimated fair value. The collateral for
collateralized bonds decreased to $2.4 billion at December 31, 2001 compared to
$3.0 billion at December 31, 2000. This decrease of $0.6 billion is primarily
the result of pay-downs on collateral offset in part by a decrease in the
unrealized loss.
Securities
Securities at December 31, 2001 and 2000 consist primarily of
adjustable-rate (ARM) 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 $5.5 million at December 31, 2001, compared to $9.4
million at December 31, 2000, primarily as a result of the sale of certain ARM
securities, which were sold in order to repay recourse debt.
Other Investments
Other investments at December 31, 2001 and 2000 consist primarily of
delinquent property tax receivables. At December 31, 2000, other investments
also included a note receivable with a remaining balance of $9.5 million
received in connection with the sale of the Company's single family mortgage
operations in May 1996. Other investments increased to $63.6 million at December
31, 2001 compared to $42.2 million at December 31, 2000. This increase of $21.4
million resulted from the reclassification in 2001 of delinquent property tax
receivables previously pledged to a collateralized bond security structure and
the purchase of $8.7 million of additional property tax receivables during 2001.
These increases were offset in part by the receipt of the $9.5 million on the
note receivable, principal payments received on delinquent property tax
receivables, and impairment charges recorded.
Loans
Loans decreased to $7.3 million at December 31, 2001 from $19.1 million
at December 31, 2000 principally due to sales. The proceeds from the sales of
loans were used to repay associated recourse debt outstanding.
Non-recourse Debt
Collateralized bonds issued by the Company are recourse only to the
assets pledged as collateral, and are otherwise non-recourse to the Company.
Collateralized bonds decreased to $2.3 billion at December 31, 2001 from $2.9
billion at December 31, 2000. This decrease was primarily a result of principal
pay-downs made during the year, from the principal payments received from the
associated collateral for collateralized bonds.
Recourse Debt
Recourse debt decreased from $134.2 million at December 31, 2000 to
$58.1million at December 31, 2001. During 2001, the Company repaid a net $35.0
million of repurchase agreement financing, $2.0 million of secured warehouse
financing, and purchased a net $39.3 of the Company's Senior Notes. The purchase
of the Senior Notes was at a net discount to principal of approximately 9.5%.
Shareholders' Equity
Shareholders' equity increased from $157.1 million at December 31, 2000
to $173.1 million at December 31, 2001. This increase resulted from a $40.7
million decrease in the net unrealized loss on investments available for sale
from $124.6 million at December 31, 2000 to $83.9 million at December 31, 2001.
This increase in shareholder's equity was partially offset by a net loss of $3.1
million during the year 2001 and a $20.1 million net reduction as a result of
the completion of two preferred stock tender offers during the year. In
addition, the Company declared and paid dividends on the preferred stock of $1.6
million during the year.
RESULTS OF OPERATIONS
- ----------------------------------------------------------------- --------------------------------------------------
For the Year Ended December 31,
(amounts in thousands except per share information) 2001 2000 1999
- ----------------------------------------------------------------- ---------------- --------------- -----------------
Net interest margin before provision for losses $ 48,082 $ 31,487 $ 64,169
Provision for losses (35,512) (34,633) (16,154)
Net interest margin 12,570 (3,146) 48,015
Net loss on sales, write-downs and impairment charges:
Related to commercial production operations (680) (50,940) (59,962)
Related to sales of investments (439) (15,872) (16,858)
Impairment charges on held-to-maturity investments and
related real estate owned (9,475) - -
Related to AutoBond litigation and AutoBond securities 7,095 (11,012) (31,732)
Related to sale of loan production operations (755) (228) 7,676
Other (860) (464) -
Trading (losses) gains (3,091) - 4,176
Equity in losses of DHI - (680) (1,923)
General and administrative expenses (10,526) (8,712) (7,740)
Net administrative fees and expenses to DHI - (381) (16,943)
Extraordinary item - gain (loss) on extinguishment of debt 2,972 - (1,517)
Net loss (3,085) (91,863) (75,135)
Preferred stock benefit (charges) 9,331 (12,911) (12,910)
Net income (loss) available to common shareholders $ 6,246 $(104,774) $(88,045)
Basic net income (loss) per common share(1) $ 0.55 $ (9.15) $ (7.67)
Diluted net income (loss) per common share(1) $ 0.55 $ (9.15) $ (7.67)
Dividends declared per share:
Common $ - $ - $ -
Series A and B Preferred 0.2925 - 1.17
Series C Preferred 0.3649 - 1.46
- ----------------------------------------------------------------- ---------------- --------------- -----------------
(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.
2001 Compared to 2000.
The increase in net income and net income per common share during 2001
as compared to 2000 is primarily the result of an increase in net interest
margin, a decrease in net loss on sales, write-downs, and impairment charges, an
increase in gains from extinguishment of debt, and a preferred stock benefit in
2001 versus charges in the prior year, partially offset by an increase in
trading losses and general and administrative expenses.
Net interest margin before provision for losses for the year ended
December 31, 2001 increased to $48.1 million, from $31.5 million for the same
period in 2000. The increase in net interest margin of $16.6 million, or 53%,
was the result of the reduction in the Company's average cost of funds, which
declined by approximately 0.70%, as a result of the overall decline in interest
rates during 2001 and a reduction in fees related to committed credit
facilities.
Provision for losses increased to $35.5 million in 2001, or 1.23% of
average interest earning assets, from $34.6 million in 2000, or 0.93% of average
interest earning assets. The provision for losses increased as a result of the
continued under-performance of the Company's manufactured housing loan
portfolio, all of which is collateral for collateralized bonds. Loss severity on
the manufactured housing loans continued to increase during 2001 as a result of
the saturation in the market place with both new and used (repossessed)
manufactured housing units. In addition, the Company has seen an increase in
overall default rates on its manufactured housing loans. The Company anticipates
that market conditions for manufactured housing loans will remain unfavorable
through 2002.
Net loss on sales, write-downs and impairment charges decreased from an
aggregate net loss of $78.5 million in 2000 to an aggregate net loss of $5.1
million. Net loss on sales, impairment charges and write-downs are largely
one-time items. During 2001, the Company settled various litigation for a net
benefit to the Company of $5.4 million including a net $7.1 million benefit
related to AutoBond Acceptance Corporation. The Company incurred losses in 2001
related principally to impairment charges incurred on its delinquent property
tax lien portfolio. The Company adjusted the carrying value of such portfolio by
$7.7 million due to other-than-temporary valuation adjustments, and $1.8 million
for adjustments to net realizable value on property tax liens that have been
foreclosed and represent real estate owned. The Company also wrote off $0.6
million of receivables related to the sale of its manufactured housing and model
home businesses in 1999.
During 2000, the Company incurred losses related to the phasing-out of
its commercial production operations, including the sales of substantially all
of the Company's remaining commercial and multifamily loan positions. In
addition, the Company recorded a loss of $30.3 million as a result of the
expiration of a Company owned option to purchase $167.8 million of tax-exempt
bonds secured by multifamily mortgage loans that expired in June 2000. The
Company did not exercise this option, as it did not have the ability to finance
this purchase, and the counter-party to the agreement retained $30.3 million in
cash collateral as settlement as provided for in the related agreements. The
Company recorded a charge against earnings of $30.3 million in 2000 as a result.
In 2001, the Company entered into three separate short positions
aggregating $1.3 billion on the June 2001, September 2001, and December 2001
ninety-day Eurodollar Futures Contracts. In addition, the Company entered into
two short positions on the one-month LIBOR futures contract. The Company entered
into these positions to, in effect, lock-in its borrowing costs on a forward
basis relative to its floating-rate liabilities. These instruments failed to
meet the hedge criteria of FAS No. 133, and were accounted for on a trading
basis. Accordingly, any gains or losses recognized on these contracts was
included in current period results. During 2001, given the continued decline in
one-month LIBOR due to reductions in the targeted Federal Funds Rate, the
Company recognized $3.1 million in losses related to these contracts.
During 2000, the Company settled the outstanding litigation with
AutoBond for $20 million. The Company had accrued a reserve as of December 31,
1999, for $27 million related to the litigation, and reversed $5.6 million of
this reserve in 2000 as a result of the settlement. In June 2000, the Company
recorded permanent impairment charges of $16.6 million on AutoBond related
securities. During the fourth quarter 2000, the Company completed the sale of
substantially all of the remaining outstanding securities and loans related to
AutoBond.
Also during 2000, the Company recorded impairment charges and loss on
sales of securities aggregating $8.5 million, relating to the write-down of
basis and then the sale of $33.9 million of securities. Such securities were
sold in order for the Company to pay-down its recourse debt outstanding. As a
result of the sale of securities, the Company either sold or terminated related
derivative hedge positions at an aggregate net loss of $7.3 million.
2000 Compared to 1999.
The decrease in net income and net income per common share during 2000
as compared to 1999 is primarily the result of a decrease in net interest
margin, which is partially offset by (i) a decrease in net loss on sales, (ii)
impairment charges and write-downs, and (iii) decreases in general and
administrative expenses and net administrative fees and expenses to DHI.
Net interest margin before provision for losses for the year ended
December 31, 2000 decreased $32.7 million, or 51% to $31.5 million, from $64.2
million for the same period for 1999. The decrease in net interest margin was
primarily the result of the decline in average interest-earning assets from $4.6
billion in 1999, to $3.7 billion in 2000. In addition, the average cost of funds
of the Company increased to 7.35% in 2000 from 6.21% in 1999 due to an overall
market increase in short-term interest rates, and to a lesser extent, fees paid
and rate increases associated with the Company's recourse borrowings.
Provision for losses increased to $34.6 million in 2000, or 0.93% of
average interest earning assets, from $16.1 million or 0.35% during 1999. The
provision for losses increased as a result of an overall increase in credit risk
retained from securities issued by the Company (principally for securities
issued in the latter portion of 1999), and a charge of $13.3 million in the
fourth quarter of 2000 due to the under-performance of the Company's securitized
manufactured housing loan portfolio. The loss severity on manufactured housing
loans increase dramatically since the end of the third quarter of 2000 as a
result of the saturation in the market place with both new and used
(repossessed) manufactured housing units. In addition, overall default rates
increased on the manufactured housing loans.
Net loss on sales, impairment charges and write-downs decreased from an
aggregated net loss of $100.9 million in 1999, to $78.5 million in 2000. During
2000, the Company incurred losses related to the phasing-out of its commercial
production operations, including the sales of substantially all of the Company's
remaining commercial and multifamily loan positions. In addition, as discussed
in Note 13 to the accompanying financial statements, the Company was party to
various conditional bond repurchase agreements whereby the Company had the
option to purchase $167.8 million of tax-exempt bonds secured by multifamily
mortgage loans which expired in June 2000. The Company did not exercise this
option, as it did not have the ability to finance this purchase, and the
counter-party to the agreement retained $30.3 million in cash collateral as
settlement as provided for in the related agreements. The Company recorded a
charge against earnings of $30.3 million in 2000 as a result.
Also during 2000, the Company recorded impairment charges and loss on
sales of securities aggregating $8.5 million, relating to the write-down of
basis and then the sale of $33.9 million of securities. Such securities were
sold in order for the Company to pay-down its recourse debt outstanding. As a
result of the sale of securities, the Company either sold or terminated related
derivative hedge positions at an aggregate net loss of $7.3 million. During
1999, the Company had gains of $4.2 million related to various
derivative-trading positions opened and closed during 1999. The Company had no
such gains in 2000.
Net administrative fees and expenses to DHI decreased $16.5 million, or
98%, to $0.4 million for the year ended December 31, 2000 as compared to the
same period in 1999. These decreases are principally a combined result of the
sale of the Company's model home purchase/leaseback and manufactured housing
loan production operations during 1999. All general and administrative expenses
of these businesses were incurred by DHI.
The following table summarizes the average balances of interest-earning
assets and their average effective yields, along with the average
interest-bearing liabilities and the related average effective interest rates,
for each of the periods presented.
Average Balances and Effective Interest Rates
(amounts in thousands) Year ended December 31,
- ------------------------------------------- --------------------------------------------------------------------------------
2001 2000 1999
Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate
- ------------------------------------------- -------------- ----------- -------------- ----------- -------------- -----------
Interest-earning assets (1):
Collateral for collateralized bonds (2) $2,826,289 7.61% $3,460,973 7.84% $3,828,007 7.43%
(3)
Securities 8,830 9.60% 55,425 6.49% 226,908 6.27
Other investments 37,185 14.69% 42,188 13.03% 202,111 8.50
Loans 4,068 12.56% 134,672 7.99% 329,507 7.97
Cash Investments 17,560 5.52% - - - -
-------------- ----------- -------------- ----------- -------------- -----------
Total interest-earning assts $2,893,932 7.70% $3,693,258 7.89% $4,586,533 7.46%
============== =========== ============== =========== ============== ===========
Interest-bearing liabilities:
Non-recourse debt (3) $2,568,716 6.41% $3,132,550 7.34% $3,363,095 6.18%
Recourse debt secured by collateralized 17,016 6.28% 65,651 7.13% 271,919 5.71%
bonds retained
-------------- ----------- -------------- ----------- -------------- -----------
2,585,732 6.41% 3,198,201 7.33% 3,635,014 6.14%
Other recourse debt - secured (4) 71,174 8.26% 119,939 5.61% 548,261 6.11%
Other recourse debt - unsecured - - 101,242 8.54% 121,743 8.78%
-------------- ----------- -------------- ----------- -------------- -----------
Total interest-bearing liabilities $2,656,906 6.46% $3,419,382 7.35% $4,305,018 6.21%
============== =========== ============== =========== ============== ===========
Net interest spread on all investments (3) 1.24% 0.54% 1.25%
=========== =========== ===========
Net yield on average interest-earning 1.77% 1.08% 1.63%
assets (3)
=========== =========== ===========
- ------------------------------------------- -------------- ----------- -------------- ----------- -------------- -----------
(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 $507, $862, and
$1,844 for the years ended December 31, 2001, 2000, and 1999, respectively. (3)
Effective rates are calculated excluding non-interest related collateralized
bond expenses and provision for credit losses. (4) The July 2002 Senior Notes
are considered secured for all of 2001 for purposes of this table.
