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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
1-9819
(Commission file number)
Virginia 52-1549373
(State or other jurisdiction of (IRS Employer I.D. No.)
incorporation or organization)
4551 Cox Road, Suite 300, Glen Allen, Virginia 23060-6740
(Address of principal executive of (Zip Code)
(804) 217-5800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- ------------------- -----------------------------------------
Common Stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Title of each class Name of each exchange on which registered
- ------------------- -----------------------------------------
Series A 9.75% Cumulative Convertible Preferred Stock, $.01 par value NASDAQ National Market
Series B 9.55% Cumulative Convertible Preferred Stock, $.01 par value NASDAQ National Market
Series C 9.73% Cumulative Convertible Preferred Stock, $.01 par value NASDAQ National Market
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X| No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
Yes |_| No |X|
As of June 30, 2002, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $53,282,125 at a closing
price on The New York Stock Exchange of $4.90. Common stock outstanding as of
March 28, 2003 was 10,873,903 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement to be filed pursuant to Regulation
14A within 120 days from December 31, 2002, are incorporated by reference into
Part III.
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DYNEX CAPITAL, INC.
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
Number
PART I.
Item 1. Business...........................................................1
Item 2. Properties........................................................11
Item 3. Legal Proceedings.................................................11
Item 4. Submission of Matters to a Vote of Security Holders...............12
PART II.
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters.......................................13
Item 6. Selected Financial Data...........................................14
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations.....................15
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........30
Item 8. Financial Statements and Supplementary Data.......................32
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................32
PART III.
Item 10. Directors and Executive Officers of the Registrant..........................................32
Item 11. Executive Compensation......................................................................32
Item 12. Security Ownership of Certain Beneficial Owners and Management..............................32
Item 13. Certain Relationships and Related Transactions..............................................32
PART IV.
Item 14. Controls and Procedures.....................................................................32
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................33
SIGNATURES ............................................................................................35
PART I
Item 1. Business
GENERAL
Dynex Capital, Inc. was incorporated in the Commonwealth of Virginia in
1987. References to "Dynex", or "the Company" contained herein refer to Dynex
Capital, Inc. together with its qualified real estate investment trust (REIT)
subsidiaries and taxable REIT subsidiary. Dynex is a financial services company,
which invests in loans and securities consisting of or secured by, principally
single family mortgage loans, commercial mortgage loans, manufactured housing
installment loans and delinquent property tax receivables. The loans and
securities in which the Company invests have generally been pooled and pledged
(i.e. securitized) as collateral for non-recourse bonds ("collateralized
bonds"), which provides long-term financing for such loans while limiting
credit, interest rate and liquidity risk. The Company has elected to be treated
as a REIT for federal income tax purposes under the Internal Revenue Code of
1986, as amended, and, as such, must distribute substantially all of its taxable
income to shareholders. Provided that the Company meets all of the proscribed
Internal Revenue Code requirements for a REIT, the Company will generally not be
subject to federal income tax. Prior to December 31, 2000, the Company operated
certain of its activities out of a taxable affiliate, Dynex Holding, Inc. (DHI),
in which the Company owned 100% of the preferred stock outstanding. As the
Company owned only non-voting preferred stock, DHI and its subsidiaries were not
consolidated for financial reporting or tax purposes, but were accounted for in
the Company's financial statements using the equity method. Effective on
December 31, 2000, DHI was liquidated into the Company.
