================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarter ended June 30, 2002
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4551 Cox Road, Suite 300, Glen Allen, Virginia 23060
(Address of principal executive offices) (Zip Code)
(804) 217-5800
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days.
| | Yes |X| No
On July 31, 2002, the registrant had 10,873,903 shares of common stock of $.01
value outstanding, which is the registrant's only class of common stock.
================================================================================
DYNEX CAPITAL, INC.
FORM 10-Q
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
June 30, 2002 and December 31,
2001 (as restated) (unaudited).............................1
Condensed Consolidated Statements of Operations
for the three and six months ended June 30, 2002
and 2001 (as restated) (unaudited).........................2
Condensed Consolidated Statements of Cash
Flows for the six months ended June 30, 2002
and 2001 (as restated) (unaudited) ........................3
Notes to Unaudited Condensed Consolidated
Financial Statements.......................................4
Item 2. Management`s Discussion and Analysis of
Financial Condition and Results of Operations.............11
Item 3. Quantitative and Qualitative Disclosures
about Market Risk.........................................22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ........................................24
Item 2. Changes in Securities and Use of Proceeds.................24
Item 3. Defaults Upon Senior Securities...........................24
Item 4. Submission of Matters to a Vote of Security Holders.......24
Item 5. Other Information.........................................25
Item 6. Exhibits and Reports on Form 8-K..........................25
SIGNATURES...................................................................26
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DYNEX CAPITAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(amounts in thousands except share data)
June 30, December 31,
2002 2001
-------------------- ---------------------
ASSETS (As Restated.
See Note 14)
Investments:
Collateral for collateralized bonds $ 2,344,885 $ 2,473,203
Other investments 58,212 63,553
Securities 2,992 5,508
Loans 14,820 7,315
------------------ ------------------
2,420,909 2,549,579
Cash 32,873 7,129
Cash - restricted 22,958 4,334
Other assets 5,776 8,817
-------------------- ---------------------
$ 2,482,516 $ 2,569,85
==================== =====================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Non-recourse debt - collateralized bonds $ 2,192,616 $ 2,264,213
Recourse debt 46,400 58,134
-------------------- ---------------------
2,239,016 2,322,347
Accrued expenses and other liabilities 3,193 5,402
-------------------- ---------------------
2,242,209 2,327,749
-------------------- ---------------------
Commitments and contingencies (Note 10) - -
SHAREHOLDERS' EQUITY
Preferred stock, par value $.01 per share,
50,000,000 shares authorized:
9.75% Cumulative Convertible Series A,
992,038 and 992,038 issued and outstanding, respectively
($30,483 and $29,322 aggregate liquidation preference, respectively) 22,658 22,658
9.55% Cumulative Convertible Series B,
1,378,707 and 1,378,807 issued and outstanding, respectively
($43,053 and $41,443 aggregate liquidation preference, respectively) 32,273 32,275
9.73% Cumulative Convertible Series C,
1,383,532 and 1,383,532 issued and outstanding, respectively
($53,120 and $51,101 aggregate liquidation preference, respectively) 39,655 39,655
Common stock, par value $.01 per share,
100,000,000 shares authorized
10,873,903 and 10,873,853 issued and outstanding, respectively 109 109
Additional paid-in capital 364,743 364,740
Accumulated other comprehensive loss (17,508) (14,825)
Accumulated deficit (201,623) (202,502)
-------------------- ---------------------
240,307 242,110
-------------------- ---------------------
$ 2,482,516 $ 2,569,859
==================== =====================
See notes to unaudited condensed consolidated financial statements.
DYNEX CAPITAL, INC.
CONDENSED CONSOLIDATED STATEMENTS
OF OPERATIONS (UNAUDITED)
(amounts in thousands except share data)
Three Months Ended June 30 Six Months Ended June 30
-------------------------- ------------------------
2002 2001 2002 2001
---- ---- ---- ----
Interest income: (As Restated - (As Restated
See Note 14) - See Note 14)
Collateral for collateralized bonds $ 44,474 $ 56,478 $ 87,188 $ 117,592
Securities 335 366 457 674
Other investments 44 1,465 55 3,392
Loans 115 180 209 333
---------------- ---------------- ---------------- ----------------
44,968 58,489 87,909 121,991
Interest and related expense:
Non-recourse debt 31,796 43,546 63,762 93,671
Recourse debt 941 1,837 1,972 4,423
Other (23) 106 421 469
---------------- ---------------- ---------------- ----------------
32,714 45,489 66,155 98,563
---------------- ---------------- ---------------- ----------------
Net interest margin before provision for losses 12,254 13,000 21,754 23,428
Provision for losses (5,241) (4,806) (10,884) (9,611)
---------------- ---------------- ---------------- ----------------
Net interest margin 7,013 8,194 10,870 13,817
Net (loss) gain on sales, write-downs, impairment
charges, and litigation (4,378) (1,326) (6,433) 3,978
Trading gain (loss) 728 (1,958) 728 (1,720)
Other income (loss) 199 (77) 395 (20)
---------------- ---------------- ---------------- ----------------
3,562 4,833 5,560 16,055
General and administrative expenses (2,625) (2,634) (4,518) (4,477)
---------------- ---------------- ---------------- ----------------
Income before extraordinary item 937 2,199 1,042 11,578
Extraordinary item - (loss) gain on extinguishment
of debt (539) 573 (162) 2,844
---------------- ---------------- ---------------- ----------------
Net income 398 2,772 880 14,422
Preferred stock (charges) benefit (2,396) 10,493 (4,792) 7,265
---------------- ---------------- ---------------- ----------------
Net (loss) income applicable to common shareholders $ (1,998) $ 13,265 $ (3,912) $ 21,687
================ ================ ================ ================
(Loss) income per common share before
extraordinary item:
Basic and Diluted $ (0.13) $ 1.11 $ (0.34) $ 1.65
================ ================ ================ ================
Net (loss) income per common share:
Basic and Diluted $ (0.18) $ 1.16 $ (0.36) $ 1.90
================ ================ ================ ================
Weighted average number of common shares
outstanding; basic and diluted 10,873,894 11,446,206 10,873,860 11,446,206
================ ================ ================ ================
See notes to unaudited condensed consolidated financial statements.
DYNEX CAPITAL, INC.
CONDENSED CONSOLIDATED STATEMENTS
OF CASH FLOWS (UNAUDITED) Six Months Ended
(amounts in thousands) June 30,
-------------------------------------------------
2002 2001
---------------------- -----------------------
(As Restated -
See Note 14)
Operating activities:
Net income $ 880 $ 14,422
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for losses 10,884 9,611
Net loss (gain) on sales, write-downs, impairment charges and litigation 6,433 (3,978)
Payment (made) received from litigation settlement, net of legal fees (863) 7,111
Extraordinary item - loss (gain) on extinguishment of debt 162 (2,844)
Amortization and depreciation 4,368 8,258
Decrease in accrued interest receivable 5 256
(Decrease) increase in accrued interest payable (361) 1,661
Net change in restricted cash (18,624) 20,248
Net change in other assets and other liabilities (710) (9,913)
---------------------- -----------------------
Net cash provided by operating activities 2,174 44,832
---------------------- -----------------------
Investing activities:
Collateral for collateralized bonds:
Investments purchased (154,852) -
Principal payments on collateral 250,370 315,684
Net (increase) decrease in funds held by trustee (935) (52)
Net (increase) decrease in loans (5,689) 16,066
Purchase of other investments - (123)
Payments received on other investments 6,162 2,740
Proceeds from sales of other investments - 233
Purchase of securities (396) -
Payments received on securities 2,514 805
Proceeds from sales of securities - 113
Proceeds from sale of loan production operations - 9,500
Capital expenditures (39) (207)
---------------------- -----------------------
Net cash provided by investing activities 97,135 344,759
---------------------- -----------------------
Financing activities:
Collateralized bonds:
Proceeds from issuance of bonds 605,272 -
Principal payments on bonds (666,871) (318,315)
Repayment of senior notes (11,966) (59,674)
Capital stock transactions - (10,963)
---------------------- -----------------------
Net cash used for financing activities (73,565) (388,952)
---------------------- -----------------------
Net increase in cash 25,744 639
Cash at beginning of period (unrestricted) 7,129 3,485
---------------------- -----------------------
Cash at end of period (unrestricted) $ 32,873 $ 4,124
====================== =======================
Cash paid for interest $ 66,721 $ 97,152
====================== =======================
See notes to unaudited condensed consolidated financial statements.