2001 compared to 2000
This increase was primarily due to the reduction of short-term interest
rates during 2001. A substantial portion of the Company's interest-bearing
liabilities reprice monthly, and are indexed to one-month LIBOR, which on
average decreased to 3.88% for 2001, versus 6.41% for 2000. This decrease in
one-month LIBOR accounts for a substantial portion of the overall decrease in
the cost of interest-bearing liabilities. The overall yield on interest-earnings
assets, decreased to 7.70% for the year ended December 31, 2001 from 7.89% for
the same period in 2000, following the falling-rate environment, yet lagging
relative to the Company's liabilities.
The net interest spread on collateral for collateralized bonds
increased 69 basis points, from 51 basis points for the year ended December 31,
2000 to 120 basis points for the same period in 2001 (each basis point is
0.01%). This increase was largely due to the effect of the decrease in
short-term rates during the year. The net interest spread on securities
increased to a positive 320 basis points for the year ended December 31, 2001,
from a negative 206 basis points for the year ended December 31, 2000. This
increase was primarily the result of decreased borrowing costs on securities due
to both the decrease in the average one-month LIBOR during the twelve months
ended December 30, 2001 and the repayment of all outstanding borrowings during
2001. Borrowings associated with loans were paid off during the fourth quarter
of 2000 while the loans were retained and earned an average of 1256 basis points
during 2001. In addition, cash investments during the year earned an average of
552 basis points.
2000 compared to 1999
The net interest spread for the year ended December 31, 2000 decreased
to 0.54%, from 1.25% for the year ended December 31, 1999. This decrease was
primarily due to the increased cost of interest-bearing liabilities as the
result of overall increases in short-term rates between the years. A substantial
portion of the Company's interest-bearing liabilities reprice monthly, and are
indexed to one-month LIBOR, which on average increased to 6.41% for 2000, versus
5.25% for 1999. This increase in one-month LIBOR accounts for a substantial
portion of the overall increase in the cost of interest-bearing liabilities. The
Company also experienced overall increases in borrowing costs on its recourse
debt as a result of extension fees, covenant violations and other related issues
during 2000. The overall yield on interest-earnings assets, increased to 7.89%
for the year ended December 31, 2000 from 7.46% for the same period in 1999,
benefited from the rising-rate environment, but lagging relative to the
Company's liabilities.
Individually, the net interest spread on collateral for collateralized
bonds decreased 78 basis points, from 129 basis points for the year ended
December 31, 1999 to 51 basis points for the same period in 2000. This decrease
was largely due to the effect of the increase in short-term rates during the
year. The net interest spread on securities decreased to a negative 206 basis
points for the year ended December 31, 2000, from a negative 24 basis points for
the year ended December 31, 1999. This decrease was primarily the result of
increased borrowing costs on securities due to both the increase in the average
one-month LIBOR during the nine months ended September 30, 2000 as well as an
increase in the interest spread on certain credit facilities during the past
twelve months. The net interest spread on other investments increased 427 basis
points, from 201 basis points for the year ended December 31, 1999, to 628 basis
points for the same period in 2000, primarily due to the sale or pay-down of
lower yielding investments, leaving principally the higher yielding delinquent
property tax receivables. The net interest spread on loans held for sale
decreased 83 basis points for the year ended December 31, 1999 from 247 basis
points to 164 basis points for the year ended December 31, 2000, primarily as a
result of increased borrowing costs due to (a) the increase in the average
one-month LIBOR during 2000, (b) increases in the interest spread on certain
credit facilities, (c) higher fees as a result of violation of certain covenants
under certain of these facilities in 2000, and (d) fees for extensions of these
facilities to provide additional time for the Company to sell the related
collateral, principally loans held for sale and funding notes and securities.
The following tables summarize the amount of change in interest income
and interest expense due to changes in interest rates versus changes in volume:
- --------------------------------------------------------------------------------------------------------------------
2001 to 2000 2000 to 1999
- --------------------------------------------------------------------------------------------------------------------
Rate Volume Total Rate Volume Total
- --------------------------------------------------------------------------------------------------------------------
Collateral for collateralized bonds $(7,949) $(48,496) $(56,445) $15,228 $(28,235) $(13,007)
Securities 1,199 (3,946) (2,747) 474 (11,107) (10,633)
Other investments (633) 1,461 828 6,239 (17,923) (11,684)
Loans 6,096 (16,132) (10,036) 65 (15,575) (15,510)
- --------------------------------------------------------------------------------------------------------------------
Total interest income (1,287) (67,113) (68,400) 22,006 (72,840) (50,834)
- --------------------------------------------------------------------------------------------------------------------
Non-recourse debt (25,183) (39,970) (65,153) 37,000 (14,958) 22,042
Recourse debt - collateralized bonds (499) (3,112) (3,611) 3,130 (13,986) (10,856)
retained
- --------------------------------------------------------------------------------------------------------------------
Total collateralized bonds (25,682) (43,082) (68,764) 40,130 (28,944) 11,186
Other recourse debt secured (621) (10,358) (10,979) 4,563 (29,851) (25,288)
Other recourse debt - unsecured - - - (287) (1,758) (2,045)
- --------------------------------------------------------------------------------------------------------------------
Total interest expense (26,303) (53,440) (79,743) 44,406 (60,553) (16,147)
- --------------------------------------------------------------------------------------------------------------------
Net margin on portfolio $ 25,016 $(13,673) $ 11,343 $(22,400) $(12,287) $(34,687)
- --------------------------------------------------------------------------------------------------------------------
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 non-interest related collateralized bond expense,
other interest expense and provision for credit losses.
Interest Income and Interest-Earning Assets
Approximately $1.8 billion of the investment portfolio as of December
31, 2001, or 72%, is comprised of loans or securities that pay a fixed-rate of
interest. Approximately $691 million, or 28%, 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 67% 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 21% 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 as of December 31, 2001, December 31, 2000 and December 31,
1999. The percentage of fixed-rate loans to all loans increased from 62% at
December 31, 2000, to 72% at December 31, 2001, as most of the prepayments in
the Company's investment portfolio have occurred in the single-family ARM
portion. The table below excludes various investments in the Company's
portfolio, including securities such as derivative and residual securities and
other securities, and non-securitized investments including other investments
and loans. Most of these excluded investments would be considered fixed-rate,
and amounted to approximately $75.2 million at December 31, 2001.
Investment Portfolio Composition (1)
($ in millions)
- ------------------ ------------------ -------------------- --------------------- --------------- ---------------
LIBOR Based ARM CMT Based Other Indices Based Fixed-Rate
December 31, Loans ARM Loans ARM Loans Loans Total
- ------------------ ------------------ -------------------- --------------------- --------------- ---------------
1999 $1,048.5 $ $430.8 $ $121.1 $2,061.5 $3,661.9
2000 758.6 309.9 97.4 1,926.3 3,092.2
2001 472.4 144.6 73.6 1,765.8 2,456.4
- ------------------ ------------------ -------------------- --------------------- --------------- ---------------
(1) Includes only the principal amount of collateral for collateralized
bonds, ARM securities and fixed securities.
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, 2001 were $22.4 million, or approximately
0.91% of the aggregate balance of the related investments. Approximately $26.8
million of this premium basis relates to multifamily and commercial mortgage
loans, with a principal balance of $803.3 million at December 31, 2001, and have
prepayment lockouts or yield maintenance provisions generally at least through
2007. Amortization expense as a percentage of principal pay-downs decreased to
1.37% for the year ended December 31, 2001 from 1.55% in 2000 as the Company
experienced lower prepayment activity during 2001 on its securitized
single-family loan portfolio which it owns above par, and higher prepayment
activity for manufactured housing loans (generally as a result of increased
defaults) owned at a discount. The principal repayment rate (indicated in the
table below as "CPR Annualized Rate") was 24% for the year ended December 31,
2001. CPR or "constant prepayment rate" is a measure of the annual prepayment
rate on a pool of loans.
Net Premium Basis and Amortization on Investments
($ in millions)
- -----------------------------------------------------------------------------------------------------
Amortization
Net CPR Annualized Expense as a %
Remaining Amortization Rate Principal of Principal
Premium Expense Paydowns Paydowns
- -----------------------------------------------------------------------------------------------------
1999 $ 38.3 $ 16.3 20% $1,145.8 1.42%
2000 30.1 8.1 20% 523.0 1.55%
2001 22.4 8.2 24% 600.8 1.37%
- -----------------------------------------------------------------------------------------------------
Credit Exposures
The Company invests in collateralized bonds or pass-through
securitization structures. Generally these securitization structures use
over-collateralization, subordination, third-party guarantees, reserve funds,
bond insurance, mortgage pool insurance or any combination of the foregoing as a
form of credit enhancement. The Company generally has retained a limited portion
of the direct credit risk in these securities. In most instances, the Company
retained the "first-loss" credit risk on pools of loans that it has securitized.
The following table summarizes the aggregate principal amount of
collateral for collateralized bonds and ARM and fixed-rate mortgage pass-through
securities outstanding; the direct credit exposure retained by the Company
(represented by the amount of over-collateralization pledged and subordinated
securities owned by the Company), net of the credit reserves and discounts
maintained by the Company for such exposure; and the actual credit losses
incurred for each year. For 2001, the table includes any subordinated security
retained by the Company, whereas in prior years the table included only
subordinated securities rated below "BBB" by one of the nationally recognized
rating agencies.
The table excludes other forms of credit enhancement from which the
Company benefits, and based upon the performance of the underlying loans, may
provide additional protection against losses as discussed above in Investment
Portfolio Risks. This table also excludes any risks related to representations
and warranties made on single-family loans funded by the Company and securitized
in mortgage pass-through securities generally funded prior to 1995. This table
also excludes any credit exposure on loans and other investments.
Credit Reserves and Actual Credit Losses
($ in millions)
- ---------------------------------------------------------------------------------------------------------
Credit Exposure, Actual Credit Exposure, Net of
Outstanding Loan Net of Credit Credit Credit Reserves to
Principal Balance Reserves Losses Outstanding Loan Balance
- ---------------------------------------------------------------------------------------------------------
1999 $ 3,770.3 $ 226.6 $ 19.7 6.01%
2000 3,245.3 186.6 26.6 5.75%
2001 2,588.4 153.5 32.6 5.93%
- ---------------------------------------------------------------------------------------------------------
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 has retained a portion of the direct credit risk included in the table
above. The delinquencies as a percentage of the outstanding collateral decreased
to 1.78% at December 31, 2001, from 1.96% at December 31, 2000, primarily from
decreasing delinquencies in the Company's single-family loan portfolio. 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, 2001, management believes the
level of credit reserves is sufficient to cover any losses that may occur as a
result of current delinquencies presented in the table below.
Delinquency Statistics
- -----------------------------------------------------------------------------------------------------
60 to 89 days 90 days and over
December 31, delinquent delinquent (2) Total
- -----------------------------------------------------------------------------------------------------
1999 (1) 0.27% 1.37% 1.64%
2000 0.37% 1.59% 1.96%
2001 0.28% 1.50% 1.78%
- -----------------------------------------------------------------------------------------------------
(1) Excludes funding notes and securities.
(2)Includes foreclosures, repossessions and REO.
Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("FAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities" is effective for all fiscal
years beginning after June 15, 2000. FAS No. 133, as amended, establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
The Company adopted FAS No. 133 effective January 1, 2001. The adoption of FAS
No. 133 did not have a significant impact on the financial position, results of
operations, or cash flows of the Company.
In September 2000, the Financial Accounting Standards Board ("FASB") issued
FAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" ("FAS No. 140"). FAS No. 140 replaces the
Statement of Financial Accounting Standards No. 125 "Accounting for the
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
("FAS No. 125"). FAS No. 140 revises the standards for accounting for
securitization and other transfers of financial assets and collateral and
requires certain disclosure, but it carries over most of FAS No. 125 provisions
without reconsideration. FAS No. 140 is effective for transfers and servicing of
financial assets and extinguishment of liabilities occurring after March 31,
2001. FAS No. 140 is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. Disclosures about
securitization and collateral accepted need not be reported for periods ending
on or before December 15, 2000, for which financial statements are presented for
comparative purposes. FAS No. 140 is to be applied prospectively with certain
exceptions. Other than those exceptions, earlier or retroactive application of
its accounting provision is not permitted. The adoption of FAS No. 140 did not
have a material impact on the Company's financial statements.
In June 2001, the FASB issued FAS No. 141, "Business Combinations". FAS
No. 141 requires that all business combinations initiated after June 30, 2001 be
accounted for under the purchase method and addresses the initial recognition
and measurement of goodwill and other intangible assets acquired in a business
combination. Business combinations originally accounted for under the pooling of
interest method will not be changed. The adoption of FAS No. 141 did not have an
impact on the financial position, results of operations or cash flows of the
Company.