Since 1999, as a result of disruptions in the fixed income markets, the
Company has focused its efforts on conserving its capital base and repaying its
outstanding recourse obligations. Prior to such time, the Company operated a
number of loan origination businesses, including single-family mortgage lending,
commercial mortgage lending, and manufactured housing lending, all of which have
been sold or otherwise discontinued. Since 2000, the Company's business
operations have been essentially limited to the management of its investment
portfolio and the active collection of its portfolio of delinquent property tax
receivables. As of December 31, 2002, the Company has repaid all of its recourse
obligations and is now free from any contractual operating and investing
restrictions. The Company's investment portfolio continues to generate
reasonable cash flow, and the Company has been evaluating alternative uses for
this cash flow in an effort to improve shareholder value, including alternatives
with respect to the Company's preferred stock outstanding. In January 2003, the
Company initiated a tender offer for approximately $52 million of its preferred
stock outstanding, to be funded with a combination of cash and senior, unsecured
notes due February 28, 2005 (the "February 2005 Notes"). In February 2003, the
Company closed the tender offer and retired a total of 1,887,600 shares of its
preferred stock for $19.3 million in cash and the issuance of $32.1 million of
February 2005 Notes. The tender offer resulted in a preferred stock benefit to
be recorded in the first quarter of 2003 of $12.6 million, comprised of the
elimination of $16.5 million of dividend in arrears on the shares tendered and a
premium paid to book value of $3.9 million. The February 2005 Notes preclude
further distributions on preferred or common stocks, other than for the Company
to maintain its status as a REIT, until the Notes are fully repaid. The Company
currently has approximately $121 million of tax net operating loss carryforwards
and $61 million of capital loss carryforwards which the Company could use to
offset future taxable income excluding excess inclusion income. See further
discussion in Federal Income Tax Considerations.
The Company's primary focus today is on maximizing cash flows from its
investment portfolio and opportunistically calling securities pursuant to
clean-up calls if the underlying collateral has value for the Company. Longer
term, the Board of Directors will continue to evaluate alternatives for the use
of the Company's cash flow in an effort to improve overall shareholder value.
Such evaluation may include a number of alternatives, including the acquisition
of a new business. The Company has considered the possible acquisition of a
depository institution, but it is the Board of Directors' view that the Company
would likely attempt to resolve the remaining preferred stock
dividends-in-arrears before the Company would move forward with an acquisition.
In addition, given the availability of tax net operating loss carryforwards, the
Company could forego its REIT status in connection with the introduction of a
new business plan, if such business plan included activities not traditionally
associated with REITs, or that are prohibited or otherwise restricted for REITs.
Business Focus and Strategy
The Company's primary business focus is on managing its investment
portfolio to maximize its earnings and cash flow. The Company acts in certain
instances as both a primary and master servicer on assets included in its
investment portfolio. The Company's principal source of earnings historically
has been its net interest income from its investment portfolio. The Company had
generally created investments for its portfolio through the issuance of
non-recourse collateralized bonds secured by a pledge of loans and securities as
collateral for collateralized bonds. Commensurate with a fundamental shift in
its business plan to conserve capital and repay recourse debt outstanding in
1999, the Company's investment portfolio has been declining as the result of
sales and pay-downs, with little additional investment having been made by the
Company over the ensuing three years. The Company's remaining investment
portfolio consists primarily of collateral for collateralized bonds and
delinquent property tax receivables.
The Company funds its investment portfolio primarily through
non-recourse collateralized bonds and funds raised from the issuance of equity.
For the portion of the investment portfolio funded with collateralized bonds or
other borrowings, the Company generates net interest income to the extent that
there is a positive spread between the yield on the interest-earning assets and
the cost of the borrowed funds. The cost of the Company's borrowings may be
increased or decreased by interest rate swap, cap or floor agreements. For the
other portion of the investment portfolio funded with equity, net interest
income is primarily a function of the yield generated from the interest-earning
asset.
The Company owns the right to purchase or redeem generally by class the
collateralized bonds on its balance sheet once the outstanding balance of such
bonds reaches 35% or less of the original amount issued or a specified date. The
Company also owns the right to call adjustable-rate and fixed-rate mortgage
pass-through securities previously issued and sold by the Company (and therefore
not currently included in its investment portfolio) once the outstanding balance
of such securities reached a call trigger, generally either 10% or less of the
original amount issued or a specified date. The aggregate projected callable
balance of such securities at the time of the projected call is approximately
$131 million, relating to ten securities. The Company may or may not elect to
call one or more of these securities when eligible to call. During 2002, the
Company initiated the call on 17 securities for approximately $164 million, and
may initiate the call of eight additional securities in 2003 with an estimated
balance of $91 million. The Company may call additional securities in the
future.