DYNEX CAPITAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(amounts in thousands except share data)
NOTE 1 - BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been prepared
in accordance with the instructions to Form 10-Q and do not include all of the
information and notes required by accounting principles generally accepted in
the United States of America, hereinafter referred to as "generally accepted
accounting principles," for complete financial statements. The condensed
consolidated financial statements include the accounts of Dynex Capital, Inc.
and its qualified REIT subsidiaries and taxable REIT subsidiary ("Dynex" or the
"Company"). All significant inter-company balances and transactions have been
eliminated in consolidation of Dynex.
In the opinion of management, all material adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation of the
condensed consolidated financial statements have been included. The Condensed
Consolidated Balance Sheet at June 30, 2002, the Condensed Consolidated
Statements of Operations for the three and six months ended June 30, 2002 and
2001, the Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2002 and 2001 and related notes to consolidated financial
statements are unaudited. Operating results for the three and six months ended
June 30, 2002 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2002.
Certain reclassifications have been made to the financial statements for 2001 to
conform to the presentation for 2002.
Cash - Restricted. At June 30, 2002 and December 31, 2001, respectively, $22,958
and $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. 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 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. 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. On July 15, 2002, the Company satisfied and discharged the entire
indebtedness under its Senior Notes and all restrictions imposed thereby have
been removed.
NOTE 2 - USE OF ESTIMATES
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 as discussed below. The discount rate used in the
determination of fair value of the collateral for collateralized bonds was 16%
at June 30, 2002 and December 31, 2001. Prepayment rate assumptions at June 30,
2002, and December 31, 2001, were generally at a "constant prepayment rate," or
CPR ranging from 40%-60% for 2002 and 2001 for collateral for collateralized
bonds consisting of single-family mortgage loans, and a CPR equivalent ranging
from 10%-12% for 2002 and 2001 for collateral for collateralized bonds
consisting of manufactured housing loan collateral. 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 based on the current level of interest rates and prepayment rates being
experienced on similar loans in the marketplace. 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
collateral 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 5, 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 Dynex's financial instruments is
based on estimates, actual gains and losses recognized may differ from those
estimates recorded in the consolidated financial statements.
NOTE 3 - NET (LOSS) INCOME PER COMMON SHARE
Net (loss) income per common share is presented on both a basic and diluted
basis. Diluted net (loss) income per common share assumes the conversion of the
convertible preferred stock into common stock, using the if-converted method and
stock appreciation rights to the extent that there are rights outstanding, using
the treasury stock method, but only if these items are dilutive. As a result of
the two-for-one split in May 1997 and the one-for-four reverse split in July
2000 of Dynex's common stock, the preferred stock is convertible into one share
of common stock for two shares of preferred stock.
The following table reconciles the numerator and denominator for both basic
and diluted net (loss) income per common share for the three and six months
ended June 30, 2002 and 2001.
- ------------------------------------- --------------------------------------------- -- ---------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
--------------------------------------------- ---------------------------------------------
--------------------- - ---------------------
2002 2001 2002 2001
- ------------------------------------- --------------------- - --------------------- --------------------- - ---------------------
Weighted- Weighted- Weighted- Weighted-
Average Average Average Average
Number of Number of Number of Number of
Income Shares Income Shares Income Shares Income Shares
------- ---------- -------- --------- -------- ---------- -------- ---------
Income before extraordinary item $937 $ 2,199 $ 1,042 $11,578
Extraordinary item - (loss) gain on
extinguishment of debt (539) 573 (162) 2,844
-------- -------- -------- --------
Net income 398 2,772 880 14,422
Preferred stock (charges) benefit (2,396) 10,493 (4,792) 7,265
------- ---------- -------- ---------- -------- ---------- -------- ---------
Net (loss) income applicable
to common shareholders $(1,998) 10,873,894 $13,265 11,446,206 $(3,912) 10,873,860 $21,687 11,446,206
======== ========== ======== ========== ========= ========== ======= ==========
(Loss) income per share before
extraordinary item:
Basic and Diluted $ (0.13) $ 1.11 $ (0.34) $ 1.65
========== ========= ========== =========
Net (loss) income per share:
Basic and Diluted $ (0.18) $ 1.16 $ (0.36) $ 1.90
========== ========= ========== =========
Dividends and potentially dilutive
common shares assuming conversion
of preferred stock:
Series A $ (580) 496,019 $ 2,427 642,317 $(1,161) 496,019 $ 1,661 648,390
Series B (806) 689,362 4,532 934,235 (1,612) 689,362 3,413 945,165
Series C (1,010) 691,766 3,534 904,600 (2,019) 691,766 2,191 912,258
--------- -------- --------- ------- -------- ---------- -------- ---------
$(2,396) 1,877,147 $10,493 2,481,152 $(4,792) 1,877,147 $ 7,265 2,505,813
========= ========== ======== ========= ======== ========== ======== =========
- ------------------------------------- ------- -- ---------- - -------- -- --------- -- -------- - ---------- - -------- -- ---------
NOTE 4 - COLLATERAL FOR COLLATERALIZED BONDS
Collateral for collateralized bonds represents collateral pledged to support the
repayment of non-recourse collateralized bonds issued by the Company. Collateral
for collateralized bonds consists of loans and debt securities backed by
adjustable-rate and fixed-rate single-family mortgage loans, fixed-rate mortgage
loans on multifamily and commercial properties and manufactured housing
installment loans secured by a UCC filing. All principal and interest (less
servicing-related fees) on the collateral is remitted to a trustee and is
available for payment on the associated collateralized bonds.
The following table summarizes the components of collateral for collateralized
bonds as of June 30, 2002 and December 31, 2001. Debt securities pledged as
collateral for collateralized bonds are considered available for sale, and are
therefore recorded at fair value.
----------------------------------------------- --------------- -- ------ ------------------
June 30, 2002 December 31, 2001
----------------------------------------------- --------------- -- ------ ------------------
(As Restated -
See Note 14)
Loans, at amortized cost $ 1,986,814 $ 2,027,619
Debt securities, at fair value 379,542 467,038
----------------------------------------------- --------------- -- ------ ------------------
2,366,356 2,494,657
Reserve for loan losses (21,471) (21,454)
----------------------------------------------- --------------- -- ------ ------------------
$ 2,344,885 $ 2,473,203
----------------------------------------------- --------------- -- ------ ------------------
The following table summarizes the amortized cost basis, gross unrealized gains
and losses and estimated fair value of debt securities pledged as collateral for
collateralized bonds as of June 30, 2002:
Gross Gross
Amortized cost unrealized unrealized Estimated
gains losses fair value
- ------------------------------------------ ---------------- -- ------------- ------ ----------------- --- --------------
Debt securities $406,484 $126 $(2,412) $404,198
- ------------------------------------------ ---------------- -- ------------- ------ ----------------- --- --------------
NOTE 5 - OTHER INVESTMENTS
Other investments at June 30, 2002 and December 31, 2001 consist substantially
of delinquent property tax receivables and related real estate owned. Delinquent
property tax receivables have been classified as non-accrual, and all cash
collections on such receivables reduce the principal balance of the Company's
investment in the receivables. During the three and six months ended June 30,
2002, the Company collected $5.3 million and $9.3 million, respectively and
reduced the carrying value of the investment accordingly. The Company also
amortized $1.3 million and $2.8 million, respectively, of discount on the
carrying value of the delinquent property tax receivables as a reduction of
accumulated other comprehensive loss. At June 30, 2002 the redemptive value of
the delinquent property tax receivable portfolio was $131.2 million.