In June 2001, the FASB issued FAS No. 142, "Goodwill and Other
Intangible Assets". FAS No. 142 addresses the initial recognition and
measurement of intangible assets acquired outside of a business combination and
the accounting for goodwill and other intangible assets subsequent to their
acquisition. FAS No. 142 provides that intangible assets with finite useful
lives be amortized and that goodwill and intangible assets with indefinite lives
will not be amortized, but will rather be tested at least annually for
impairment. As the Company has no goodwill or intangible assets that it is
amortizing, the adoption of SFAS No. 142 will have no effect on the financial
position, results of operations or cash flows of the Company.
In June 2001, the FASB issued FAS No. 143, "Accounting for Asset
Retirement Obligations." FAS 143 addresses financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. FAS No.143 is effective for fiscal years
beginning after June 15, 2002. The company does not believe the adoption of FAS
No. 143 will have a significant impact on the financial position, results of
operations or cash flows of the Company. In August 2001, the FASB issued FAS No.
144, "Accounting for the Impairment of Long-Lived Assets" which supercedes FAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be disposed of" and the accounting and reporting provisions of
Accounting Principles Board (APB) No. 30, "Reporting the Results of Operations -
Reporting and Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions" for the disposal of
a segment of business. This statement is effective for fiscal years beginning
after December 15, 2001. FAS No. 144 retains many of the provisions of FAS No.
121, but addresses certain implementation issues associated with that Statement.
The company does not believe the adoption of FAS No. 144 will have a significant
impact on the financial position, results of operations or cash flows of the
Company.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations from a variety of
sources. These sources have included 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 recourse) and long-term (after
securitization, and non-recourse) basis. However, market conditions since
October 1998 have substantially reduced the Company's access to capital. The
Company has been unable to access short-term warehouse lines of credit, and,
with the exception for the re-securitization of seasoned loans in its investment
portfolio, has been unable to efficiently access 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. Since 1999, the Company has
focused on substantially reducing its recourse debt and minimizing its capital
requirements. The Company has made substantial progress in both areas since
1999, and based upon its expected investment portfolio cash flows, and
anticipated proceeds from the sale and re-securitization of assets, the Company
anticipates that it will repay all of its existing recourse debt obligations in
accordance with their respective terms during 2002.
The Company's cash flow from its investment portfolio for the year and
quarter ended December 31, 2001 was approximately $77 million and $22 million,
respectively. Such cash flow is after payment of principal and interest on the
associated collateralized bonds (i.e., non-recourse debt) outstanding. From the
cash flow on its investment portfolio, the Company funds its operating overhead
costs, including the servicing of its delinquent property tax receivables, and
repays any remaining recourse debt. Excluding any cash flow derived from the
sale or re-securitization of assets, the Company anticipates that the cash flow
from its investment portfolio will decline in 2002 versus 2001 as the investment
portfolio pay downs and if interest rates, as expected, increase. The Company
anticipates, however, that it will have sufficient cash flow from its investment
portfolio to meet all of its obligations on both a short-term and long-term
basis.
Recourse Debt
At December 31, 2001, the Company had $58.2 million of recourse debt
outstanding, consisting of senior notes issued in July 1997 and due July 15,
2002 (the "Senior Notes") and a $0.2 million capital lease obligation which will
be fully paid in 2002. During 2001, the Company reduced its recourse debt by
approximately $76.5 million. Recourse debt was reduced through the use of
investment portfolio cash flows and the sale of various assets of the Company.
In January 2002, the Company purchased $8.6 million of its Senior Notes, at a 4%
discount to par. As of March 22, 2002, the Company has approximately $49.3
million in recourse debt remaining outstanding. The Company's ability to make
distributions on its capital stock and to reinvest cash flow from its investment
portfolio and other assets are materially restricted as a result of the
amendment to the indenture governing the Senior Notes entered into in March 2001
and a settlement agreement entered into in October 2001 by and between the
Company and ACA Financial Guaranty Corporation (ACA) as a result of an action
which ACA brought against the Company in the United States District Court for
the Southern District of New York (the amendment to the indenture and the
settlement agreement, collectively the "Senior Note Agreements"). Until the
Senior Notes are defeased or fully repaid, the Senior Note Agreements
effectively restrict the Company from making any new distributions on its
capital stock, or from making any new investments, except to call securities
previously issued by the Company. Additional exceptions to the restrictions
exist to the extent of cash proceeds of any "permitted subordinated
indebtedness" and cash proceeds of the issuance of any "qualified capital
stock". Further, as a result of the Senior Note Agreements, the Company has
pledged substantially all of its assets (including the stock of its material
subsidiaries) to the indenture trustee and deposits cash in excess of a working
capital balance of $3 million into a restricted account. The Senior Note
Agreements also require the Company to call and re-securitize certain of its
existing collateralized bond and pass-through securities by April 30, 2002, and
if such re-securitization is not completed, to sell certain other securities.
Should the Company fail to close the re-securitization by April 30, 2002 and
sell certain securities by May 31, 2002, ACA has the right, at its option, to
cause the sale of certain securities owned by the Company pursuant to a durable
power of attorney granted to it by the Company.
The table below sets forth the recourse debt and recourse debt to
equity ratio of the Company as of December 31, 2001, 2000, and 1999. Total
recourse debt decreased from $537.1 million for December 31, 1999 to $134.2
million in 2000 and $58.1 million in 2001. These decreases are the result of the
Company's efforts since the end of 1998 to reduce its exposure to recourse debt
through the securitization or sale of assets.
Total Recourse Debt
($ in millions)
- --------------------------------------------------------------------------------
Total Recourse Debt, Net Total Recourse
December 31, of Issuance Debt to Equity Ratio
Costs
- --------------------------------------------------------------------------------
1999 $ 537.1 165%
2000 134.2 85%
2001 58.1 34%
- --------------------------------------------------------------------------------
Non-recourse Debt
The Company, 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 the Company. Collateral for collateralized bonds is 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,
2001, the Company had $2.3 billion of collateralized bonds outstanding.
Summary of Selected Quarterly Results (unaudited)
(amounts in thousands except share data)
- ------------------------------------------------------ ---------------- ---------------- --------------- ----------------
First Second Quarter Third Quarter Fourth Quarter
Year ended December 31, 2001 Quarter
- ------------------------------------------------------ ---------------- ---------------- --------------- ----------------
Operating results:
Total revenues $ 63,797 $ 58,412 $ 52,454 $ 48,873
Net interest margin 3,837 6,411 (2,422) 4,740
Net income (loss) 11,647 2,772 (7,483) (10,024)
Basic net income (loss) per common share 0.74 1.16 (0.75) (0.59)
Diluted net income (loss) per common share 0.74 1.16 (0.75) (0.59)
Cash dividends declared per common share - - - -
- ------------------------------------------------------ ---------------- ---------------- --------------- ----------------
Average interest-earning assets 3,116,556 2,986,595 2,774,778 2,615,966
Average borrowed funds 2,911,595 2,746,032 2,595,423 2,358,461
- ------------------------------------------------------ ---------------- ---------------- --------------- ----------------
Net interest spread on interest-earning assets 0.93% 1.31% 1.40% 1.48%
Average asset yield 8.09% 7.82% 7.55% 7.40%
Net yield on average interest-earning assets (1) 1.40% 1.83% 1.80% 2.06%
Cost of funds 7.16% 6.52% 6.15% 5.92%
- ------------------------------------------------------ ---------------- ---------------- --------------- ----------------
First Second Quarter Third Quarter Fourth Quarter
Year ended December 31, 2000 Quarter
- ------------------------------------------------------ ---------------- ---------------- --------------- ----------------
Operating results:
Total revenues $ 79,214 $ 75,850 $ 70,789 $ 64,879
Net interest margin 5,979 1,901 1,252 (12,278)
Net loss (10,704) (68,695) (836) (11,629)
Basic net loss per common share (1.22) (6.28) (0.35) (1.30)
Diluted net loss per common share (1.22) (6.28) (0.35) (1.30)
Cash dividends declared per common share - - - -
- ------------------------------------------------------ ---------------- ---------------- --------------- ----------------
Average interest-earning assets 4,084,732 3,868,116 3,503,052 3,317,136
Average borrowed funds 3,758,559 3,563,818 3,268,035 3,087,114
- ------------------------------------------------------ ---------------- ---------------- --------------- ----------------
Net interest spread on interest-earning assets 0.83% 0.46% 0.40% 0.42%
Average asset yield 7.75% 7.81% 8.05% 7.98%
Net yield on average interest-earning assets (1) 1.38% 1.04% 0.92% 0.94%
Cost of funds 6.93% 7.35% 7.65% 7.56%
- ------------------------------------------------------ ---------------- ---------------- --------------- ----------------
(1) Computed as net interest margin excluding non-interest collateralized bond expenses.
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 will rely on cash flow from its
investment portfolio to fund its operations, and anticipated proceeds from the
call and re-securitization of securities previously issued by the Company to
repay the remaining outstanding Senior Notes due July 15, 2002. The Company may
be unable to repay such notes when due in the event of a decline in cash flow or
failure to complete such re-securitization. Cash flows from our portfolio are
subject to fluctuation due to changes in interest rates, repayment rates and
default rates and related losses. The Company also relies on an investment bank
for substantially all of the funds necessary to call securities prior to their
re-securitization. The failure of such investment bank to provide such funds
would make it difficult to complete the re-securitization. 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 has been reduced, which
may impair the Company's ability to call and re-securitize its existing
securitizations in the future.
Interest Rate Fluctuations. The Company's income depends on its ability
to earn greater interest on its investments than the interest cost to finance
these investments. Interest rates in the markets served by the Company generally
rise or fall with interest rates as a whole. A majority of the loans currently
pledged as collateral for collateralized bonds by the Company are fixed-rate.
The Company currently finances these fixed-rate assets through non-recourse
debt, approximately $184 million of which is variable rate. In addition, a
significant amount of the investments held by the Company is adjustable-rate
collateral for collateralized bonds. These investments are financed through
non-recourse long-term collateralized bonds. The net interest spread for these
investments could decrease during a period of rapidly rising short-term interest
rates, since the investments generally have interest rates which reset on a
delayed basis and have periodic interest rate caps; the related borrowing have
no delayed resets or 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. The allowance for
losses is calculated on the basis of historical experience and management's best
estimates. Actual default rates or loss severity may differ from the Company's
estimate as a result of economic conditions. In particular, the default rate and
loss severity on the Company's portfolio of manufactured housing loans has been
higher than initially estimated. Actual defaults on ARM loans may increase
during a rising interest rate environment. The Company believes that its
reserves are adequate for such risks on loans that were delinquent as of
December 31, 2001.
Third-party Servicers. Third-party servicers service the majority of
the Company's investment portfolio. To the extent that these servicers are
financially impaired, the performance of the Company's investment portfolio may
deteriorate, and defaults and credit losses may be greater than estimated.
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.
Depository Institution Strategy. The Company intends to explore the
formation or acquisition of a depository institution. However, the pursuit of
this strategy is subject to the outcome of the Company's investigation. No
business plan has been prepared for such strategy. Therefore, any
forward-looking statement made in the report is subject to the outcome of a
variety of factors that are unknown at this time.
Competition. The financial services industry is a highly competitive
market. Increased competition in the market has adversely affected the Company,
and may continue to do so.
Regulatory Changes. The Company's businesses as of December 31, 2001
are not subject to any material federal or state regulation or licensing
requirements. However, changes in existing laws and regulations or in the
interpretation thereof, or the introduction of new laws and regulations, could
adversely affect the Company and the performance of the Company's securitized
loan pools or its ability to collect on its delinquent property tax receivables.
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 margin comprises the
primary component of the Company's earnings. Additionally, cash flow from the
investment portfolio represents the primary component of the Company's incoming
cash flow. 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 re-price within specified periods. The Company's
strategy has been 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 and cash
flow in a variety of interest rate and prepayment environments.
The Company 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.
The Company focuses on the sensitivity of its cash flow, and measures
such sensitivity 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 net interest margin cash flow
for the next twenty-four 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 cash flow.
The following table summarizes the Company's net interest margin cash
flow sensitivity analysis as of December 31, 2001. This analysis represents
management's estimate of the percentage change in net interest margin cash flow
given a parallel shift in interest rates, as discussed above. Other investments
are excluded from this analysis because they are not interest rate sensitive.
The "Base" case represents the interest rate environment as it existed as of
December 31, 2001. At December 31, 2001, One-month LIBOR was 1.87% and Six-month
LIBOR was 1.98%. 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 significantly from the modeled results. In addition, certain financial
instruments provide a degree of "optionality." The most significant option
affecting the Company's portfolio is the borrowers' option to prepay the loans.
The model applies prepayment rate assumptions representing management's estimate
of prepayment activity on a projected basis for each collateral pool in the
investment portfolio. The model applies the same prepayment rate assumptions for
all five cases indicated below. The extent to which borrowers utilize the
ability to exercise their option may cause actual results to significantly
differ from the analysis. Furthermore, the projected results assume no additions
or subtractions to the Company's portfolio, and no change to the Company's
liability structure. Historically, there have been significant changes in the
Company's assets and liabilities, and there are likely to be such changes in the
future.