On April 25, 2002, the Company completed the securitization of $602
million of single-family mortgage loans and the associated issuance of $605
million of collateralized bonds. Of the $602 million of single-family mortgage
loans securitized, $447 million were loans which were already owned by the
Company and $155 million 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.
Primary Servicing
The Company services as primary servicer its portfolio of delinquent
property tax receivables and a small amount of remaining commercial mortgage
loans which have not been securitized. The Company also retains an interest in
the servicing of approximately $91 million of securitized single-family mortgage
loans, which are being sub-serviced by a former subsidiary of the Company. As a
result of retaining this interest in the servicing, the Company is obligated to
advance scheduled principal and interest on delinquent loans in accordance with
the underlying loan servicing agreements.
The Company's delinquent property tax receivable servicing operation
resides in Pittsburgh, Pennsylvania, with a satellite office in Cleveland, Ohio.
The Company's responsibilities as servicer include collecting voluntary payments
from property owners, and if collection efforts fail, foreclosing, stabilizing
and selling the underlying properties. As of December 31, 2002, the Company was
servicing delinquent property tax receivables with an aggregate redemptive value
of approximately $123 million of delinquent property tax receivables in six
states, but with the majority in Pennsylvania and Ohio. The Company plans to
offer during 2003 third-party collection services to taxing jurisdictions for
the collection of delinquent property tax receivables. The Company plans to
initially target jurisdictions in Ohio and Pennsylvania; however, there can no
assurance such effort will be successful.
Master Servicing
The Company performs the function of master servicer for certain of the
series of collateralized bond securities which it has issued, and certain loans
which have not been securitized. The master servicer's function typically
includes monitoring and reconciling the loan payments remitted by the servicers
of the loans, determining the payments due on the securities and determining
that the funds are correctly sent to a trustee or investors for each series of
securities. Master servicing responsibilities also include monitoring the
servicers' compliance with its servicing guidelines. As of December 31, 2002,
the Company monitored the performance of four third-party servicers of single
family loans; the performance of GMAC Commercial Mortgage Corporation as the
servicer one of the series of the Company's securitized commercial mortgage
loans, and Origen Financial, LLC as the servicer of the Company's manufactured
housing loans. In its capacity as master servicer, the Company is obligated to
advance scheduled principal and interest on delinquent loans in accordance with
the underlying servicing agreements should the primary servicer fail to make
such advance.
As master servicer, the Company is paid a monthly fee based on the
outstanding principal balance of each such loan master serviced or serviced by
the Company as of the last day of each month. As of December 31, 2002, the
Company master serviced $920 million in securities.
Securitization
The Company's predominate securitization structure is collateralized
bonds, whereby loans and securities are pledged to a trust and the trust issues
non-recourse collateralized bonds pursuant to an indenture. Generally, for
accounting and tax purposes, the loans and securities financed through the
issuance of collateralized bonds are treated as assets of the Company, and the
collateralized bonds are treated as debt of the Company. The Company earns the
net interest spread between the interest income on the loans and securities and
the interest and other expenses associated with the collateralized bond
financing. The net interest spread is directly impacted by the credit
performance of the underlying loans and securities, by the level of prepayments
of the underlying loans and securities and, to the extent collateralized bond
classes are variable-rate, may be affected by changes in short-term rates. The
Company's investment in the collateralized bonds is typically referred to as the
over-collateralization. The Company analyzes and values its investment in
collateralized bonds on a "net investment basis" (i.e., the excess of the
collateral pledged over the outstanding collateralized bonds, and the resulting
net cash flow to the Company), as further discussed below.
Investment Portfolio
Composition. The following table presents the balance sheet composition
of the investment portfolio by investment type and the percentage of the total
investments as of December 31, 2002 and 2001. Collateral for collateralized
bonds includes loans which are carried at amortized cost, and debt securities,
which are considered available-for-sale pursuant to the provisions of SFAS No.
115 and are carried at fair value. Other investments include a security backed
by delinquent tax receivables, which is classified as held-to-maturity pursuant
to the provisions of SFAS No. 115, and is carried at amortized cost. Other
investments also include unsecuritized delinquent tax receivables which are
carried at amortized cost. Securities consist of mortgage-related debt
securities, are considered available-for-sale, and are carried at fair value.