The following table summarizes the Company's investment in delinquent property
tax receivables and real estate owned at June 30, 2002 and December 31, 2001:
- ------------------------------------------------------------------------ ---------------------- -- -----------------------
June 30, 2002 December 31, 2001
---------------------- -----------------------
Amortized cost basis of receivables, before discount $ 67,631 $ 75,785
Discount recorded as adjustment to other comprehensive loss (15,611) (18,451)
---------------------- -----------------------
Amortized cost basis of receivables, net 52,020 57,334
Real estate owned 6,018 5,948
- ------------------------------------------------------------------------ ---------------------- -- -----------------------
$ 58,038 $ 63,282
- ------------------------------------------------------------------------ ---------------------- -- -----------------------
NOTE 6 - LOANS
The following table summarizes the Company's carrying basis in unsecuritized
loans at June 30, 2002 and December 31, 2001, respectively.
- -----------------------------------------------------------------------------------------------------------
June 30, 2002 December 31, 2001
- -----------------------------------------------------------------------------------------------------------
Secured by multifamily and commercial properties $ 2,774 $ 2,791
Secured by consumer installment contracts 2,176 3,601
Secured by single-family mortgage loans 9,730 906
-------------------- ----------------------
14,680 7,298
Net premium and allowance for losses 140 17
-------------------- ----------------------
Total loans $ 14,820 $ 7,315
- -----------------------------------------------------------------------------------------------------------
Of the above amounts, loans with a carrying amount of $12,692 and $3,712,
respectively, are classified as held for sale at June 30, 2002 and December 31,
2001.
NOTE 7 - RECOURSE DEBT
The following table summarizes the Company's recourse debt outstanding at June
30, 2002 and December 31, 2001:
- ------------------------------------------------------- ------------------------- --- -------------------------
June 30, 2002 December 31, 2001
------------------------- -------------------------
7.875% Senior Notes $ 46,280 $ 57,969
Capital lease obligations 128 244
Capitalized costs (8) (79)
------------------------- -------------------------
$ 46,400 $ 58,134
- ------------------------------------------------------- ------------------------- --- -------------------------
As of June 30, 2002 and December 31, 2001, Dynex had $46,280 and $57,969,
respectively, outstanding of its Senior Notes. On March 30, 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 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 the Company to maintain
its REIT status. The Company has purchased Senior Notes in the open market from
time-to-time. In April 2002, the Company purchased $550 of Senior Notes.
On July 15, 2002, the Company satisfied and discharged the entire indebtedness
under its Senior Notes.
NOTE 8 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 143, "Accounting for
Asset Retire- ment Obligations." SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002. The Company does not believe the
adoption of SFAS No. 143 will have a significant impact on the financial posi-
tion, results of operations or cash flows of the Company.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets" which supercedes SFAS 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
Opinion No. 30, "Reporting the Results of Operations - Reporting the 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.
SFAS No. 144 retains many of the provisions of SFAS No. 121, but addresses
certain implementation issues associated with that Statement. The adoption of
FAS No. 144 as of January 1, 2002 did not have a significant impact on the
financial position, results of operations or cash flows of the Company.
In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections".
Effective January 1, 2003, SFAS No. 145 requires gains and losses from the
extinguishment or repurchase of debt to be classified as extraordinary items
only if they meet the criteria for such classification in APB 30. Until January
1, 2003, gains and losses from the extinguishment or repurchase of debt must be
classified as extraordinary items, as Dynex has done. After January 1, 2003, any
gain or loss resulting from the extinguishment or repurchase of debt classified
as an extraordinary item in a prior period that does not meet the criteria for
such classification under APB 30 must be reclassified. The Company is in the
process of evaluating this SFAS but believes it will not have a significant
impact on the financial position, results of operations or cash flows of the
Company.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." Effective January 1, 2003, SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. This SFAS applies to activities that are initiated after
December 31, 2002. The Company has not yet assessed the impact of this statement
on its financial position or results of operations.
NOTE 9 - PREFERRED STOCK
As of June 30, 2002 and December 31, 2001, the total liquidation preference on
the Preferred Stock was $126,656 and $121,867, respectively, and the total
amount of dividends in arrears on Preferred Stock were $27,563 and $22,771,
respectively. Individually, the amount of dividends in arrears on the Series A,
the Series B and the Series C were $6,674 ($6.73 per Series A share), $9,275
($6.73 per Series B share) and $11,614 ($8.39 per Series C share) at June 30,
2002 and $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) at December 31, 2001.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
GLS Capital, Inc. ("GLS"), a subsidiary of the Company, together with the County
of Allegheny, Pennsylvania ("Allegheny County"), were 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 was related to the purchase by GLS of delinquent
property tax receivables from Allegheny County in 1997, 1998, and 1999 for
approximately $58,258. On July 5, 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 amount
recoverable on the delinquent property tax receivables, including attorney fees
incurred in the collection process.
The Company is also subject to other lawsuits or claims which have arisen 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 11 - RELATED PARTY TRANSACTIONS
The Company has made a loan to Thomas H. Potts, president of the Company, as
evidenced by a demand promissory note (the "Potts Note") which is secured by
substantially all of the common stock of the company owned by Mr. Potts.
Interest is charged on the Potts Note at the applicable short-term monthly
applicable federal rate (commonly known as the AFR Rate) as published by the
Internal Revenue Service. As of June 30, 2002 and December 31, 2001, the
outstanding balance of the Potts Note was $184 and $369, respectively, and
interest was current. On July 15, 2002, the Potts note was repaid in full and
the Company released all of the shares pledged as collateral.
NOTE 12--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 changes in 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 trade positions using criteria established in SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended.
For Interest Rate Agreements designated as cash flow hedging 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 Protection Agreement designated
as a hedge is reported in accumulated other comprehensive income, and the
ineffective portion of such hedge is reported in income.
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 fair value of the hedging
instrument 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.
The Company has entered into an interest rate swap, which matures on June
28, 2005, to mitigate its interest rate risk exposure on $100 million in
notional value of its variable rate collateralized bonds, which finance a like
amount of fixed rate assets. Under the agreement, the Company will pay interest
at a fixed rate of 3.73% on the notional amount and will receive interest based
on one month LIBOR on the same amount. This contract has been treated as a cash
flow hedge with gains and losses associated with the change in the value of the
hedge being reported as a component of comprehensive income. In June, 2002, the
Company recognized $374 in comprehensive income on this transaction.