% Change in Net
Basis Point Interest Margin Cash
Increase (Decrease) in Flow From
Interest Rates Base Case
- ------------------------------ ---------------------------
+200 (4.3)%
+100 (2.2)%
Base
-100 2.2%
-200 4.3%
Approximately $691 million of the Company's investment portfolio as of
December 31, 2001 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 67% and 21%
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, to the extent that the Company has entered into such
agreements.
The remaining portion of the Company's investment portfolio as of
December 31, 2001, approximately $1.8 billion, is comprised of loans or
securities that have coupon rates that are fixed. The Company has substantially
limited its interest rate risk on such investments through (i) the issuance of
fixed-rate collateralized bonds which approximated $1.3 billion as of December
31, 2001, and (ii) equity, which was $173.1 million. 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-27 of this Form 10-K.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to directors and executive
officers of the Company is included in the Company's proxy statement for its
2002 Annual Meeting of Stockholders (the 2002 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 2002 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 2002 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 2002 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 Company's Registration 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.)
10.6 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.)
10.8 Terms of Employment between Dynex Capital, Inc. and Mr. Thomas H.
Potts dated September 4, 2001.
10.9 Terms of Employment between Dynex Capital, Inc. and Mr. Stephen J.
Benedetti dated September 4, 2001.
21.1 List of consolidated entities of the Company (filed herewith)
23.1 Consent of Deloitte & Touche 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)
March 27, 2002 /s/ Thomas H. Potts
-------------------------------------------
Thomas H. Potts
President
(Principal Executive Officer)
March 27, 2002 /s/ Stephen J. Benedetti
-------------------------------------------
Stephen J. Benedetti
Executive Vice President
and Chief Financial Officer
(Principal Accounting and Financial Officer)
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature Capacity Date
/s/ Thomas H. Potts Director March 27, 2002
- ---------------------------------
Thomas H. Potts
/s/ J. Sidney Davenport, IV Director March 27, 2002
- ---------------------------------
J. Sidney Davenport, IV
/s/ Barry S. Shein Director March 27, 2002
- ---------------------------------
Barry S. Shein
/s/ Donald B. Vaden Director March 27, 2002
- ---------------------------------
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, 2001
YNEX CAPITAL, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
Financial Statements: Page
----
Independent Auditors' Report for the Years Ended
December 31, 2001, 2000 , and 1999 F-3
Consolidated Balance Sheets -- December 31, 2001 and 2000 F-4
Consolidated Statements of Operations -- Years ended
December 31, 2001, 2000 and 1999 F-5
Consolidated Statements of Shareholders' Equity -- Years ended
December 31, 2001, 2000 and 1999 F-6
Consolidated Statements of Cash Flows -- Years ended
December 31, 2001, 2000 and 1999 F-7
Notes to Consolidated Financial Statements --
December 31, 2001, 2000, and 1999 F-8
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Dynex Capital, Inc.
We have audited the accompanying consolidated balance sheets of Dynex Capital,
Inc. and subsidiaries (the "Company") as of December 31, 2001 and 2000, and the
related consolidated statements of operations, shareholder's equity, and cash
flows for each of the three years in the period ended December 31, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with 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 Dynex Capital, Inc. and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States of America.
DELOITTE & TOUCHE LLP
Richmond, Virginia
March 5, 2002
CONSOLIDATED BALANCE SHEETS
DYNEX CAPITAL, INC.
December 31, 2001 and 2000
(amounts in thousands except share data)
2001 2000
------------------ -----------------
ASSETS
Investments:
Collateral for collateralized bonds $ 2,404,157 $ 3,042,158
Other investments 63,553 42,284
Securities 5,508 9,364
Loans 7,315 19,102
------------------ -----------------
2,480,533 3,112,908
Cash 7,129 3,485
Cash - restricted 4,334 23,288
Accrued interest receivable 38 323
Other assets 8,778 19,592
------------------ -----------------
$ 2,500,812 $ 3,159,596
================== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Non-recourse debt - collateralized bonds $ 2,264,213 $ 2,856,728
Recourse debt 58,134 134,168
-------------- --------------
2,322,347 2,990,896
Accrued interest payable 2,099 3,775
Accrued expenses and other liabilities 3,303 7,794
------------------ -----------------
2,327,749 3,002,465
------------------ -----------------
SHAREHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 50,000,000 shares authorized:
9.75% Cumulative Convertible Series A,
992,038 and 1,309,061, issued and outstanding, respectively 22,658 29,900
($29,322 and $36,012 aggregate liquidation preference, respectively)
9.55% Cumulative Convertible Series B,
1,378,807 and 1,912,434 issued and outstanding, respectively 32,275 44,767
($41,443 and $53,568 aggregate liquidation preference, respectively)
9.73% Cumulative Convertible Series C,
1,383,532 and 1,840,000 issued and outstanding, respectively 39,655 52,740
($51,101 and $63,259 aggregate liquidation preference, respectively)
Common stock, par value $.01 per share,
100,000,000 shares authorized,
10,873,853 and 11,444,099 issued and outstanding, respectively 109 114
Additional paid-in capital 364,740 351,999
Accumulated other comprehensive loss (83,872) (124,589)
Accumulated deficit (202,502) (197,800)
------------------ -----------------
173,063 157,131
------------------ -----------------
$ 2,500,812 $ 3,159,596
================== =================
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
DYNEX CAPITAL, INC.
Years ended December 31, 2001, 2000 and 1999 (amounts in thousands except share
data)
2001 2000 1999
------------------- ------------------- -------------------
Interest income:
Collateral for collateralized bonds $ 215,018 $ 271,463 $ 284,470
Securities 848 3,595 14,228
Other investments 6,164 5,336 4,388
Loans 730 10,766 26,276
Other - - 12,087
------------------- ------------------- -------------------
222,760 291,160 341,449
------------------- ------------------- -------------------
Interest and related expense:
Non-recourse debt 167,098 232,916 210,794
Recourse debt 6,975 21,595 59,906
Other 605 5,162 6,580
------------------- ------------------- -------------------
174,678 259,673 277,280
------------------- ------------------- -------------------
Net interest margin before provision for losses 48,082 31,487 64,169
Provision for losses (35,512) (34,633) (16,154)
------------------- ------------------- -------------------
Net interest margin 12,570 (3,146) 48,015
Net loss on sales, write-downs, and impairment charges (5,114) (78,516) (100,876)
Equity in net loss of Dynex Holding, Inc. - (680) (1,923)
Trading (losses) gains (3,091) - 4,176
Other income (expense) 104 (428) 1,673
------------------- ------------------- -------------------
4,469 (82,770) (48,935)
General and administrative expenses (10,526) (8,712) (7,740)
Net administrative fees and expenses to Dynex Holding, Inc. - (381) (16,943)
------------------- ------------------- -------------------
Loss before extraordinary item (6,057) (91,863) (73,618)
Extraordinary item - gain (loss) on extinguishment of debt 2,972 - (1,517)
-------------------- ----------------- ------------------
Net loss (3,085) (91,863) (75,135)
Preferred stock benefits (charges) 9,331 (12,911) (12,910)
------------------- ------------------- -------------------
Net income (loss) available to common shareholders $ 6,246 $ (104,774) $ (88,045)
=================== =================== ===================
Net income (loss) per common share before extraordinary item:
Basic $ 0.29 $ (9.15) $ (7.53)
=================== =================== ===================
Diluted $ 0.29 $ (9.15) $ (7.53)
=================== =================== ===================
Net income (loss) per common share after extraordinary item:
Basic $ 0.55 $ (9.15) $ (7.67)
=================== =================== ===================
Diluted $ 0.55 $ (9.15) $ (7.67)
=================== =================== ===================
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
DYNEX CAPITAL, INC.
Years ended December 31, 2001, 2000, and 1999 (amounts in thousands except share
data)
Accumulated Retained
Additional Other Earnings
Preferred Common Paid-in Comprehensive (Accumulated
Stock Stock Capital (Loss) Income Deficit) Total
----------------------------------------------------------------------------------------
Balance at January 1, 1999 $ 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 (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 awards - - (69) - - (69)
Dividends on preferred stock - - - - (6,454) (6,454)
----------------------------------------------------------------------------------------
Balance at December 31, 1999 127,407 114 351,995 (48,507) (105,937) 325,072
Comprehensive loss:
Net loss - 2000 - - - - (91,863) (91,863)
Change in net unrealized loss on
investments classified as available
for sale during the period - - - (76,082) - (76,082)
-------------
Total comprehensive loss (167,945)
Issuance of common stock - - 4 - - 4
----------------------------------------------------------------------------------------
Balance at December 31, 2000 127,407 114 351,999 (124,589) (197,800) 157,131
Comprehensive loss:
Net loss - 2001 - - - - (3,085) (3,085)
Change in net unrealized loss on
investments classified as available
for sale during the period - - - 40,717 - 40,717
-------------
Total comprehensive income 37,631
Repurchase of preferred stock (32,819) - 12,735 - - (20,084)
Dividends on preferred stock - - - - (1,617) (1,617)
Retirement of common stock - (5) 6 - - 1
----------------------------------------------------------------------------------------
$ 94,588 $ 109 $ 364,740 $ (83,872) $ (202,502) $ 173,063
========================================================================================
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
DYNEX CAPITAL, INC.
Years ended December 31, 2001, 2000 and 1999 (amounts in thousands except share
data)
2001 2000 1999
--------------- --------------- ---------------
Operating activities:
Net (loss) income $ (3,085) $(91,863) $(75,135)
Adjustments to reconcile net (loss) income to
cash provided by operating activities:
Provision for losses 35,512 34,633 16,154
Net loss on sales, write-downs, and impairment charges 5,114 78,516 96,700
Equity in net loss of Dynex Holding, Inc. - 680 1,923
Extraordinary item - (gain) loss on extinguishment of debt (2,972) - 1,517
Amortization and depreciation 12,278 16,117 28,133
Receipt (Payment) of litigation settlements 7,095 (20,000) -
Net change in restricted cash 18,954 8,014 (6,865)
Net change in accrued interest, other assets and other (3,345) (5,629) (9,425)
liabilities
--------------- --------------- ---------------
Net cash provided by operating activities 69,551 20,468 53,002
--------------- --------------- ---------------
Investing activities:
Collateral for collateralized bonds:
Fundings of investments subsequently securitized - - (627,290)
Principal payments on collateral 595,822 521,355 1,119,841
Decrease in accrued interest receivable 4,028 2,132 5,080
Net decrease (increase) in funds held by trustee 125 774 (1,051)
Net decrease in loans 9,622 198,785 84,762
Purchase of securities and other investments (7,865) (9,476) (57,085)
Payments received on securities and other investments 15,609 24,891 90,263
Proceeds from sales of securities and other investments 3,662 24,579 61,415
Payments for sale of tax-exempt bond obligations - (30,284) -
Investment in and advances to Dynex Holding, Inc. - 4,134 (26,335)
Proceeds from sale of loan production operations 8,820 9,500 213,591
Capital expenditures (109) (92) (281)
--------------- --------------- ---------------
Net cash provided by investing activities 629,714 746,298 862,910
--------------- --------------- ---------------
Financing activities:
Collateralized bonds:
Proceeds from issuance of bonds 507,586 140,724 1,069,048
Principal payments on bonds (1,107,247) (524,040) (1,091,216)
Increase (decrease) in accrued interest payable (1,209) 780 3,677
Repayment of senior notes (38,886) (13,570) (17,833)
Repayment of recourse debt borrowings, net (34,164) (390,310) (851,771)
Net proceeds from issuance of stock - 4 30
Retirement of common stock - - (700)
Retirement of preferred stock (20,084) - -
Dividends paid (1,617) - (9,682)
--------------- --------------- ---------------
Net cash used for financing activities (695,621) (786,412) (898,447)
--------------- --------------- ---------------
Net increase (decrease) in cash 3,644 (19,646) 17,465
Cash at beginning of period 3,485 23,131 5,666
--------------- --------------- ---------------
Cash at end of period $ 7,129 $ 3,485 $ 23,131
=============== =============== ===============
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
December 31, 2001, 2000, and 1999
(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., its qualified REIT subsidiaries and taxable REIT subsidiary
(together, the "Company"). During 2000 and 1999, the Company operated its
lending and servicing activities out of a taxable affiliate, Dynex Holding, Inc.
("DHI"), which was not consolidated for financial reporting purposes but was
accounted for under an accounting method similar to the equity method. In
November 2000, certain subsidiaries of DHI were sold to the Company, and on
December 31, 2000, DHI was liquidated in a taxable transaction into the Company.
As a result of the liquidation, effectively all of the assets and liabilities of
DHI were transferred to Company as of December 31, 2000. All significant
inter-company balances and transactions with Company's consolidated subsidiaries
have been eliminated in consolidation.
Reclassifications
Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Federal Income Taxes
The Company has elected to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code. As a result, the Company generally
will not be subject to federal income taxation at the corporate level on amounts
distributed to shareholders, provided that it distributes at least 90 percent of
its taxable income to its shareholders within the prescribed 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 the Company believes it has met or will
meet the prescribed requirements. In addition, the Company has net operating
loss carry-forwards of approximately $125,000, and capital loss carry-forwards
of approximately $61,000. Substantially all of the $125,000 in net operating
losses carry-forwards expire in 2014 and 2015, and of the $61,000 of capital
loss carry-forwards, $33,000 expires in 2003 and $28,000 expires in 2004.