Securities also include a security backed by consumer installment loans, which
is also classified as held-to-maturity pursuant to the provisions of SFAS No.
115, and is carried at amortized cost. Loans are carried at amortized cost.
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(amounts in thousands) As of December 31,
2002 2001
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Balance % of Total Balance % of Total
- -------------------------------------------- ----------------- ------------------ ----------------- -----------------
Investments:
Collateral for collateralized bonds
Loans (at amortized cost, net) $1,818,577 82.0% $2,006,165 78.7%
Debt securities (at fair value) 329,920 14.9% 467,038 18.3%
Other investments 54,322 2.4 63,553 2.5
Securities:
Adjustable-rate mortgage securities - - 1,740 0.1
Fixed-rate securities 3,664 0.2 4,774 0.2
Mortgage-related securities 2,544 0.1 2,523 0.1
Loans 9,288 0.4 3,786 0.1
- -------------------------------------------- ----------------- ------------------ ----------------- -----------------
Total investments $2,218,315 100.0% $2,549,579 100.0%
- -------------------------------------------- ----------------- ------------------ ----------------- -----------------
Collateral for collateralized bonds. Collateral for collateralized
bonds includes loans and securities, consisting of, or secured 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. Collateral for collateralized
bonds have been pledged to support the repayment of associated collateralized
bonds outstanding. Interest margin on the Company's net investment in
collateralized bonds (defined as the principal balance of collateral for
collateralized bonds less the principal balance of the collateralized bonds
outstanding) is derived primarily from the difference between (i) the interest
income generated from the collateral pledged to secure the collateralized bonds
and (ii) the interest expense on the collateralized bonds and related insurance
and administrative expenses. Collateralized bonds are non-recourse to the
Company. The Company's return on its net investment in collateralized bonds is
affected primarily by changes in interest rates, prepayment rates and credit
losses on the underlying loans. By virtue of its net investment, the Company
generally retains the net interest margin cashflow generated by the
collateralized bond structure. The Company may retain for its investment
portfolio certain classes of the collateralized bonds issued and in the past has
pledged such classes as collateral for repurchase agreements.
Other investments. Other investments include a security backed by
delinquent tax receivables, which is classified as held-to-maturity pursuant to
the provisions of SFAS No. 115, and is carried at amortized cost. Other
investments also include unsecuritized delinquent tax receivables, which are
carried at amortized cost. During 2002, the Company collected approximately
$16.6 million on its delinquent property tax receivables, with collections of
$7.3 million relating to delinquent property tax receivables located in
Allegheny County, Pennsylvania, $7.3 million relating to delinquent property tax
receivables located in Cuyahoga County, Ohio, and $2.0 million relating to
various other jurisdictions.
Securities. Securities at December 31, 2002 include fixed-rate
securities, which included fixed-rate mortgage securities consisting of
mortgage-related debt securities that have a fixed-rate of interest over their
remaining life and asset-backed securities collateralized by consumer
installment loans, and mortgage-related securities. Mortgage-related securities
consist primarily of interest-only securities ("I/Os"), principal-only
securities ("P/Os") and inverse-floaters. An I/O is a class of a collateralized
bond or a mortgage pass-through security that pays to the holder substantially
all interest. A P/O is a class of a collateralized bond or a mortgage
pass-through security that pays substantially all principal to the holder. An
inverse floater is a class of a mortgage pass-through security where interest is
earned based on a defined target rate, less LIBOR multiplied by a defined
factor. The yields on the above referenced securities are affected primarily by
changes in prepayment rates and by changes in short-term interest rates.
Loans. As of December 31, 2002, loans consist principally of delinquent
single-family mortgage loans, mezzanine loans secured by healthcare properties,
and participations in first mortgage loans secured by multifamily and commercial
mortgage properties.