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 trading instruments are terminated. Amounts
payable to or receivable from counterparties, if any, are included on the
consolidated balance sheets in other assets or other liabilities. In June 2002,
the Company entered into a $100,000 notional short position on 5-Year Treasury
Notes futures contracts expiring in September 2002. The Company entered into
this position to, in effect, to mitigate its exposure to rising interest rates
on a like amount of floating-rate liabilities. These instruments fail to meet
the hedge criteria of SFAS No. 133, and therefore are accounted for on a trading
basis. During the three and six month periods ended June 30, 2002, the Company
recognized $728 in trading gains related to these contracts. In August 2002, the
Company terminated these contracts at a loss of $3,308.
NOTE 13 - NET GAIN (LOSS) ON SALES, WRITE-DOWNS, IMPAIRMENT CHARGES
AND LITIGATION
The following table sets forth the composition of net gain (loss) on sales,
write-downs and impairment charges for the six months ended June 30, 2002 and
2001.
--------------------------------------------------------- --------------------------------------------
Six months ended June 30,
--------------------------------------------
2002 2001
-------------------- ---------------------
Impairment charges $ (6,975) $ (3,566)
Litigation settlement - 7,111
Other 542 433
-----------------------------------------------------------------------------------------------------
$ (6,433) $ 3,978
------------------------------------------------------------------------------------------------------
Impairment charges included $1,882 for the adjustment to the lower of cost
or market for certain delinquent single-family mortgage loans not included in
the securitization completed in April. Such loans were included in securities
called by the Company, the balances of which were included in the
securitization. Impairment charges also include other-than-temporary impairment
of debt securities of $4,520 and $3,566 for 2002 and 2001, respectively.
NOTE 14 - RESTATEMENT OF FINANCIAL STATEMENTS
Subsequent to the issuance of its financial statements for the three months
ended March 31, 2002 and the year ended December 31, 2001, the Company
determined that the assets previously reported as debt securities subject to the
requirements of SFAS No.115, " Accounting for Certain Investments in Debt and
Equity Securities" were, in fact, collateralized borrowings, where the
collateral being pledged as securities were loans that should have been
accounted for under the requirements of SFAS No. 5, "Accounting for
Contingencies" or SFAS No. 114, "Accounting by Creditors for Impairment of a
Loan." As a result, the accompanying condensed consolidated financial statements
for the three and six month period ended June 30, 2001 and the condensed
consolidated balance sheet as of December 31, 2001 have been restated from the
amounts previously reported to correct the accounting for these investments.
A summary of the significant effects of the restatement is as follows:
(amounts in thousands) December 31, December 31,
2001 2001
-------------------- ---------------------
(As Previously (As Restated)
Reported)
Collateral for collateralized bonds $ 2,404,157 $ 2,473,203
Total investments 2,480,533 2,549,579
Total assets 2,500,812 2,569,859
Accumulated other comprehensive loss $ (83,872) $ (14,825)
Total stockholders' equity 173,063 242,110
Three Months Ended June 30 Six Months Ended June 30
-------------------------- ------------------------
2001 2001 2001 2001
---- ---- ---- ----
(As Previously (As Previously
Reported) (As Restated) Reported) (As Restated)
Provision for losses $(6,589) $ (4,806) $ (13,177) $ (9,611)
Net interest margin 6,411 8,194 10,251 13,817
Net (loss) gain on sales, write-downs, impairment
charges, and litigation 457 (1,326) 7,544 3,978
The restatement had no effect on income before extraordinary items, net income,
or related per share amounts.
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
As discussed in Note 14 to the condensed consolidated financial statements
included in Item 1, the Company has restated its financial statements as of
December 31, 2001 and for the three and six-month period ended June 30, 2001.
The following management discussion and analysis takes into account the effects
of the restatement. The Company intends to amend its Annual Report of Form 10-K
for the year ended December 31, 2001 and its quarterly report on Form 10-Q for
the quarterly period ended March 31, 2002 to include the restated financial
statements as soon as practicable
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, commercial mortgage lending and manufactured housing lending. Through
its specialty finance business, the Company also has provided for the purchase
and management of delinquent property tax receivables. The Company no longer
originates loans. 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 prescribed Internal
Revenue Code requirements for a REIT, the Company will generally not be subject
to federal income tax.
The Company owns 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 reaches a call trigger, generally either
10% or less of the original amount issued or a specified date. At June 30, 2002,
the aggregate callable balance of such securities at the time of the projected
call is approximately $136.0 million, relating to 12 securities. The Company may
or may not elect to call one or more of these securities when eligible to call.
During the first six months of 2002, the Company initiated the call of seventeen
securities with a balance of $592 million. All securities acquired pursuant to
such calls were included in a securitization completed by the Company in April
2002. The Company expects to call five additional securities in 2002 with a call
balance of approximately $15 million and may call additional securities in the
future.
On April 25, 2002, the Company completed the securitization of $602,000 of
single-family mortgage loans and the associated issuance of $605,000 of
collateralized bonds. Of the $602,000 of single-family mortgage loans
securitized, $447,000 million were loans which were already owned by the Company
and $155,000 represented new loans from the purchase of adjustable-rate and
fixed-rate mortgage backed securities from third parties pursuant to certain
call rights owned by the Company. The securitization was accounted for as a
financing; thus the loans and associated bonds were included in the accompanying
consolidated balance sheet as assets and liabilities of the Company. Net cash
proceeds to the Company from the securitization were approximately $24 million.
The Company used the proceeds from the securitization toward repayment of the
Senior Notes due July 15, 2002. Approximately $12 million of delinquent loans
were not included in the securitization and were retained by the Company.
The Board of Directors continues to evaluate business strategies to improve
overall shareholder value. Such strategies include the possible acquisition of a
depository institution. The Company is also reviewing other near-term and
longer-term alternatives for improving overall shareholder value. The Board of
Directors has not, as yet, established a timetable for the completion of the
review of such alternatives.
FINANCIAL CONDITION
(amounts in thousands)
-------------------------------------------------- ------------------------- ---------------------
June 30, 2002 December 31, 2001
-------------------------------------------------- ------------------------- ---------------------
Investments:
Collateral for collateralized bonds $2,344,885 $2,473,203
Securities 2,992 5,508
Other investments 58,212 63,553
Loans 14,820 7,315
Non-recourse debt - collateralized bonds 2,192,616 2,264,213
Recourse debt 46,400 58,134
Shareholders' equity 240,307 242,110
-------------------------------------------------- ------------------------- ---------------------
Collateral for collateralized bonds
Collateral for collateralized bonds consists of loans and securities backed by
adjustable-rate and fixed-rate mortgage loans secured by first liens on single
family housing, 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. As of June 30, 2002, the Company
had 23 series of collateralized bonds outstanding. The collateral for
collateralized bonds decreased to $2.34 billion at June 30, 2002 compared to
$2.47 billion at December 31, 2001. This decrease of $0.13 billion is primarily
the result of $250.4 million in paydowns on the collateral, additional reserves
for losses of $8.7 million and market value adjustments of $25.8 offset by the
addition of $154.9 million of new collateral which was included in the April
securitization.