Investments
Pursuant to the requirements of Statement of Financial Accounting
Standards No. 115 ("FAS No. 115"), "Accounting for Certain Investments in Debt
and Equity Securities," the Company is required to classify certain of its
investments considered debt securities as either trading, available-for-sale or
held-to-maturity. In certain instances the Company may reclassify investments
from available-for-sale to held-to-maturity, but only when it has the intent and
the ability to hold such investments to maturity. At the time of the
reclassification, the carrying value of the investment is adjusted to its
estimated fair market value with a corresponding adjustment to accumulated other
comprehensive income. In accordance with FAS No. 115, such adjustment is
amortized as an adjustment to earnings on the associated investment using the
effective yield method.
Collateral for Collateralized Bonds and Securities. The Company 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 that 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.
Other Investments. Other investments considered debt securities under
FAS No. 115 are classified as held-to-maturity and are carried at their
amortized cost basis. Other investments not considered debt securities are
carried at their amortized cost basis, less reserves as applicable. Other
investments may include real estate owned acquired through, or in lieu of,
foreclosure. Such investments are considered held for sale and are initially
recorded at fair value at the date of foreclosure, establishing a new cost
basis. Subsequent to foreclosure, management periodically performs valuations
and the investments are carried at the lower of carrying amount or fair value
less cost to sell. Revenue and expenses from operations and changes in the
valuation allowance are included in other income (expense).
Loans. Loans considered held for sale are carried at the lower of amortized
cost or market. Loans held to maturity are carried at amortized cost.
Interest Income. Interest income is recognized when earned according to
the terms of the underlying investment and when, in the opinion of management,
it is collectible. The accrual of interest on investments is discontinued, or
the rate on which interest is accrued is reduced at the time the collection of
interest is considered doubtful. All interest accrued but not collected for
investments that are placed on non-accrual status or charged-off is reversed
against interest income. Interest on these investments is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual.
Investments are returned to accrual status when all the principal and interest
amounts contractually due are brought current and future payments are reasonably
assured.
Premiums and Discounts
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 hedging gains and losses on associated investments and
obligations are included in premiums and discounts.
Deferred Issuance Costs
Costs incurred in connection with the issuance of collateralized bonds
and unsecured notes are deferred and amortized over the estimated lives of their
respective debt obligations using a method that approximates the effective yield
method.
Derivative Financial Instruments
The Company 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 the
inception of the hedge, these instruments are designated as either hedge
positions or trading positions using criteria established in Statement of
Financial Accounting Standards ("FAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities".
For Interest Rate Agreements designated as hedge instruments, the
Company evaluates the effectiveness of these hedges against the financial
instrument being hedged under various interest rate scenarios. The effective
portion of the gain or loss on an Interest Rate Agreement designated as a hedge
is reported in accumulated other comprehensive income, and the ineffective
portion of such hedge is reported in income.
As a part of the Company's interest rate risk management process, the
Company 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.
If the underlying asset, liability or commitment is sold or matures,
the hedge is deemed partially or wholly ineffective, 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 or otherwise
previously been recognized in income.
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 counter-parties, if any, are
included on the consolidated balance sheets in accrued expenses and other
liabilities.
Statement of Financial Accounting Standards ("FAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities," is effective for all fiscal
years beginning after June 15, 2000. FAS No. 133, as amended, establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
Under FAS No. 133, certain contracts that were not formerly considered
derivatives may now meet the definition of a derivative. The Company adopted FAS
No. 133 effective January 1, 2001. The adoption of FAS No. 133 did not have a
significant impact on the financial position, results of operations, or cash
flows of the Company.
Cash - Restricted
At December 31, 2001, $4,334 of cash was held in trust to cover losses
on securities not otherwise covered by insurance or was held in trust as
collateral for the payment of principal on the Senior Notes. At December 31,
2000, $23,288 of cash was held as collateral for outstanding letters of credit
or was held in trust to cover losses on securities not otherwise covered by
insurance. As a result of an amendment to the indenture governing the Company's
senior notes due July 2002 (the "Senior Notes") entered into in March 2001 and a
settlement agreement entered into in October 2001 with ACA Financial Guaranty
Corporation (ACA), the Company's ability to make distributions on its capital
stock and to reinvest cash flow from its investment portfolio and other assets
are materially restricted (the amendment to the indenture and the settlement
agreement, collectively the "Senior Note Agreements"). Until the Senior Notes
are defeased or fully repaid, the Senior Note Agreements effectively restricted
the Company from making any new distributions on its capital stock, or from
making any new investments, except to call securities previously issued by the
Company. In addition, as a result of the Senior Note Agreements, the Company has
pledged substantially all its assets (including the stock of its material
subsidiaries) to the indenture trustee and deposits cash in excess of a working
capital balance of $3,000 into a restricted account. Payments received on
certain of the securities pledged to the indenture trustee are held by the
trustee for payment of principal on the Senior Notes. At December 31, 2001,
$1,240 of cash was held in this account.
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 August 1999 of Company'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 accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reported period. Actual results could differ from those
estimates. The primary estimates inherent in the accompanying consolidated
financial statements are discussed below.
Fair Value. The Company uses estimates in establishing fair value for
its financial instruments. Estimates of fair value for financial instruments may
be based on market prices provided by certain dealers. Estimates of fair value
for certain other financial instruments are determined by calculating the
present value of the projected cash flows of the instruments using appropriate
discount rates, prepayment rates and credit loss assumptions. Collateral for
collateralized bonds make up a significant portion of the Company's investments.
The estimate of fair value for collateral for collateralized bonds is determined
by calculating the present value of the projected cash flows of the instruments,
using discount rates, prepayment rate assumptions and credit loss assumptions
established by management. The discount rate used in the determination of fair
value of the collateral for collateralized bonds was 16% at December 31, 2001
and 2000. Prepayment rate assumptions at December 31, 2001 and 2000 were
generally at a "constant prepayment rate," or CPR, ranging from 35%-60% for
2001, and 28% for 2000, respectively, for collateral for collateralized bonds
consisting of single-family mortgage loans, and a CPR equivalent ranging from
9%-10% for 2001 and 7% for 2000, respectively for collateral for collateralized
bonds consisting of manufactured housing loan collateral. Commercial mortgage
loan collateral was generally assumed to repay in accordance with their
contractual terms. CPR assumptions for each year are based in part on the actual
prepayment rates experienced for the prior six-month period and in part on
management's estimate of future prepayment activity. The loss assumptions
utilized vary for each series of collateral for collateralized bonds, depending
on the collateral pledged. The cash flows for the collateral for collateralized
bonds were projected to the estimated date that the security could be called and
retired by the Company if there is economic value to the Company in calling and
retiring the security. Such call date is typically triggered on the earlier of a
specified date or when the remaining security balance equals 35% of the original
balance (the "Call Date"). The Company estimates anticipated market prices of
the underlying collateral at the Call Date.
As discussed in Note 4, the Company estimated the fair value of certain
other investments as the present value of expected future cash flows, less costs
to service such investments, discounted at a rate of 12%.
Estimates of fair value for other financial instruments are based
primarily on management's judgment. Since the fair value of Company's financial
instruments is based on estimates, actual gains and losses recognized may differ
from those estimates recorded in the consolidated financial statements. The fair
value of all on- and off-balance sheet financial instruments is presented in
Note 9.
Allowance for Losses. As discussed in Note 6, the Company 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. The Company's actual
credit losses may differ from those estimates used to establish the allowance.
Derivative and Residual Securities. Income on certain derivative and
residual securities is accrued using the effective yield method based upon
estimates of future cash flows to be received over the estimated remaining lives
of the related 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
Statement of FAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" is effective for all fiscal years beginning after June 15,
2000. FAS No. 133, as amended, establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. The Company adopted FAS No. 133
effective January 1, 2001. The adoption of FAS No. 133 did not have a
significant impact on the financial position, results of operations, or cash
flows of the Company.
In September 2000, the Financial Accounting Standards Board ("FASB") issued
Statement of FAS No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities" ("FAS No. 140"). FAS No. 140 replaces
the Statement of Financial Accounting Standards No. 125 "Accounting for the
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
("FAS No. 125"). FAS No. 140 revises the standards for accounting for
securitization and other transfers of financial assets and collateral and
requires certain disclosure, but it carries over most of FAS No. 125 provisions
without reconsideration. FAS No. 140 is effective for transfers and servicing of
financial assets and extinguishment of liabilities occurring after March 31,
2001. FAS No. 140 is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. Disclosures about
securitization and collateral accepted need not be reported for periods ending
on or before December 15, 2000, for which financial statements are presented for
comparative purposes. FAS No. 140 is to be applied prospectively with certain
exceptions. Other than those exceptions, earlier or retroactive application of
its accounting provision is not permitted. The adoption of FAS No. 140 did not
have a material impact on the Company's financial statements.
In June 2001, the FASB issued Statement of FAS (FAS) No. 141, Business
Combinations. FAS No. 141 requires that all business combinations initiated
after June 30, 2001 be accounted for under the purchase method and addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. Business combinations originally accounted
for under the pooling of interest method will not be changed. The adoption of
FAS 141 did not have an impact on the financial position, results of operations
or cash flows of the Company.
In June 2001, the FASB issued FAS No. 142, Goodwill and Other
Intangible Assets. FAS No. 142 addresses the initial recognition and measurement
of intangible assets acquired outside of a business combination and the
accounting for goodwill and other intangible assets subsequent to their
acquisition. FAS No. 142 provides that intangible assets with finite useful
lives be amortized and that goodwill and intangible assets with indefinite lives
will not be amortized, but will rather be tested at least annually for
impairment. As the Company has no goodwill or intangible assets that it is
amortizing, the adoption of FAS No. 142 will have no effect on the financial
position, results of operations or cash flows of the Company.
In June 2001, the FASB issued FAS No. 143, "Accounting for Asset Retirement
Obligations." FAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. FAS No. 143 is effective for fiscal years
beginning after June 15, 2002. The company does not believe the adoption of FAS
No. 143 will have a significant impact on the financial position, results of
operations or cash flows of the Company.
In August 2001, the FASB issued FAS No. 144, "Accounting for the
Impairment of Long-lived Assets" which supercedes FAS No. 121, "Accounting for
the Impairment of Long-lived Assets and for Long-lived Assets to be disposed of"
and the accounting and reporting provisions of APB No. 30, "Reporting the
Results of Operations - Reporting and Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" for the disposal of a segment of business. This statement is
effective for fiscal years beginning after December 15, 2001. FAS No. 144
retains many of the provisions of FAS No. 121, but addresses certain
implementation issues associated with that Statement. The company does not
believe the adoption of FAS No. 144 will have a significant impact on the
financial position, results of operations or cash flows of the Company.
NOTE 3 - SUBSEQUENT EVENTS
On January 15, 2002, the Company purchased $8,642 of its Senior Notes
due July 15, 2002 for an aggregate purchase price of $8,296, or a 4% discount to
par. After such purchase, the remaining outstanding balance of the Senior Notes
was $49,327.
NOTE 4 - COLLATERAL FOR COLLATERALIZED BONDS, SECURITIES AND OTHER INVESTMENTS
The following table summarizes the Company's amortized cost basis and fair value
of investments classified as available-for-sale, as of December 31, 2001 and
2000, and the related average effective interest rates:
- ------------------------------------------- ------------------------------ ----- ------------------------------
2001 2000
Effective Effective
Fair Value Interest Rate Fair Value Interest Rate
- ------------------------------------------- --------------- -------------- ----- -------------- ---------------
Collateral for collateralized bonds:
Amortized cost $2,496,992 7.6% $ 3,189,414 7.8%
Allowance for losses (27,161) (25,314)
- ------------------------------------------- --------------- -------------- ----- -------------- ---------------
Amortized cost, net 2,469,831 3,164,100
Gross unrealized gains 35,188 37,803
Gross unrealized losses (100,862) (159,745)
- ------------------------------------------- --------------- -------------- ----- -------------- ---------------
$2,404,157 $ 3,042,158
- ------------------------------------------- --------------- -------------- ----- -------------- ---------------
Securities:
Adjustable-rate mortgage securities $ 600 11.9% $ 5,008 10.9%
Fixed-rate mortgage securities 351 11.8% 1,505 9.3%
Derivative and residual securities 4,358 8.0% 5,553 7.9%
- ------------------------------------------- --------------- -------------- ----- -------------- ---------------
5,309 12,066
Allowance for losses (55) (55)
- ------------------------------------------- --------------- -------------- ----- -------------- ---------------
Amortized cost, net 5,254 12,011
Gross unrealized gains 2,134 411
Gross unrealized losses (1,880) (3,058)
- ------------------------------------------- --------------- -------------- ----- -------------- ---------------
$ 5,508 $ 9,364
- ------------------------------------------- --------------- -------------- ----- -------------- ---------------
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.
The components of collateral for collateralized bonds at December 31,
2001 and 2000 are as follows:
- -------------------------------------------- ------------------- ----- ---------
2001 2000
- ------------------------------------ ------------------- ----- -----------------
Collateral, net of allowance $ 2,429,968 $ 3,111,413
Funds held by trustees 391 515
Accrued interest receivable 16,594 20,622
Unamortized premiums and
discounts, net 22,878 31,550
Unrealized loss, net (65,674) (121,942)
- -------------------------------------------- ------------------- ----- ---------
$ 2,404,157 $ 3,042,158
- ------------------------------------ ------------------- ----- -----------------
Securities. Adjustable-rate mortgage securities ("ARM") consist of
mortgage certificates secured by ARM loans. Fixed-rate mortgage securities
consist of mortgage certificates secured by mortgage loans that have a fixed
rate of interest for at least one year from the balance sheet date. Derivative
securities are classes of collateralized bonds, mortgage pass-through
certificates or mortgage certificates that pay to the holder substantially all
interest (i.e., an interest-only security), or substantially all principal
(i.e., a principal-only security). Residual interests represent the right to
receive the excess of (i) the cash flow from the collateral pledged to secure
related mortgage-backed securities, together with any reinvestment income
thereon, over (ii) the amount required for principal and interest payments on
the mortgage-backed securities or repurchase arrangements, together with any
related administrative expenses.