Additional Information on Collateralized Bond Securities
The Company analyzes and values its investment in collateral for
collateralized bonds on a net investment basis. As previously discussed, the
Company, through its subsidiaries, pledges collateral (i.e., single-family
mortgage loans and securities, manufactured housing mortgage loans and
securities, or commercial mortgage loans) for collateralized bond obligations
that are issued based on the pledge of such collateral. These collateralized
bonds are recourse only to the collateral pledged, and not to the Company. The
structure created by the pledge of collateral and sale of the associated
collateralized bonds is referred to hereafter as a "collateralized bond
security". The "principal balance of net investment" in a collateralized bond
security represents the principal balance of the collateral pledged less the
outstanding balance of the associated collateralized bonds owned by third
parties. This net investment is also commonly referred to as
"over-collateralization". The "amortized cost basis of net investment" is the
over-collateralization amount plus or minus collateral and collateralized bond
premiums and discounts and related costs. The Company generally has sold the
investment grade classes of the collateralized bonds to third parties, and has
retained the portion of the collateralized bond security that is below
investment grade. The Company estimates the fair value of its net investment in
collateralized bond securities as the present value of the projected cash flow
from the collateral, adjusted for the impact of and assumed level of future
prepayments and credit losses, less the projected principal and interest due on
the bonds owned by third parties. Below is a summary as of December 31, 2002, by
each series where the fair value exceeds $0.5 million of the Company's net
investment in collateralized bond securities. The Company master services four
of its collateral for collateralized bond securities. Structured Asset
Securitization Corporation (SASCO) Series 2002-9 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.
The following tables show the Company's net economic investment in each
of the securities presented below. As the Company does not present its
investment in collateralized bonds on a net investment basis and carries only
its investment in MERIT Series 11 at fair value, the table below 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.
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(amounts in thousands) Principal
Principal Balance of Principal Amortized
Balance Collateralized Balance Cost Basis
Collateralized Of Bonds Of Of
Bond Collateral Outstanding to Net Net
Series (1) Collateral Type Pledged Third Parties Investment Investment
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MERIT Series 11 Securities backed by $ 334,078 $ 293,171 $ 40,907 $ 30,366
single-family mortgage
and manufactured housing
loans
MERIT Series 12 Manufactured housing loans 253,402 228,908 24,494 22,250
MERIT Series 13 Manufactured housing loans 304,908 271,214 33,694 28,719
SASCO 2002-9 Single family loans 481,308 473,232 8,076 19,089
MCA Series 1 Commercial mortgage loans 82,354 77,636 4,718 (287)
CCA One Series 2 Commercial mortgage loans 294,833 272,729 22,104 8,130
CCA One Series 3 Commercial mortgage loans 400,322 356,349 43,973 52,230
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$ 2,151,205 $ 1,973,239 $ 177,966 $ 160,497
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(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, and the cash flow received from such net investment during
2002. As the Company does not present its investment in collateralized bonds on
a net investment basis and carries only its investment in MERIT Series 11 at
fair value, the table below 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.
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Fair Value Assumptions ($ in thousands)
--------------------------------------
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Collateralized Bond Weighted-average Projected cash Fair value of net Cash flows
Series prepayment speeds Losses flow termination investment (1) received in 2002,
date net (2)
- --------------------------------------------------------------------------------------------------------------------
MERIT Series 11 30%-45% CPR on SF 3.4% annually on Anticipated final $ 30,342 $ 26,093
securities; 11% MH loans maturity in 2025
CPR on MH
securities
MERIT Series 12 11% CPR 3.3% annually on Anticipated final 2,081 1,117
MH loans maturity in 2027
MERIT Series 13 12% CPR 4.2% annually Anticipated final 1,861 1,285
maturity in 2026
SASCO 2002-9 (5) 26% CPR 0.2% annually Anticipated call 32,230 14,928
date in 2005
MCA One Series 1 (3) Losses of $2,500 Anticipated final 1,695 607
in 2004, $1,000 maturity in 2018
in 2006 and $650
in 2008
CCA One Series 2 (4) 0.40% annually Anticipated call 10,211 1,722
beginning in 2003 date in 2012
CCA One Series 3 (4) 0.60% annually Anticipated call 19,833 2,618
beginning in 2003 date in 2009
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$ 98,253 $ 48,370
- --------------------------------------------------------------------------------------------------------------------
(1) Calculated as the net present value of expected future cash flows,
discounted at 16%. Expected cash flows were based on the forward LIBOR
curve as of December 31, 2002, and incorporates the resetting of the
interest rates on the adjustable rate assets to a level consistent with
projected prevailing rates. Increases or decreases in interest rates and
index levels from those used in the projection would impact the calculation
of fair value, as would differences in actual prepayment speeds and credit
losses versus the assumptions set forth above.