Below is a summary as of June 30, 2002, by each series where the fair value
exceeds $0.5 million of the Company's net investment in collateralized bond
securities. The tables that follow are meant to show the Company's net economic
investment in each of the securities presented below, and is not meant to
present the Company's investment in collateral for collateralized bonds or
collateralized bonds in accordance with generally accepted accounting principles
applicable to the Company's transactions. The Company master services four of
its collateralized bond securities. Structured Asset Securitization Corporation
(SASCO) 2002-09 is master-serviced by Wells Fargo Bank. CCA One Series 2 and
Series 3 are master-serviced by Bank of New York. 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 Net Basis of Net
Collateralized Bond Collateral Type collateral bonds Investment Investment
Series (1) pledged outstanding to
third parties
- ---------------------------------------------------------------------------------------------------------------------------
MERIT Series 11A Debt securities backed by
Single-family loans and $ 370,139 $ 331,865 $ 38,274 $ 41,763
Manufactured housing loans
MERIT Series 12-1 Manufactured housing loans 268,117 240,280 27,837 25,673
MERIT Series 13 Manufactured housing loans 325,004 285,751 39,253 34,427
SASCO 2002-9 Single family loans 568,201 561,812 6,389 10,100
MCA One Series 1 Commercial mortgage loans 85,601 81,052 4,549 (439)
CCA One Series 2 Commercial mortgage loans 297,514 278,260 19,254 8,340
CCA One Series 3 Commercial mortgage loans 411,574 366,301 45,273 55,940
- ---------------------------------------------------------------------------------------------------------------------------
2,326,150 2,145,321 180,829 175,804
On-balance sheet reserves for credit losses (21,859) (21.859)
- ---------------------------------------------------------------------------------------------------------------------------
$2,326,150 $2,145,321 $ 158.970 $ 153,945
- ---------------------------------------------------------------------------------------------------------------------------
(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. SASCO stands for Structured Asset Securitization Corporation.
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 the six months ended June 30,
2002.
- -----------------------------------------------------------------------------------------------------------------------------
Fair Value Assumptions ($ in thousands)
----------------------------------------------------------------------
Cash flows
Weighted-average Projected cash flow Fair value of received
Collateralized Bond prepayment speeds Losses termination date net in 2002,
Series investment (1) net (2)
- -----------------------------------------------------------------------------------------------------------------------------
MERIT Series 11A 42%-60% CPR on SF 3.3% annually on Anticipated final maturity
securities; 12% CPR MH securities in 2025
on MH securities $39,351 $15,160
MERIT Series 12-1 11% CPR 2.9% annually on Anticipated final maturity
MH Loans in 2027 2,971 469
MERIT Series 13 12% CPR 4.0% annually Anticipated final maturity
in 2026 3,318 529
SASCO 2002-9 (5) 30% CPR 0.15% annually Anticipated call date in
2005 28,166 4,562
MCA One Series 1 (3) Losses of $2,096 in Anticipated final
2004, $1,500 in maturity in 2018 1,760 55
2006 and $1,000 in
2008
CCA One Series 2 (4) 0.60% annually Anticipated call date in
beginning in 2003 2012 7,892 861
0.60% annually Anticipated call date in
CCA One Series 3 (4) beginning in 2004 2009 20,961 1,226
- -----------------------------------------------------------------------------------------------------------------------------
$104,419 $22,862
- -----------------------------------------------------------------------------------------------------------------------------
(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 June 30, 2002, and incorporates the resetting of the interest
rates on the adjustable rate assets to a level consistent with the
respective index level as of June 30, 2002. Increases or decreases in
interest rates and index levels from June 30, 2002 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 six months ended June 30,
2002, 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
(5) SASCO 2002-9 was completed on April 25, 2002.
The following table compares the fair value of these investments at various
discount rates, but otherwise using the same assumptions as set forth for the
two immediately preceding tables:
- -----------------------------------------------------------------------------------------------------------------------------
Fair Value of Net Investment
- -----------------------------------------------------------------------------------------------------------------------------
Collateralized Bond Series 12% 16% 20% 25%
- -----------------------------------------------------------------------------------------------------------------------------
MERIT Series 11A $ 44,599 $ 39,351 $ 35,266 $ 31,272
MERIT Series 12-1 3,055 2,971 2,854 2,689
MERIT Series 13 3,429 3,318 3,187 3,011
SASCO 2002-9 30,194 28,166 26,301 24,178
MCA One Series 1 2,086 1,760 1,509 1,271
CCA One Series 2 9,509 7,892 6,687 5,580
CCA One Series 3 25,533 20,961 17,369 13,921
- ------------------------------------- --------------------- --------------------- --------------------- ---------------------
$ 118,405 $ 104,419 $ 93,173 $ 81,922
- ------------------------------------- --------------------- --------------------- --------------------- ---------------------
Other investments. Other investments at June 30, 2002 consist primarily of
delinquent property tax receivables. Other investments decreased from $63.6
million at December 31, 2001 to $58.2 million at June 30, 2002. This decrease is
primarily the result of pay-downs of delinquent property tax receivables that
totaled $9.3 million during the six months ended June 30, 2002, partially offset
by the amortization of discounts recorded to accumulated other comprehensive
loss.
Loans. Loans increased from $7.3 million at December 31, 2001 to $14.8 million
at June 30, 2002 as the result of the exclusion of approximately $12 million of
delinquent single-family loans not included in the April securitization. This
increase was partially offset by pay downs during the first six months of 2002.
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 from $2.3 billion at December 31, 2001
to $2.2 billion at June 30, 2002. This decrease was primarily a result of
principal payments received on the associated collateral pledged which were used
to pay down the collateralized bonds in accordance with the respective
indentures.
Recourse debt. Recourse debt decreased to $46.4 million at June 30, 2002 from
$58.1 million at December 31, 2001. This decrease was due to $11.7 million of
purchases of the July 2002 Senior Notes.
Shareholders' equity. Shareholders' equity decreased to $240.3 million at June
30, 2002 from $242.1 million at December 31, 2001. This decrease was a combined
result of a $2.7 million increase in the net unrealized loss on investments
available-for-sale from $14.8 million at December 31, 2001 to $17.5 million at
June 30, 2002 partially offset by net income of $0.9 million during the six
months ended June 30, 2002.
RESULTS OF OPERATIONS
Three months ended June 30, Six months ended June 30,
- --------------------------------------------- ------------------------------------- --------------------------------------
(amounts in thousands except per share 2002 2001 2002 2001
information)
- --------------------------------------------- ---------------- ---------------- ----------------- -----------------
Net interest margin $ 7,013 $ 8,194 $ 10,870 $ 13,817
Net (loss) gain on sales, write-downs,
impairment charges and litigation (4,378) (1,326) (6,433) 3,978
Trading gains (losses) 728 (1,958) 728 (1,720)
General and administrative expenses 2,625 2,634 4,518 4,477
Extraordinary item - (loss) gain on
extinguishment of debt (539) 573 (162) 2,844
Net income
398 2,772 880 14,422
Preferred stock (charges) benefits (2,396) 10,493 (4,792) 7,265
Net (loss) income applicable to common shareholders (1,998) 13,265 (3,912) 21,687
Basic and diluted net (loss) income per
common share before extraordinary gain $ (0.13) $ 1.11 $ (0.34) $ 1.65
Basic and diluted net (loss) income per
common share $ (0.18) $ 1.16 $ (0.36) $ 1.90
Dividends declared per share:
Common $ - $ - $ - $ -
Preferred:
Series A $ - $ 0.2925 $ - $ 0.2925
Series B $ - $ 0.2925 $ - $ 0.2925
Series C $ - $ 0.3649 $ - $ 0.3649
- --------------------------------------------- --- ---------------- --- ---------------- -- ----------------- -- -----------------
Three and Six Months Ended June 30, 2002 Compared to Three and Six Months Ended
June 30, 2001. The decrease in net income and net income per common share during
the six months ended June 30, 2002 as compared to the same period in 2001 is
primarily the result of several positive non-recurring items in 2001, including
the favorable settlement of litigation, and the extraordinary gain related to
the early extinguishment of $38.9 million of the Company's July 2002 Notes in
2001. The decrease in net income during the three months ended June 30, 2002 as
compared to the same period in 2001 is a result of the decline in net interest
margin. Net income to common shareholders basic and diluted earnings per common
share for the second quarter 2001 reflect the discount to book value of the
purchase price of the Company's Series A, Series B, and Series C Preferred Stock
tendered pursuant to the tender offer for the Preferred Stock completed on June
8, 2001, and the associated cumulative dividend in arrears on those tendered
shares, which were cancelled.