Other investments. Other investments consist primarily of delinquent
property tax receivables. Other investments at December 31, 2000 also included
an installment note receivable received in connection with the sale of the
Company's single family mortgage operations in May 1996. One pool of the
delinquent property tax receivables was previously pledged as collateral for
collateralized bonds, and in 2001 was reclassified to other investments
commensurate with the repayment of the associated collateralized bonds
outstanding to third parties. Such pool is considered a debt security under FAS
No. 115 and commensurate with its reclassification to other investments in 2001,
was reclassified as held-to-maturity from available-for-sale. At the time of
reclassification, the carrying value of the delinquent property tax receivables
was adjusted to fair value, resulting in an impairment charge of $6,774 for the
portion of the adjustment that was deemed an other-than-temporary impairment,
and a charge of $18,452 to accumulated other comprehensive loss. The aggregate
fair value of such pool of receivables was determined based on the present value
of the cash flows expected to be received from these receivables, less costs to
service, at a discount rate of 12%. In accordance with the provisions of FAS No.
115, the $18,452 in adjustment to accumulated other comprehensive loss will be
amortized in accordance with the level yield method. The Company purchased
$8,719 and $7,585 of delinquent property tax receivables under a preexisting
contract during 2001 and 2000, respectively. At December 31, 2001, the Company
has real estate owned with a current carrying value of $5,928 resulting from
foreclosures on delinquent property tax receivables. At December 31, 2001,
$57,354 of delinquent property tax receivables is on non-accrual status,
consisting of two large pools of property tax receivables aggregating $34,855
and $21,397, and other pools of property tax receivables aggregating $1,102.
Cash collections on these pools of receivables during 2001 was $7,457,
$8,254,and $1,039, respectively
Sale of investments. Proceeds from sales of investments totaled $3,662,
$24,579, and $61,415, in 2001, 2000, and 1999, respectively. See Note 12, Net
Loss on Sales, Write-downs and Impairment Charges for further discussion.
Sensitivity analysis. The Company owned interest-only and
principal-only securities, some of which were pledged to support certain of the
Company's collateralized bond securities, and purchased from an affiliate during
the period 1992-1995. These interest-only and principal-only securities had an
investment basis of $3,073 and $1,287, respectively, and estimated market values
of $1,401 and $1,180, respectively at December 31, 2001. The Company based on
quotes from a third party dealer obtained market values. The majority of these
interest-only and principal-only securities are rated `AAA' by at least one
nationally recognized ratings agency, and have very little sensitivity to the
credit risk of the underlying single-family mortgage loans. The majority of the
risk associated with the Company's investment in these securities relates to the
prepayment speeds of the underlying single-family mortgage loans. In providing
market prices, the third party used average prepayment speed assumptions of 40%
CPR and 25% CPR, respectively, for the interest-only and principal-only
securities.
The Company performed a sensitivity analysis on the CPR assumptions for
the interest-only securities by increasing the CPR 10% and 20%, and performed a
sensitivity analysis on the principal-only securities by reducing CPR by 5% and
10%. In addition, the Company performed a sensitivity analysis on the discount
rate assumptions used by the third party by increasing and decreasing the
respective discount rates by 100 basis points and 150 basis points. In all
cases, the changes in value were immaterial to the overall value of the
investment portfolio.
These sensitivity analyses are based on management estimates and are
hypothetical in nature. Actual results will differ from projected results.
NOTE 5 - LOANS
The following table summarizes the Company's carrying basis in loans at
December 31, 2001 and 2000, respectively.
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Secured by multifamily and
commercial properties $2,791 $19,224
Secured by consumer installment contracts 3,601 308
Secured by single-family mortgage loans 906 -
---------------- ----------------
7,298 19,532
Net premium (discount) 17 (123)
Allowance for losses - (307)
- --------------------------------------------------------------------------------
Total loans $7,315 $9,102
- --------------------------------------------------------------------------------
The Company did not fund any loans during 2001 and funded multifamily
mortgage loans with an aggregate principal balance of $29,529 during 2000. Loans
secured by consumer installment contracts at December 31, 2001 were previously
pledged to support non-recourse collateralized bonds, and such bonds were
paid-off in 2001. Of the above amounts, loans with a carrying amount of $3,712
and $19,102 respectively are considered held for sale at December 31, 2001 and
2000.
NOTE 6 - ALLOWANCE FOR LOSSES
The Company reserves for credit risk where it has exposure to losses on
various investments in its investment portfolio. The following table summarizes
the aggregate activity for the allowance for losses of principal on investments
for the years ended December 31, 2001 and 2000:
- -------------------------- ---------------- ----------------- ------------------
2001 2000 1999
- -------------------------- ---------------- ----------------- ------------------
Allowance at beginning
of year $ 25,728 $ 17,484 $ 20,370
Provision for losses 35,512 34,633 16,154
Credit losses, net of
recoveries (34,024) (26,389) (19,040)
- --------------------------- ---------------- ----------------- -----------------
Allowance at end of year $ 27,216 $ 25,728 $ 17,484
- --------------------------- ---------------- ----------------- -----------------
Collateral for collateralized bonds. The Company 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 "over-collateralization"), excluding price
premiums and discounts and hedge gains and losses. In some cases, the aggregate
loss exposure may be increased by the use of surplus cash or cash reserve funds
contained within the security structure to cover losses. The allowance for
losses on the over-collateralization totaled $27,161 and $25,314 at December 31,
2001 and 2000 respectively, and is included in collateral for collateralized
bonds in the accompanying consolidated balance sheets.
Securities and Other Investments. On certain securities collateralized
by mortgage loans purchased by the Company for which mortgage pool insurance is
used as the primary source of credit enhancement, the Company has limited
exposure to certain credit risks such as fraud in the origination and special
hazards not covered by such insurance. An allowance was established based on the
estimate of losses at the time of securitization. The Company also has credit
risk on certain other investments. The allowance for losses for securities and
other investments was $55 and $414 at December 31, 2001 and 2000, respectively.
NOTE 7 - NON-RECOURSE DEBT - COLLATERALIZED BONDS
The Company, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds. Each series of
collateralized bonds may consist of various classes of bonds, either at fixed or
variable rates of interest. Payments received on the collateral for
collateralized bonds and any reinvestment income thereon are used to make
payments on the collateralized bonds (see Note 4). The obligations under the
collateralized bonds are payable solely from the collateral for collateralized
bonds and are otherwise non-recourse to the Company. The maturity of each class
is directly affected by the rate of principal prepayments on the related
collateral. Each series is also subject to redemption according to specific
terms of the respective indentures, generally when the remaining balance of the
bonds equals 35% or less of the original principal balance of the bonds, or on a
specific date. As a result, the actual maturity of any class of a series of
collateralized bonds is likely to occur earlier than its stated maturity.
The Company 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, 2001 and
2000 were $65,601 and $151,072, respectively. As these limited-purpose finance
subsidiaries are included in the consolidated financial statements of the
Company, such retained bonds are eliminated in the consolidated financial
statements, while the associated repurchase agreements outstanding, if any, are
included as recourse debt.
The components of collateralized bonds along with certain other
information at December 31, 2001 and 2000 are summarized as follows:
- ------------------------------- ------------------------------------ --- ----------------------------------
2001 2000
- ------------------------------- ------------------------------------ --- ----------------------------------
Bonds Outstanding Range of Bonds Range of
Interest Rates Outstanding Interest Rates
- ------------------------------- ------------------- ---------------- --- ----------------- ----------------
Variable-rate classes $ 937,973 2.5% - 5.6% $ 1,464,087 6.9% -10.1%
Fixed-rate classes 1,294,751 6.2% - 11.5% 1,365,085 6.2% -11.5%
Accrued interest payable 8,935 10,144
Deferred bond issuance costs (7,840) (9,254)
Unamortized net bond premium
30,394 26,666
- ------------------------------- ------------------- ---------------- --- ----------------- ----------------
$ 2,264,213 $ 2,856,728
- ------------------------------- ------------------- ---------------- --- ----------------- ----------------
Range of stated maturities 2009-2033 2009-2033
Number of series 23 23
- ------------------------------- ------------------- ---------------- --- ----------------- ----------------
The variable rate classes are based on one-month London InterBank
Offered Rate (LIBOR). At December 31, 2001, the weighted-average effective rate
of the variable-rate classes was 3.2%, and the weighted-average effective rate
of fixed rate classes was 7.1%. The average effective rate of interest for
non-recourse debt was 6.4%, 7.3%, and 6.2% for the years ended December 31,
2001, 2000, and 1999, respectively.
NOTE 8 - RECOURSE DEBT
The Company utilizes repurchase agreements, secured credit facilities
and notes payable (together, "recourse debt") to finance certain of its
investments. The following table summarizes the Company's recourse debt
outstanding and the weighted-average annual rates at December 31, 2001 and 2000:
- ------------------------------------------ ----------------------------------------- -- -----------------------------------------
2001 2000
- ------------------------------------------ ----------------------------------------- -- -----------------------------------------
Weighted- Weighted-
Average Market Average Market Value
Amount Annual Value of Amount Annual of
Outstanding Rate Collateral Outstanding Rate Collateral
- ------------------------------------------ ------------- ------------- ------------- -- ------------- ------------- -------------
7.875% Senior Notes $ 57,969 7.88% See below $ 97,250 7.88% $ 94,183
Repurchase agreements - - - 35,015 7.66%
Credit facilities - - - 2,000 7.81% 9,658
Capitalized lease obligations 244 7.81% 234 430 7.64% 373
Capitalized costs (79) - (527) -
- ----------------------------------------- ------------- ------------- ------------- ----------------- ------------- -------------
$ 58,134 $ 234 $134,168 $104,214
- ------------------------------------------ ------------- ------------- ------------- -- ------------- ------------- -------------
At December 31, 2001 and December 31, 2000, recourse debt consisted of
none and $35,015, respectively, of repurchase agreements secured by cash,
investments and retained collateralized bonds; none and $2,000, respectively,
outstanding under a revolving credit facility secured by other investments; and
$244 and $430, respectively, of amounts outstanding under a capital lease. The
secured revolving credit facility was extinguished in January 2001 and the
repurchase agreements were fully repaid in November 2001.
As of December 31, 2001 and December 31, 2000, the Company had $57,969
and $97,250, respectively, outstanding of its Senior Notes. In March 2001, the
Company entered into an amendment to the related indenture governing the Senior
Notes whereby the Company pledged to the Trustee of the Senior Notes
substantially all of the Company's unencumbered assets in its investment
portfolio and the stock of its material subsidiaries. In consideration of this
pledge, the indenture was further amended to provide for the release of the
Company from certain covenant restrictions in the indenture, and specifically
provided for the Company's ability to make distributions on its capital stock in
an amount not to exceed the sum of (i) $26,000, (ii) the cash proceeds of any
"permitted subordinated indebtedness", (iii) the cash proceeds of the issuance
of any "qualified capital stock", and (iv) any distributions required in order
for Company to maintain its REIT status. In addition, in March 2001, the Company
entered into a Purchase Agreement with holders of 50.1% of the Senior Notes
which required the Company to purchase, and such holders to sell, their
respective Senior Notes at various discounts prior to maturity based on a
computation of the Company's available cash. Through December 31, 2001, the
Company has retired $39,281 of Senior Notes for $36,364 in cash under the
Purchase Agreement. On January 15, 2002, the Company purchased for $8,296 the
remaining amount available of $8,642 to be purchased under the Purchase
Agreement.
At December 31, 2000, the Company had a secured non-revolving credit
facility under which $66,765 of letters of credit to support tax-exempt bonds
had been issued. These letters of credit were released during the first quarter
of 2001, as a result of the purchase, sale or transfer of the underlying
tax-exempt bonds, and the facility was extinguished.
The Company has entered into capital leases for financing its furniture
and computer equipment. Interest expense on these capital leases was $25, $52,
and $177 for the years ended December 31, 2001, 2000, and 1999, respectively.
The leases expire in 2002. The aggregate payments due under the capital leases
for 2002 is $255.
NOTE 9 - FAIR VALUE AND ADDITIONAL INFORMATION ABOUT FINANCIAL INSTRUMENTS
FAS No. 107, "Disclosures about Fair Value of Financial Instruments"
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 Company's financial instruments as of December 31, 2001
and 2000:
- --------------------------------------------- ----------------------------------- --------------------------------
2001 2000
----------------------------------- --------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- --------------------------------------------- ---- -------------- --------------- -- --------------- -------------
Assets:
Collateral for collateralized bonds $2,469,994 $2,404,157 $3,164,100 $3,042,158
Securities 5,309 5,508 12,011 9,364
Other investments 63,553 56,925 42,284 42,284
Loans 7,315 7,493 19,102 19,102
Liabilities:
Non-recourse debt 2,264,213 2,264,213 2,856,728 2,856,728
Recourse debt:
Repurchase agreements - - 35,015 35,015
Credit facilities - - 2,000 2,000
Senior Notes 57,890 55,650 96,723 87,737
- --------------------------------------------- ---- ------------- ------------ ------ ------------ ----------------
The fair value of collateral for collateralized bonds, securities,
other investments, and loans 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. Repurchase
agreements and credit facilities are short-term in nature and reprice monthly.