(2) Cash flows received by the Company during the year, equal to the excess of
the cash flows received on the collateral pledged, over the cash flow
requirements of the collateralized bond security
(3) Computed at 0% CPR through June 2008, then 20% CPR thereafter (4) Computed
at 0% CPR until the respective call date (5) SASCO 2002-9 securitization
was completed April 25, 2002
The above tables illustrate the Company's estimated fair value of its
net investment in collateralized bond securities. In its consolidated financial
statements, the Company carries its investments at amortized cost, except for
its investment in MERIT Series 11, which it carries at estimated fair value.
Inclusive of recorded allowance for losses aggregating $25.4 million, the
Company's net investment in collateralized bond securities as reported in its
consolidated financial statements is approximately $134.9 million. This amount
compares to an estimated fair value, utilizing a discount rate of 16%, of
approximately $98.3 million, as set forth in the table above.
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 $ 33,583 $ 30,342 $ 27,819 $ 25,338
MERIT Series 12-1 1,959 2,081 2,123 2,110
MERIT Series 13 1,714 1,861 1,936 1,967
SASCO 2002-9 34,104 32,230 30,502 28,528
MCA One Series 1 2,005 1,695 1,454 1,224
CCA One Series 2 12,658 10,211 8,413 6,792
CCA One Series 3 23,915 19,833 16,575 13,399
- ------------------------------------- --------------------- --------------------- --------------------- ---------------------
$ 109,938 $ 98,253 $ 88,822 $ 79,358
- ------------------------------------- --------------------- --------------------- --------------------- ---------------------
Investment Portfolio Risks
The Company is exposed to several types of risks inherent in its
investment portfolio. These risks include credit risk (inherent in the loan
and/or security structure), prepayment/interest rate risk (inherent in the
underlying loan) and margin call risk (inherent in the security if it is used as
collateral for recourse borrowings).
Credit Risk. Credit risk is the risk of loss to the Company from the
failure by a borrower (or the proceeds from the liquidation of the underlying
collateral) to fully repay the principal balance and interest due on a loan. A
borrower's ability to repay, or the value of the underlying collateral, could be
negatively influenced by economic and market conditions. These conditions could
be global, national, regional or local in nature. Upon securitization of the
pool of loans or securities backed by loans, the credit risk retained by the
Company is generally limited to its net investment in the collateralized bond
structure (referred to as "principal balance of net investment", or as
"over-collateralization") and/or subordinated securities that it may retain from
a securitization. For securitized pools of loans, the Company provides for
reserves for expected losses based on the current performance of the respective
pool or on an individual loan basis; if losses are experienced more rapidly due
to market conditions than the Company has provided for in its reserves, the
Company may be required to provide for additional reserves for these losses. The
Company also has credit risk related to certain debt securities, principally on
those pledged as collateral for collateralized bonds, and recognizes losses when
incurred or when such security is deemed to be impaired on an other than
temporary basis.
The Company evaluates and monitors its exposure to credit losses and
has established reserves and discounts for probable credit losses based upon
anticipated future losses on the loans and securities, general economic
conditions and historical trends in the portfolio. For loans and securities
pledged as collateral for collateralized bonds, the Company considers its credit
exposure to include over-collateralization. The Company has also retained
subordinated securities from other securitizations. As of December 31, 2002, the
Company's credit exposure on subordinated securities retained or as to
over-collateralization was $168.2 million. The Company has reserves and
discounts of $76.3 million relative to this credit exposure. The Company also
has credit risk on the entire amount of investments that are not securitized, or
are securitized and the Company retained the entire security issued. Such
investments include loans and delinquent property tax receivables of $9.3
million and $54.3 million, respectively, at December 31, 2002. Delinquent
property tax receivables are carried at amortized cost, and all amounts
collected on these receivables is applied against the carrying value of these
receivables.