Net interest margin for the six months ended June 30, 2002 decreased to $10.9
million from $13.8 million for the same period for 2001. This decrease was
primarily the result of an increase in provision for losses of $1.3 million and
the non-accrual of interest on property tax receivables during the six months
ended June 30, 2002. $2.8 million of interest on property tax receivables was
accrued during the six months ended June 30, 2001. The increase in provision for
losses was a result of increasing the reserve for losses on various manufactured
housing loan pools pledged as collateral for collateralized bonds where the
Company has retained credit risk. These increases were partially offset by a
$1.5 million decrease in interest expense for the Senior Notes.
Net (loss) gain on sales, write-downs, impairment charges and litigation
declined by $10.5 million, from a gain of $4.0 million during the six months
ended June 30, 2001, to a loss of $6.4 million during the six months ended June
30, 2002. During the six months ended June 30, 2001, the Company favorably
resolved litigation for $7.1 million, net of legal expenses. During the six
months ended June 30, 2002, the Company experienced a $1.9 loss on valuation
adjustment on a group of loans which were not included in the SASCO 2002-9
securitization but were retained and reported at the lower of cost or market.
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
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
---------------------------------------------- ----------------------------------------------
(amounts in thousands) 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Average Effective Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate Balance Rate
---------------------- ------------ ---------- ------------ ---------------------------------
Interest-earning assets: (1)
Collateral for collateralized
bonds (2) (3) $2,381,822 7.47% $2,905,337 7.78% $2,373,907 7.35% $2,990,618 7.86%
Securities 3,823 35.02 11,353 10.89 4,581 19.95 11,615 10.34
Other investments 74,579 (0.30) 35,845 14.01 76,276 (0.21) 35,988 15.36
Loans 14,603 3.13 3,596 11.47 8,785 4.60 4,956 13.21
Cash 30,908 1.50 19,639 4.27 19,094 1.65 28,709 5.30
---------------------- ------------ ---------- ------------ ---------------------------------
Total interest-earning assets $ 2,505,587 7.18% $ 2,975,770 7.84% $ 2,482,643 7.08% $ 3,071,886 7.95%
====================== ============ ========== ============ =================================
Interest-bearing liabilities:
Non-recourse debt (3) $2,226,869 5.59% $2,638,813 6.51% $2,209,681 5.65% $2,710,052 6.82%
Recourse debt - secured by
collateralized bonds - - 23,741 6.17 - - 27,503 6.54
---------------------- ------------ ---------- ------------ ---------------------------------
2,226,869 5.59 2,662,554 6.50 2,209,681 5.65 2,737,555 6.82
Other recourse debt - secured 46,395 8.10 69,083 8.51 48,492 8.12 84,061 8.29
---------------------- ------------ ---------- ------------ ---------------------------------
Total interest-bearing liabilities $2,273,264 5.64% $2,731,637 6.55% $2,258,173 5.71% $2,821,616 6.87%
============ ======== ============ ========== ============ =================================
Net interest spread on all
investments (3) 1.54% 1.29% 1.38% 1.08%
========== ========== ========== ==========
Net yield on average interest-earning
assets (3) 2.07% 1.83% 1.89% 1.64%
========== ========== ========== ==========
- ------------------------------------------------------------------------------------------------------------------------------------
(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 $601 and $490 for
the three months ended June 30, 2002 and 2001, respectively, and $568
and $463 for the six months ended June 30, 2002 and 2001, respectively.
(3) Effective rates are calculated excluding non-interest related
collateralized bond expenses. If included, the effective rate on interest-
bearing liabilities would be 5.76% and 6.66% for the three months
ended June 30, 2002 and 2001, respectively, and 5.86% and 6.99% for
the six months ended June 30, 2002 and 2001, respectively, while the net
yield on average interest-earning assets would be 1.12% and 1.09% for
the three months ended June 30, 2002 and 2001, respectively, and
1.24% and 1.14% for the six months ended June 30, 2002 and 2001,
respectively.
The net interest spread increased 25 basis points, to 154 basis points for the
three months ended June 30, 2002 from 129 basis points for the same period in
2001 (each basis point is 0.01%). The net interest spread for the six months
ended June 30, 2002 also improved relative to the same period in 2001, to 138
basis points from 108 basis points. The improvement in the Company's net
interest spread can be attributed to a decline in the cost of interest-bearing
liabilities from the respective 2001 period, which have declined as a result in
the decline of One-Month LIBOR due to the reduction in short-term interest rates
by the Federal Reserve. This was partially offset by the discontinuance of
accrual of interest on the Company's investment in delinquent property tax
receivables in 2002. The majority of the Company's variable-rate
interest-bearing liabilities are indexed relative to One-Month LIBOR.
Interest-bearing liability costs declined 91 basis points and 116 basis points
for the three- and six-month periods ended June 30, 2002, respectively, compared
to the same period in 2001. For the three month period ended June 30, 2002,
there has been a lesser decline in the effective interest-earning yield on the
collateral for collateralized bonds due to the `reset' lag and `floors' (the
loans generally adjust or `reset' every six or twelve months and are generally
limited to maximum adjustments upwards or downwards of 1% each six months) on
the approximate $607 million in single-family and manufactured housing ARM loans
that comprise a portion of the collateral for collateralized bonds. The Company
would expect its net interest spread on its interest-earning assets for the
balance of 2002 to decrease as rates on adjustable collateral loans continue to
adjust downward while rates on collateralized bonds remain flat or begin to
adjust upward. The average One-Month LIBOR rate declined to 1.85% for the three
and six-month periods ended June 30, 2002 from 5.52% and 4.91%, respectively,
for the three and six-month periods ended June 30, 2001.
From June 30, 2001 to June 30, 2002, average interest-earning assets declined
$589 million, or approximately 19%. A large portion of such reduction relates to
paydowns on the Company's adjustable-rate single-family mortgage loans. The
Company's portfolio as of June 30, 2002 consists of $606.5 million of adjustable
rate assets and $1.7 billion of fixed-rate assets. The Company currently
finances approximately $289.3 million of the fixed-rate assets with non-recourse
LIBOR based floating-rate liabilities. The Company, through the use of an
interest-rate swap, converted $100 million of such floating-rate liabilities
into fixed rate. Assuming short-term interest rates stay at or about current
levels, the single-family ARM loans should continue to reset downwards in rate
(subject to the floors) which will have the impact of reducing net interest
spread in future periods.
Interest Income and Interest-Earning Assets. At June 30, 2002, $1.7 billion of
the investment portfolio consists of loans which pay a fixed-rate of interest.
Also at June 30, 2002, approximately $606.5 million of the investment portfolio
is comprised of loans or securities that have coupon rates which adjust over
time (subject to certain periodic and lifetime limitations) in conjunction with
changes in short-term interest rates. Approximately 73% of the ARM loans
underlying the ARM securities and collateral for collateralized bonds are
indexed to and reset based upon the level of six-month LIBOR; approximately 15%
of the ARM loans are indexed to and reset based upon the level of the one-year
Constant Maturity Treasury (CMT) index. The following table presents a
breakdown, by principal balance, of the Company's collateral for collateralized
bonds and ARM and fixed mortgage securities by type of underlying loan. This
table excludes derivative and residual securities, other investments and loans
held for sale.