Therefore, their carrying value approximates the fair value. Non-recourse debt
is both floating and fixed, and is considered within the security structure
along with the associated collateral for collateralized bonds. For the Senior
Notes, the fair value was determined by calculating the present value of the
projected cash flows using appropriate discount rates.
Derivative Financial Instruments
At December 31, 2001 and 2000, the Company had no outstanding
derivative financial instruments positions.
In 2001, the Company entered into three separate short positions
aggregating $1,300,000 on the June 2001, September 2001, and December 2001,
ninety-day Eurodollar Futures Contracts. The Company entered into these
positions to, in effect, lock-in its borrowing costs on a forward basis relative
to a portion of its floating-rate liabilities. In addition, the Company entered
into two short positions on the one-month LIBOR futures contract. These
instruments failed to meet the hedge criteria of FAS No. 133, and therefore were
accounted for on a trading basis. During 2001, the Company recognized $3,091 in
losses related to these positions.
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, 2001, 2000, and 1999.
- ---------------------------------------- --------------------------- ---------------------------- -----------------------------
2001 2000 1999
- ---------------------------------------- ------------- ------------- ------------- -------------- ------------- ---------------
Weighted-Average Weighted-Average Weighted-Average
Number of Number of Number of
Shares Shares Shares
Income Income Income
(loss) (loss) (loss)
- ---------------------------------------- ------------- ------------- ------------- -------------- ------------- ---------------
(Loss) before extraordinary item $(6,057) $(91,863) $(73,618)
Extraordinary item - gain (loss) on
extinguishment of debt 2,972 - (1,517)
------------- ------------- -------------
Net (Loss) (3,085) (91,863) (75,135)
Preferred stock benefit (charges) 9,331 (12,911) (12,910)
------------- ------------- ------------- -------------- ------------- ---------------
Net income (loss) available to common
shareholders $ 6,246 11,430,471 $(104,774) 11,445,236 $(88,045) 11,483,977
Effect of dividends and additional
shares of Series A, Series B, and
Series C preferred stock - - - - - -
------------- ------------- ------------- -------------- ------------- ---------------
$ 6,246 11,430,471 $(104,774) 11,445,236 $(88,045) 11,483,977
============= ============= ============= ============== ============= ===============
Diluted Earnings per share before
extraordinary item:
Basic EPS $0.29 $(9.15) ($7.53)
============= ===============
==============
Diluted EPS $0.29 $(9.15) ($7.53)
============= ============== ===============
Earnings per share after extraordinary item:
Basic EPS $0.55 $(9.15) ($7.67)
============= ============== ===============
Diluted EPS $0.55 $(9.15) ($7.67)
============= ============== ===============
Reconciliation of anti-dilutive shares:
Dividends and additional shares of
preferred stock:
Series A $918 591,535 $3,063 654,531 $3,063 654,531
Series B 950 845,827 4,475 956,217 4,475 956,217
Series C 1,536 835,986 5,373 920,000 5,372 920,000
Expense and incremental shares of
stock appreciation rights - - - - - 28,931
------------- ------------- ------------- -------------- ------------- ---------------
$3,404 $2,273,348 $12,911 2,530,748 $12,910 2,559,679
- ---------------------------------------- ------------- ------------- ------------- -------------- ------------- ---------------
During 2001, the Company purchased $39,281 of the Senior Notes and
recorded an extraordinary gain, net of associated costs, of $2,829. During 2001,
the Company exercised its call rights on one series of previously issued
collateralized bonds, subsequently re-offered the bonds called, and as a result,
recognized an extraordinary loss of $1,013. During 2001, the Company fully
extinguished one series of collateralized bonds at a discount of $1,156 to
principal, resulting in an extraordinary gain of a similar amount. During 1999,
the Company 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. In addition,
the Company purchased $2,750 of the Senior Notes during 1999, which resulted in
an extraordinary gain of $597. As a result of the early redemptions of the
above, both the basic and diluted earnings per share were increased $0.26 in
2001 and reduced by $0.14 in 1999. No such early redemptions occurred in 2000.
NOTE 11 - PREFERRED STOCK
The following table presents a summary of the Company's issued and
outstanding preferred stock:
- --------------------------------------------------------------------------------------------------------------------------
Issue Dividends Paid
Price Per Share
------------------------------------
Per share 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------------
Series A 9.75% Cumulative Convertible Preferred stock ("Series A") $ 24.00 $ 0.2925 $ - $ 1.17
Series B 9.55% Cumulative Convertible Preferred stock ("Series B") 24.50 0.2925 - 1.17
Series C 9.73% Cumulative Convertible Preferred stock ("Series C") 30.00 0.3649 - 1.46
- --------------------------------------------------------------------------------------------------------------------------
The Company is authorized to issue up to 50,000,000 shares of preferred
stock. For all series issued, dividends are cumulative from the date of issue
and are payable quarterly in arrears. The dividends are equal, per share, to the
greater of (i) the per quarter base rate of $0.585 for Series A and Series B,
and $0.73 for Series C, or (ii) one-half times the quarterly dividend declared
on the Company'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 the Company 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 two-times the issue price, or (ii) for cash at the issue
price, plus any accrued and unpaid dividends. No shares of Series A, B or C
preferred stock were converted during 2001 or 2000.
In the event of liquidation, the holders of all series of preferred
stock will be entitled to receive out of the assets of the Company, prior to any
such distribution to the common shareholders, the issue price per share in cash,
plus any accrued and unpaid dividends.
In 2001, the Company completed two separate tender offers on its Series
A, Series B, and Series C Preferred Stock (together, the "Preferred Stock"),
resulting in the purchase by the Company of 1,307,118 shares of the Preferred
Stock, consisting of 317,023 shares of Series A, 533,627 shares of Series B and
456,468 shares of Series C, for an aggregate purchase price of $19,998 and which
had an aggregate issue price of $34,376, a book value of $32,819, and including
dividends in arrears, a liquidation preference of $40,854. The difference of
$12,735 between the repurchase price and the book value has been included in the
accompanying financial statements as an addition to net income available to
common shareholders in the line item captioned Preferred Stock benefit (charges)
as required by EITF's D-42 and D-53. Also included in Preferred Stock benefit
(charges) is the cumulative dividend in arrears of $6,736 related to those
shares tendered, and which were effectively cancelled at such time they were
tendered. In addition, Preferred Stock benefit (charges) includes the current
period dividend accrual amount for the Preferred Stock outstanding for the year
ended December 31, 2001.
As of December 31, 2001, the total amount of dividends in arrears was
$22,771. Individually, the amount of dividends in arrears on the Series A, the
Series B and the Series C was $5,513 ($5.56 per Series A share), $7,663 ($5.56
per Series B share) and $9,595 ($6.94 per Series C share), respectively.
NOTE 12 - NET LOSS ON SALES, WRITE-DOWNS AND IMPAIRMENT CHARGES
The following table sets forth the composition of net loss on sales,
write-downs and impairment charges for the years ended December 31, 2001, 2000,
and 1999.
- ------------------------------------------ --------- ------------------------------------------------
For the years ended,
2001 2000 1999
- -----------------------------------------------------------------------------------------------------
Phase-out of commercial production operations $680 $50,940 $ 59,962
Sales of investments 439 15,872 16,858
Impairment charges on held-to-maturity investments
and related real estate owned 9,475 - -
AutoBond litigation and AutoBond securities (7,095) 11,012 31,732
Sales of loan production operations 755 228 (7,676)
Other 860 464 -
- -----------------------------------------------------------------------------------------------------
$ 5,114 $ 78,516 $ 100,876
- -----------------------------------------------------------------------------------------------------
During each of the years ended December 31, 2001, 2000 and 1999, the
Company incurred losses related to the phasing-out of its commercial production
operations, including the sale of substantially all of the Company's remaining
commercial and multifamily loans not previously securitized. During 1999, 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 at December 31,
1999. The reclassification was necessary, as the Company no longer had the
intent or the ability to hold such loans to maturity. During 2000, the Company
sold substantially all of its remaining loans held for sale, and including the
lower of cost or market adjustment for those loans held for sale remaining at
December 31, 2000, incurred losses aggregating $20,656 during 2000. The Company
also wrote-off $28,365 during 1999 of previously deferred hedging costs related
to the expiration of the forward commitments to fund $255,577 of multifamily and
commercial loans. During 2000, the Company incurred losses of $30,284 related to
a conditional repurchase option to purchase $167,800 of tax-exempt bonds secured
by multifamily mortgage loans, and which the Company did not exercise. The
counter-party to the option agreement retained $30,284 of cash in collateral as
a result.
The Company incurred gross gains of $291, none, and $285 and gross
losses of $730, $15,872, and $9,598 related to the sales of investments in 2001,
2000, and 1999, respectively. Gross losses included write-downs and impairment
charges recorded in anticipation of the sale of such investments. Sales of
investments for the year ended December 31, 1999 also includes losses of $7,386
related to the sale of $58,724 of commercial loans during the year.
During 2001, the Company incurred other-than-temporary impairment
charges of $7,678 on its investment in delinquent property tax receivables and
valuation adjustments of $1,797 for related real estate owned.
As discussed in Note 15, the Company settled the outstanding litigation
with AutoBond Acceptance Corporation ("AutoBond") for $20,000 during 2000. The
Company had accrued a reserve in December 1999 for $27,000 related to the
litigation. The Company reversed $5,600 of this reserve during the year ended
December 31, 2000. As a condition to the settlement, the Company received all of
the outstanding capital stock of the AutoBond entities (the "AutoBond Entities")
from which Company had previously purchased securities, and the AutoBond
Entities were included in the Company's consolidated financial statements from
that point forward. The Company recorded permanent impairment charges of $16,612
in 2000, resulting from write-downs required on securities that the Company
owned that it had purchased in 1998 and 1999 from the AutoBond Entities. During
the fourth quarter 2000, the Company completed the sale of substantially all of
the remaining outstanding securities and loans issued or owned by the AutoBond
Entities. In 1999, the Company recorded an impairment charge of $4,732 relating
to AutoBond related securities held by the Company at December 31, 1999. In
February 2001, the Company resolved a matter related to AutoBond to the mutual
satisfaction of the parties involved. In connection with the resolution of this
matter, the Company received $7,500, and recorded a gain of $7,095 net of
expenses.
In 1999, the Company sold its manufactured housing lending operations,
which was operated through its affiliate, Dynex Financial, Inc. ("DFI"), to a
subsidiary of Bingham Financial Services Corporation (NYSE: BFSC) ("BFSC") for
$18,602. Under the terms of the sale, BFSC purchased all of the outstanding
stock of DFI, certain computer software rights, and manufacturing housing 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. In 2001, the Company settled
arbitration with BFSC related to amounts due under the associated purchase
agreement. The Company recorded a charge of $627 from the settlement, and
incurred additional charges of $128 related to payments made related to
representations and warranties made at the time of sale. In 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 withheld
from the sale proceeds amounting to $3,000. As of December 31, 2001, all escrows
and reserves had been released to the Company.
NOTE 13 - 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 $276 for SARs and DERs related to the Employee
Incentive Plan during 2000, and there was no expense during 2001 and 1999.
The Company issued 30,000 SARs to an executive during 2001 at an
exercise price of $2.00 and which vest 100% at the earlier of (i) June 30, 2002
or (ii) the termination of the executive by the Company without cause.
Stock Incentive Plan for Outside Directors
In 1995, the Company adopted a Stock Incentive Plan for its Board of
Directors (the "Board Incentive Plan") with terms similar to the Employee
Incentive Plan. The maximum number of shares of common stock encompassed by the
SARs granted under the Board Incentive Plan is 200,000.
The Company expensed $14 for SARs and DERs related to the Board
Incentive Plan during 2000 and there was no expense during 2001 and 1999.
In connection with the possible acquisition of the Company by
California Investment Fund, LLC ("CIF") discussed in Note 15, the Company in
2000 redeemed for cash all SARs and related DERs outstanding at such time,
valuing the SARs and related DERs pursuant to a commonly used option-valuation
model and the consideration for the common stock to be paid by CIF.
The following table presents a summary of the SARs activity for both
the Employee Incentive Plan and the Board Incentive Plan.
---------------------------------- --------------------------------------------------------------------------------------
Years ended December 31,
-------------------------------------------------------------------------------------------------------------------------
2001 2000 1999
---------------------------------- ------------- ---------- ----- ------------ ----------- ---- ------------- -----------
Weighted- Weighted- Weighted-
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
---------------------------------- ------------- ---------- ----- ------------ ----------- ---- ------------- -----------
SARs outstanding at beginning of year - $ - 278,712 $42.41 219,695 $44.72
SARs granted 30,000 2.00 94,500 8.81 111,858 14.00
SARs forfeited or redeemed - - (288,151) 27.17 (33,316) 34.15
SARs exercised - - (85,061) 26.89 (19,525) 10.86
- ---------------------------------- ------------- ---------- ----- ------------ ----------- ---- ------------- -----------
SARs outstanding at end of year 30,000 2.00 - - 278,712 33.33
- ---------------------------------- ------------- ---------- ----- ------------ ----------- ---- ------------- -----------
SARs vested and exercisable - $ - - $ - 103,458 $42.41
- ---------------------------------- ------------- ---------- ----- ------------ ----------- ---- ------------- -----------
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 2001, 2000, and 1999 was $91, $130, and $541,
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 2001, 2000, and 1999 was $21, $8, and $60, respectively.