The Company also has various other forms of credit enhancement which,
based upon the performance of the underlying loans and securities, may provide
additional protection against losses. Specifically, $166.2 million and $137.4
million of the commercial mortgage loans are subject to guarantees of $14.3
million and $14.4 million, respectively, whereby losses on such loans would need
to exceed the respective guarantee amount before the Company would incur credit
losses; $272 million of the single family mortgage loans in various pools are
subject to various mortgage pool insurance policies whereby losses would need to
exceed the remaining stop loss of at least 48.4% on such policies before the
Company would incur losses; and $94.0 million of the single family mortgage
loans are subject to various loss reimbursement agreements totaling $30.2
million with a remaining aggregate deductible of approximately $1.4 million.
Prepayment/Interest Rate Risk. The interest rate environment may also
impact the Company. For example, in a rising rate environment, the Company's net
interest margin may be reduced, as the interest cost for its funding sources
could increase more rapidly than the interest earned on the associated asset
financed. The Company's floating-rate funding sources are substantially based on
the one-month London InterBank Offered Rate ("LIBOR") and reprice at least
monthly, while the associated assets are principally six-month LIBOR or one-year
Constant Maturity Treasury ("CMT") based and generally reprice every six to
twelve months. Additionally, the Company has approximately $254 million of
fixed-rate assets financed with floating-rate collateralized bond liabilities.
In a declining rate environment, net interest margin may be enhanced for the
opposite reasons. In a period of declining interest rates, however, loans and
securities in the investment portfolio will generally prepay more rapidly (to
the extent that such loans are not prohibited from prepayment), which may result
in additional amortization of asset premium. In a flat yield curve environment
(i.e., when the spread between the yield on the one-year Treasury security and
the yield on the ten-year Treasury security is less than 1.0%), single-family
adjustable rate mortgage ("ARM") loans and securities tend to rapidly prepay,
causing additional amortization of asset premium. In addition, the spread
between the Company's funding costs and asset yields would most likely compress,
causing a further reduction in the Company's net interest margin. Lastly, the
Company's investment portfolio may shrink, or proceeds returned from prepaid
assets may be invested in lower yielding assets. The severity of the impact of a
flat yield curve to the Company would depend on the length of time the yield
curve remained flat.
FEDERAL INCOME TAX CONSIDERATIONS
General
The Company believes it has complied with the requirements for
qualification as a REIT under the Internal Revenue Code (the "Code"). To the
extent the Company qualifies as a REIT for federal income tax purposes, it
generally will not be subject to federal income tax on the amount of its income
or gain that is distributed as dividends to shareholders. The Company uses the
calendar year for both tax and financial reporting purposes. There may be
differences between taxable income and income computed in accordance with
Generally Accepted Accounting Principles ("GAAP"). These differences primarily
arise from timing differences in the recognition of revenue and expense for tax
and GAAP purposes. The Company's estimated taxable income for 2002, excluding
net operating losses carried forward from prior years, was $5.5 million,
comprised entirely of ordinary income. Such amounts were fully offset by tax
loss carry-forwards of a similar amount. The Company currently has tax operating
loss carry-forwards of approximately $121 million. Included in the $5.5 million
in ordinary income is excess inclusion income of $1.4 million which is required
to be distributed by the Company by the time the Company files its consolidated
income tax return in order to maintain its REIT status. The Company intends to
make such distribution in accordance with the prescribed requirements.
Substantially all of the $121 million in net operating losses carry-forwards
expire in 2014 and 2015, and of the $61 million of capital loss carry-forwards,
$34 million expires in 2003 and $27 million expires in 2004.
The REIT rules generally require that a REIT invest primarily in real
estate-related assets, that its activities be passive rather than active and
that it distribute annually to its shareholders substantially all of its taxable
income. The Company could be subject to income tax if it failed to satisfy those
requirements or if it acquired certain types of income-producing real property.
Although no complete assurances can be given, the Company does not expect that
it will be subject to material amounts of such taxes.