Investment Portfolio Composition (1)
($ in millions)
- ---------------------------- ------------------ ------------------ ------------------- ------------------ ------------------
Other Indices
LIBOR Based ARM CMT Based ARM Based ARM Fixed-Rate
Loans Loans Loans Loans Total
- ---------------------------- ------------------ ------------------ ------------------- ------------------ ------------------
2001, Quarter 3 527.4 173.2 78.2 1,802.4 2,581.2
2001, Quarter 4 472.4 144.6 73.6 1,765.8 2,456.4
2002, Quarter 1 410.2 100.2 65.7 1,725.1 2,301.2
2002, Quarter 2 452.6 90.1 63.8 1,740.2 2,346.7
- ---------------------------- ------------------ ------------------ ------------------- ------------------ ------------------
(1) Includes only the principal amount of collateral for collateralized bonds,
ARM securities and fixed-rate mortgage 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, net
premium on the collateral for collateralized bonds, ARM securities, fixed-rate
mortgage securities at June 30, 2001, was $18.3 million, or approximately 0.78%
of the aggregate balance of collateral for collateralized bonds, ARM securities
and fixed-rate securities. The $18.3 million net premium consists of gross
collateral premiums of $42.7 million, less gross collateral discounts of $24.4
million. Of the $42.7 million in gross premiums on collateral, $30.7 million
relates to the premium on multifamily and commercial mortgage loans with a
principal balance of $795.8 million at June 30, 2002, and that have average
prepayment lockouts or yield maintenance to 2008. Net premium on such
multifamily and commercial loans is $24.9 million. Amortization expense as a
percentage of principal pay-downs has increased from 1.31% for the three months
ended June 30, 2001 to 1.51% for the same period in 2002. The principal
prepayment rate for the Company (indicated in the table below as "CPR Annualized
Rate") was approximately 17% for the three months ended June 30, 2002. CPR or
"constant prepayment rate" is a measure of the annual prepayment rate on a pool
of loans.
Premium Basis and Amortization
($ in millions)
- -------------------------------------------------------------------------------------------------------------------------
Amortization
CPR Expense as a % of
Amortization Annualized Principal Principal
Net Premium Expense Rate Paydowns Paydowns
- -------------------------------------------------------------------------------------------------------------------------
2001, Quarter 3 23.7 2.1 28% 162.9 1.30%
2001, Quarter 4 22.4 1.8 24% 122.0 1.46%
2002, Quarter 1 20.0 2.4 26% 150.9 1.59%
2002, Quarter 2 18.3 1.5 17% 99.4 1.51%
- -------------------------------------------------------------------------------------------------------------------------
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 2002 and 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. These additional protections include loss
reimbursement guarantees with a remaining balance of $30.3 and a remaining
deductible aggregating $2.0 million on $108 million of securitized single family
mortgage loans which are subject to such reimbursement agreements; guarantees
aggregating $28.7 million on $308.3 million of securitized commercial mortgage
loans, whereby losses on such loans would need to exceed the respective
guarantee amount before the Company would incur credit losses; and $326 million
of securitized single family mortgage loans which are subject to various
mortgage pool insurance policies whereby losses would need to exceed the
remaining stop loss of at least 39% on such policies before the Company would
incur losses.
Credit Reserves and Actual Credit Losses
($ in millions)
- ----------------------------------------------------------------------------------------------------------------------
Outstanding Loan Credit Exposure, Net Actual Credit Credit Exposure, Net of Credit
Principal Balance of Credit Reserves Losses Reserves to Outstanding Loan
Balance
- ----------------------------------------------------------------------------------------------------------------------
2001, Quarter 3 2,771.2 130.4 9.2 4.71%
2001, Quarter 4 2,588.4 153.5 7.1 5.93%
2002, Quarter 1 2,423.0 141.8 6.0 5.85%
2002, Quarter 2 2,437.8 114.6 8.4 4.70%
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 the Company has
retained a portion of the direct credit risk. The delinquencies as a percentage
of the outstanding collateral balance have increased to 2.78% at June 30, 2002
from 1.87% at June 30, 2001 primarily due to four commercial loans which have
become delinquent; one of which has subsequently been brought current. 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.
Delinquency Statistics (1)
- -------------------------------------------------------------------------------------------------------------------------
90 days and over delinquent
60 to 90 days delinquent (2) Total
- -------------------------------------------------------------------------------------------------------------------------
2001, Quarter 3 0.39% 1.61% 2.00%
2001, Quarter 4 0.28% 1.99% 2.27%
2002, Quarter 1 0.76% 1.83% 2.59%
2002, Quarter 2 0.59% 2.19% 2.78%
(1) Excludes other investments and loans held for sale or securitization.
(2) Includes foreclosures, repossessions and REO.
Recent Accounting Pronouncements. In June 2001, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002.
The Company does not believe the adoption of SFAS 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 SFAS No. 144, "Accounting for the
Impairment of Long-lived Assets" which supercedes SFAS 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
Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions (APB 30)" for the disposal of a segment of
business. This statement is effective for fiscal years beginning after December
15, 2001. SFAS No. 144 retains many of the provisions of SFAS No. 121, but
addresses certain implementation issues associated with that Statement. The
adoption of SFAS No. 144 did not have a significant impact on the financial
position, results of operations or cash flows of the Company.
In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections".
Effective January 1, 2003, SFAS No. 145 requires gains and losses from the
extinguishment or repurchase of debt to be classified as extraordinary items
only if they meet the criteria for such classification in APB 30. Until January
1, 2003, gains and losses from the extinguishment or repurchase of debt must be
classified as extraordinary items, as Dynex has done. After January 1, 2003, any
gain or loss resulting from the extinguishment or repurchase of debt classified
as an extraordinary item in a prior period that does not meet the criteria for
such classification under APB 30 must be reclassified.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". Effective January 1, 2003, SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. This SFAS applies to activities that are initiated after
December 31, 2002. The Company has not yet assessed the impact of this statement
on its financial position or results of operations.
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. In
addition, while the Company was operating its loan production operations, the
Company generated cash flow from common stock offerings including 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). Since 1999,
the Company has focused on substantially reducing its recourse debt and
minimizing its capital requirements. Effective July 15, 2002, with the repayment
in full of the July 2002 Senior Notes, the Company has essentially repaid all
remaining outstanding recourse debt. Furthermore, the Company's investment
portfolio continues to provide positive cash flow, which can be utilized by the
Company for reinvestment or other purposes. Cash at June 30, 2002 was $55.8
million of which $48.1 million was used to pay off the Senior Notes on July 15,
2002. .Should the Company's future operations require access to sources of
capital such as lines of credit and repurchase agreements, the Company believes
that it would be able to access such sources.
Non-recourse Debt. Dynex, through limited-purpose finance subsidiaries, has
issued non-recourse debt in the form of collateralized bonds to fund the
majority of its investment portfolio. The obligations under the collateralized
bonds are payable solely from the collateral for collateralized bonds and are
otherwise non-recourse to Dynex. 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 on the earlier of a specified date
or when the remaining balance of the bonds equals 35% or less of the original
principal balance of the bonds. At June 30, 2002, Dynex had $2.2 billion of
collateralized bonds outstanding.
Recourse Debt. As of June 30, 2002, the Company has $46.3 million outstanding of
its senior notes issued in July 1997 and due July 15, 2002 (the "Senior Notes").