NOTE 14 - 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.
As of December 31, 2001, the Company is obligated under non-cancelable
operating leases with expiration dates through 2005. Rent and lease expense
under those leases was $444, $442, and $278, respectively in 2001, 2000, and
1999. The future minimum lease payments under these non-cancelable leases are as
follows: 2002--$420; 2003--$383; 2004--$317 and 2005--$102.
NOTE 15 - LITIGATION
GLS Capital, Inc. ("GLS"), a subsidiary of the Company, together with
the County of Allegheny, Pennsylvania ("Allegheny County"), are defendants in a
lawsuit in the Commonwealth Court of Pennsylvania (the "Commonwealth Court")
wherein the plaintiffs challenged the right of Allegheny County and GLS to
collect certain interest, costs and expenses related to delinquent property tax
receivables in Allegheny County. This lawsuit is related to the purchase by GLS
of delinquent property tax receivables from Allegheny County in 1997, 1998, and
1999 for approximately $58,258. In July 2001, the Commonwealth Court ruling
addressed, among other things, (i) the right of the Company to charge to the
delinquent taxpayer a rate of interest of 12% versus 10% on the collection of
its delinquent property tax receivables, (ii) the charging of attorney's fees to
the delinquent taxpayer for the collection of such tax receivables, and (iii)
the charging to the delinquent taxpayer of certain other fees and costs. The
Commonwealth Court remanded for further consideration to the Court of Common
Pleas items (i) and (iii), and ruled that neither Allegheny County nor GLS had
the right to charge attorney's fees to the delinquent taxpayer related to the
collection of such tax receivables, reversing the Court of Common Pleas
decision. The Pennsylvania Supreme Court has accepted the Application for
Extraordinary Jurisdiction filed by Allegheny County and GLS. No damages have
been claimed in the action; however, the decision may impact the ultimate
recoverability of the delinquent property tax receivables. To date, GLS has
incurred attorneys fees of approximately $2,000 related to foreclosures on such
delinquent property tax receivables, approximately $1,000 of which have been
reimbursed to GLS by the taxpayer or through liquidation of the underlying real
property.
In November 2000, the Company entered into an Agreement and Plan of
Merger with CIF, for the purchase of all of the equity securities of the Company
for $90,000 (the "Merger Agreement"). In connection with entering into the
Merger Agreement, CIF placed into escrow 572,178 shares of Company common stock
and $1,000 (the "Escrow Amount"). In January 2001, when CIF failed to meet
certain requirements as set forth in the Merger Agreement, the Company
terminated the Merger Agreement and requested the release to the Company of the
Escrow Amount. Subsequent to the termination, the Company filed for Declaratory
Judgment in United States District Court for the Eastern District of Virginia,
Alexandria Division. In October 2001, the jury returned a verdict that resulted
in (i) the Escrow Amount plus interest being awarded to the Company, and (ii)
the Company having to pay CIF a termination fee of $2,000. The Company and CIF
agreed to settle this matter in accordance with the jury verdict. The Company
recorded a net charge of $960 in the accompanying financial statements and
retired the 572,178 common shares received.
In February 1999, AutoBond commenced an action in the District Court of
Travis County, Texas (250th Judicial District) against the Company alleging that
the Company breached the terms of a Credit Agreement, dated June 9, 1998. The
terms of the Credit Agreement provided for the purchase by the Company of
funding notes and collateralized by automobile installment contracts acquired by
AutoBond. The Company suspended purchasing the funding notes in February 1999 on
grounds that AutoBond had violated certain provisions of the Credit Agreement.
In June 2000, the Company settled the matter with AutoBond for a cash payment of
$20,000. In return for the payment, the Company received a complete release of
all claims against it by AutoBond, and ownership of the AutoBond Entities that
own the underlying automobile installment contracts. In February 2001, the
Company resolved a matter related to AutoBond to the mutual satisfaction of the
parties involved. In connection with the resolution of this matter, the Company
received $7,500.
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 effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
NOTE 16 - SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS INFORMATION
- ---------------------------------------------------------- ----------------------------------------------------
Years ended December 31,
- ---------------------------------------------------------- ----------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------- -------------- --------------- -------------
Cash paid for interest $ 177,674 $ 249,699 $ 264,130
Supplemental disclosure of non-cash activities:
Collateral for collateralized bonds owned
subsequently securitized - - 1,607,891
Securities owned subsequently securitized - 71,209 4,986
---------------------------------------------------------- -------------- -- --------------- -- ---------------
NOTE 17 - RELATED PARTY TRANSACTIONS
Prior to the liquidation of DHI in 2000, the Company had a credit
arrangement with DHI whereby DHI and any of DHI's subsidiaries could borrow
funds from Company to finance its operations. Under this arrangement, the
Company could also borrow funds from DHI. The terms of the agreement allowed DHI
and its subsidiaries to borrow up to $50,000 from the Company at a rate of Prime
plus 1.0%. The Company could borrow up to $50,000 from DHI at a rate of
one-month LIBOR plus 1.0%. As of December 31, 2000, as a result of the
liquidation, amounts due to DHI under the borrowing arrangement were forgiven.
Net interest expense under this agreement was $1,403 and $706 for the years
ended December 31, 2000 and 1999, respectively.
The Company had a funding agreement with Dynex Commercial, Inc.
("DCI"), formerly an operating subsidiary of DHI, whereby the Company paid DCI a
fee for commercial mortgage loans transferred to the Company from DCI. The
Company paid DCI none, $288, and $2,147, respectively under this agreement for
the years ended December 31, 2001, 2000, and 1999. Effective December 31, 2000,
DCI is no longer an operating subsidiary of the Company or DHI and is now owned
by certain officers of the Company. The Company and DCI have been jointly named
in litigation regarding the activities of DCI while it was an operating
subsidiary of DHI. The Company and DCI entered into a Litigation Cost Sharing
Agreement whereby the parties set forth how the costs of defending against
litigation would be shared, and whereby the Company agreed to fund all costs of
such litigation, including DCI's portion. DCI has no assets but has asserted
counterclaims in the litigation. DCI's portion of costs associated with the
litigation and funded by the Company is $1,542 and is secured by the proceeds of
any counterclaims that DCI may receive in the litigation. DCI costs funded by
the Company are considered loans, and bear simple interest at the rate of Prime
plus 8.0% per annum. At December 31, 2001, the amount due the Company under the
Litigation Cost Sharing Agreement was $1,583, which has been fully reserved by
the Company.
Prior to the sale of its manufactured housing lending operations in
December 1999, the Company had a loan funding agreement with Dynex Financial,
Inc. ("DFI"), an operating subsidiary of DHI, whereby the Company paid DFI on a
fee plus cost basis for the origination of manufactured housing loans on behalf
of the Company. During 1999, the Company paid DFI $12,369 under such agreement.
This agreement was terminated as a result of the sale of the manufactured
housing operations during 1999.
Prior to its sale, the Company had note agreements with Dynex
Residential, Inc. ("DRI"), formerly an operating subsidiary of DHI, whereby DRI
and its subsidiaries could borrow up to $287,000 from the Company 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%. In November 1999, DRI was sold to Residential Funding
Corporation and SMFC Funding Corporation ("SMFC") at the time an affiliate of
DRI and a subsidiary of DHI, assumed notes from DRI with an unpaid principal
balance of $4,577. The remainder of the DRI notes was paid at the time of the
sale. SMFC paid off the notes in 2000. Interest income recorded by the Company
for the years ended December 31, 2000, and 1999 was $164, and $12,793.
The Company had entered into sub-servicing agreements with DCI, Dynex
Commercial Services, Inc. ("DCSI"), DFI and GLS Capital Services, Inc. ("GLS")
to service commercial, single family, and consumer loans and property tax
receivables. All of these entities were formerly subsidiaries of DHI. For
servicing the commercial loans, DCI or DSCI, as applicable, received an annual
servicing fee of 0.02% of the aggregate unpaid principal balance of the loans.
DSCI sold the majority of its commercial mortgage loan-servicing portfolio to a
third party in 2000. 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 servicing agreement with DFI was amended and restated due to the sale
of DFI in December 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 the Company
under such agreements were $258 and $2,873 in 2000, and 1999, respectively. GLS
is included in the consolidated financial statements of Company for 2001.
During 1999, the Company made a loan to Thomas H. Potts, president of
the Company, as evidenced by a promissory note in the aggregate principal amount
of $935 (the "Potts Note"). Interest accrued on the outstanding balance through
1999 at a simple interest rate of Prime plus one-half percent per annum, and for
2000 and 2001, at the short-term monthly "applicable federal rate" (commonly
known as the AFR rate) based on tables published by the Internal Revenue
Service. Mr. Potts directly owns 415,799 shares of common stock of the Company,
all of which have been pledged as collateral to secure the Potts Note, including
stock held in the Company's 401(k) plan which amounts to 17,994 shares. As of
December 31, 2001, interest on the Potts Note was current and the outstanding
balance of the Potts Note was $369.
NOTE 18 - Non-Consolidated Affiliates
During 1999 and 2000 the Company owned a 99% preferred stock interest
in DHI. Effective December 31, 2000, DHI was liquidated pursuant to Internal
Revenue Code Sections 331 and 336 in a taxable liquidation. The results of
operations and financial position of DHI prior to its liquidation are summarized
below:
- -------------------------------------------------------------------- -----------------------------------------------------
Consolidated Statement of Operations December 31,
- -------------------------------------------------------------------- -----------------------------------------------------
- -------------------------------------------------------------------- --------------------------- -------------------------
2000 1999
- -------------------------------------------------------------------- --------------------------- -------------------------
Total revenues $4,157 $40,710
Total expenses 4,838 42,653
Net income (loss) (681) (1,943)
- -------------------------------------------------------------------- -----------------------------------------------------
Consolidated Balance Sheet December 31,
- -------------------------------------------------------------------- -----------------------------------------------------
- -------------------------------------------------------------------- --------------------------- -------------------------
2000 1999
- -------------------------------------------------------------------- --------------------------- -------------------------
Total assets - $36,822
Total liabilities - 9,075
Total equity - 27,747
- -------------------------------------------------------------------- --------------------------- -------------------------
As a result of the liquidation of DHI into the Company in December
2000, at December 31, 2001 the Company owned a 1% limited partnership interest
in a partnership which owns a low income housing tax credit multifamily housing
property located in Texas. During 2001, the Company sold a ninety-eight percent
limited partnership interest in partnership to a director for a purchase price
of $198, which was equal to its estimated fair value. By reason of the
director's investment in the partnership, the Company has guaranteed to the
director the use of the low-income housing tax credits associated with the
property, proportionate to his investment, that are reported annually to the
Internal Revenue Service. During 2001, the Company loaned the partnership $232,
and the Company through its subsidiary, Commercial Capital Access One, Inc., has
made a first mortgage loan to the partnership secured by the Property, with a
current unpaid principal balance of $1,961. As the Company does not have control
or exercise significant influence over the operations of this partnership, its
investment and advances of $240 at December 31, 2001 is accounted for using the
cost method.
The Company has a 99% limited partnership interest in a partnership
that owns a commercial office building located in St. Paul, Minnesota. The
building is leased pursuant to a triple-net master lease to a single-tenant, and
the second mortgage lender has a bargain purchase option to purchase the
building in 2007. Rental income derived from the master lease for the term of
the lease exactly covers the operating cash requirements on the building,
including the payment of debt service. The Company, through its consolidated
subsidiary Commercial Capital Access One, Inc., has made a first mortgage loan
secured by the commercial office building with an unpaid principal balance as of
December 31, 2001 of $25,105. As the Company does not have control or exercise
significant influence over the operations of this partnership, its investment of
$11 at December 31, 2001 in such partnership is accounted for using the cost
method.
EXHIBIT INDEX
Exhibit Sequentially
Numbered Page
21.1 List of consolidated entities I
23.1 Consent of Deloitte & Touche LLP II
Exhibit 21.1
Dynex Capital, Inc.
List of Consolidated Entities
As of December 31, 2001
AutoBond Funding Corporation 1997-A
Dynex Commercial Services, Inc.
Dynex Healthcare Capital, Inc.
Dynex Home Loan, Inc.
Dynex Securities, Inc.
Financial Asset Securitization, Inc.
GLS Capital Services, Inc.
GLS Development, Inc.
SMFC Funding Corporation
MSC I L.P.
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 Properties, LLC
Allegheny Commercial Properties I, LLC
Allegheny Income Properties I, LLC
Allegheny Special Properties, LLC
GLS Capital Services - Marlborough, Inc.
GLS Capital - Cuyahoga, Inc.
GLS-Cuyahoga Lien Pool One, Inc.
SHF Corp.
NOTE: All companies were incorporated in Virginia except for AutoBond Funding
Corporation 1997-A (Nevada) and GLS Properties, LLC, Allegheny
Commercial Properties I, LLC, Allegheny Income Properties I, LLC, and
Allegheny Special Properties, LLC (Pennsylvania).
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
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 March 5, 2002, appearing in this Annual Report on Form
10-K of Dynex Capital, Inc. for the year ended December 31, 2001.
DELOITTE & TOUCHE LLP
Richmond, Virginia
March 27, 2002