On March 30, 2001, the Company entered into an amendment to the related
indenture governing the Senior Notes (the "Supplemental Indenture") whereby the
Company pledged to the Trustee of the Senior Notes substantially all of the
Company's unencumbered assets 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 (a) $26 million, (b) the
cash proceeds of any "permitted subordinated indebtedness", (c) the cash
proceeds of the issuance of any "qualified capital stock", and (d) any
distributions required in order for the Company to maintain its REIT status. In
addition, the Company entered into a Purchase Agreement with holders of 50.1% of
the Senior Notes which require the Company to purchase, and such holders to
sell, their respective Senior Notes at various discounts based on a computation
of the Company's available cash. The discounts provided for under the Purchase
Agreement are as follows: by April 15, 2001, 10%; by July 15, 2001, 8%; by
October 15, 2001, 6%; by January 15, 2002, 4%; by March 1, 2002, 2%; thereafter
until maturity, 0%. Through June 30, 2002, the Company has retired $50,420 of
Senior Notes for $46,297 in cash under the Purchase Agreement, and the Company
had no further obligations under such Purchase Agreement.
On July 15, 2002, the Company satisfied and discharged the entire
indebtedness on the Senior Notes. Collateral pledge to secure the Senior Notes
was released and the Company was released from all associated operating and
distribution restrictions .
Table 1
Non-GAAP Net Balance Sheet (1)
($ in thousands)
June 30, 2002
-----------------
ASSETS
Investments:
Collateral for collateralized bonds $ 2,344,885
Less: Collateralized bonds issued (2,192,818)
-----------------
Net investment in collateralized bonds securities 152,067
Securities 2,992
Other investments 58,211
Loans 14,820
-----------------
228,090
Cash 55,831
Other assets 5,979
-----------------
$ 289,900
=================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable $ 46,400
Other liabilities 3,193
-----------------
49,593
-----------------
Shareholders' Equity:
Preferred stock, par value $.01 per share 94,586
Common stock, par value $.01 per share 109
Additional paid-in capital 364,743
Accumulated other comprehensive loss (17,508)
Accumulated deficit (201,623)
-----------------
240,307
-----------------
$ 289,900
=================
(1) This presents the balance sheet where the collateralized bonds are
"netted" against the collateral for collateralized bonds. This presentation does
not comply with generally accepted accounting principles applicable to the
Company's transactions. Management has included this table to illustrate the
Company's net investment in the collateralized bonds, which represents its
economic interest in the collateralized bond securities.
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-Q made by the Company, that are not
historical fact constitute "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such forward-looking statements may
involve factors that could cause the actual results of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. The Company cautions the public not to place
undue reliance on forward-looking statements, which may be based on assumptions
and anticipated events that do not materialize. The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.
Factors that may cause actual results to differ from historical results or from
any results expressed or implied by forward-looking statements include the
following:
Economic Conditions. The Company is affected by 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 performance of the Company's
securitized loan pools and on the Company's overall financial performance.
Capital Resources. Cash flows from our portfolio are subject to fluctuation due
to changes in interest rates, repayment rates and default rates and related
losses.
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 $289.3 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 materially 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, whereas the
related borrowing have no delayed resets or such interest rate caps.
Defaults. Defaults by borrowers on loans securitized by the Company and where it
has retained credit risk 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 June 30, 2002.
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
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 June 30, 2002 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 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument due to fluctuations in
interest and foreign exchange rates and in equity and commodity prices. Market
risk is inherent to both derivative and non-derivative financial instruments,
and accordingly, the scope of the Company's market risk management extends
beyond derivatives to include all market risk sensitive financial instruments.
As a financial services company, net interest 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 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 only be minimally impacted.
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 June 30, 2002. 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 June
30, 2002. At June 30, 2002, one-month LIBOR was 1.84% and six-month LIBOR was
1.96%. 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
Increase (Decrease) Cash Flow From
in Interest Rates Base Case
- ------------------------------ ---------------------------
+200 (14.4)%
+100 (7.9)%
Base
-100 9.2%
-200 19.3%
Approximately $607 million of the Company's investment portfolio as of June 30,
2002 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 73% and 15% 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 June 30, 2002,
approximately $1.74 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 June 30, 2002, and
(ii) equity, which was $240.3 million. Overall, the Company's interest rate risk
is primarily related both to the rate of change in short term interest rates,
and to the level of short-term interest rates.
In addition, the company has entered into an interest rate swap to mitigate
its interest rate risk exposure on $100 million in notional value of its
variable rate bonds. The swap agreement has been constructed such that the
Company will pay interest at a fixed rate of 3.73% on the notional amount and
will receive interest based on one month LIBOR on the same notional amount. The
impact on cash flows from the interest rate swap has been included in the table
above for each of the respective interest-rate scenarios.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
GLS Capital, Inc. ("GLS"), a subsidiary of the Company, together with the County
of Allegheny, Pennsylvania ("Allegheny County"), were 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 was related to the purchase by GLS of delinquent
property tax receivables from Allegheny County in 1997, 1998, and 1999 for
approximately $58.3 million. 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 amount
recoverable on the delinquent property tax receivables, including attorney fees
incurred in the collection process.
The Company is also subject to other lawsuits or claims which have arisen 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 2. Changes in Securities and Use of Proceeds
On April 25, 2002, the Company completed the issuance of $605 million of
collateralized bonds. These bonds were collateralized by single-family loans
aggregating $602 million, $447 million of which were loans already owned by the
Company and $155 million of which represented new loans from the purchase of
mortgage backed securities from third parties pursuant to certain call rights
owned by the Company. The transaction has been accounted for as a financing;
thus the loans and associated bonds are included in the Company's second quarter
2002 consolidated balance sheet as assets and liabilities of the Company. Cash
proceeds from the securitization, net of related costs, was approximately $24
million. The Company used the proceeds from the securitization toward repayment
of the Senior Notes due July 15, 2002.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
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.)
3.12 Amendments to the Bylaws of the Company.
(b) Reports on Form 8-K
Current report on Form 8-K as filed with the Commission on April 29, 2002, regarding the settlement Agreement dated
April 26, 2002, by and among Dynex Capital, Inc. and Leeward Capital LP, Leeward Investments, L.L.C., Mr. Eric Van
der Porten and Mr. James M. Bogin.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNEX CAPITAL, INC.
By: /s/ Stephen J. Benedetti
-------------------------------------
Stephen J. Benedetti,
Executive Vice President
(authorized officer of registrant)
By: /s/ Stephen J. Benedetti
-------------------------------------
Stephen J. Benedetti
(principal accounting officer)
Dated: August 20, 2002
Exhibit 3.12
CERTIFICATE OF AMENDMENT OF BYLAWS
OF
DYNEX CAPITAL, INC.
The undersigned, being the duly appointed Secretary of Dynex Capital, Inc.,
a Virginia corporation (the "Company"), hereby certifies that, by the unanimous
vote of the Board of Directors at a meeting duly held on July 25, 2002, the
Company's Amended and Restated Bylaws ("Bylaws") was amended as follows:
(1) By adding a new Section 3.16 to Article III, to read in its entirety
as follows:
"SECTION 3.16 Parliamentary Authority. The rules contained in
the current edition of Robert's Rules of Order Newly Revised shall
govern the Company in all cases to which they are applicable and in
which they are not inconsistent with these Bylaws and any special rules
of order the Company may adopt."
(2) By deleting the last sentence of Section 5.01 of Article V of the
Bylaws and inserting in lieu thereof the following:
"The Board of Directors may elect from among the members of
the Board, a Chairman of the Board and Vice Chairman of the Board,
both of whom need not be an officer of the Company."
Dated: August 20, 2002
/s/ STEPHEN J. BENEDETTI
---------------------------------------
Stephen J. Benedetti, Secretary