Failure to satisfy certain Code requirements could cause the Company to
lose its status as a REIT. If the Company failed to qualify as a REIT for any
taxable year, it would be subject to federal income tax (including any
applicable alternative minimum tax) at regular corporate rates and would not
receive deductions for dividends paid to shareholders. The Company could utilize
loss carry-forwards to offset any taxable income. In addition, given the size of
its tax loss carry-forwards, the Company could pursue a business plan in the
future whereby the Company would voluntarily forego its REIT status. Once the
Company loses its status as REIT, the Company could not elect REIT status again
for five years.
In December 1999, with an effective date of January 1, 2001, Congress
signed into law several changes to the provisions of the Code relating to REITs.
The most significant of these changes relates to the reduction of the
distribution requirement from 95% to 90% of taxable income and to the ability of
REITs to own a 100% interest in taxable REIT subsidiaries. The Company had one
taxable REIT subsidiary at December 31, 2002.
Qualification of the Company as a REIT
Qualification as a REIT requires that the Company satisfy a variety of
tests relating to its income, assets, distributions and ownership. The
significant tests are summarized below.
Sources of Income. To continue qualifying as a REIT, the Company must
satisfy two distinct tests with respect to the sources of its income: the "75%
income test" and the "95% income test". The 75% income test requires that the
Company derive at least 75% of its gross income (excluding gross income from
prohibited transactions) from certain real estate-related sources. In order to
satisfy the 95% income test, 95% of the Company's gross income for the taxable
year must consist either of income that qualifies under the 75% income test or
certain other types of passive income.
If the Company fails to meet either the 75% income test or the 95%
income test, or both, in a taxable year, it might nonetheless continue to
qualify as a REIT, if its failure was due to reasonable cause and not willful
neglect and the nature and amounts of its items of gross income were properly
disclosed to the Internal Revenue Service. However, in such a case the Company
would be required to pay a tax equal to 100% of any excess non-qualifying
income.
Nature and Diversification of Assets. At the end of each calendar
quarter, three asset tests must be met by the Company. Under the 75% asset test,
at least 75% of the value of the Company's total assets must represent cash or
cash items (including receivables), government securities or real estate assets.
Under the "10% asset test", the Company may not own more than 10% of the
outstanding voting securities of any single non-governmental issuer, provided
such securities do not qualify under the 75% asset test or relate to taxable
REIT subsidiaries. Under the "5% asset test," ownership of any stocks or
securities that do not qualify under the 75% asset test must be limited, in
respect of any single non-governmental issuer, to an amount not greater than 5%
of the value of the total assets of the Company.
If the Company inadvertently fails to satisfy one or more of the asset
tests at the end of a calendar quarter, such failure would not cause it to lose
its REIT status, provided that (i) it satisfied all of the asset tests at the
close of a preceding calendar quarter and (ii) the discrepancy between the
values of the Company's assets and the standards imposed by the asset tests
either did not exist immediately after the acquisition of any particular asset
or was not wholly or partially caused by such an acquisition. If the condition
described in clause (ii) of the preceding sentence was not satisfied, the
Company still could avoid disqualification by eliminating any discrepancy within
30 days after the close of the calendar quarter in which it arose.
Distributions. With respect to each taxable year, in order to maintain
its REIT status, the Company generally must distribute to its shareholders an
amount at least equal to 90% of the sum of its "REIT taxable income" (determined
without regard to the deduction for dividends paid and by excluding any net
capital gain) and any after-tax net income from certain types of foreclosure
property minus any "excess non-cash income" (the "90% distribution
requirement"). The Code provides that in certain circumstances distributions
relating to a particular year may be made in the following year for purposes of
the 90% distribution requirement. The Company will balance the benefit to the
shareholders of making these distributions and maintaining REIT status against
their impact on the liquidity of the Company. In certain situations, it may
benefit the shareholders if the Company retained cash to preserve liquidity and
thereby lose REIT status.
Ownership. In order to maintain its REIT status, the Company must not
be deemed to be closely held and must have more than 100 shareholders. The
closely held prohibition requires that not more than 50% of the value of the
Company's outstanding shares be owned by five or fewer persons at anytime during
the last half of the Company's taxable year. The more than 100 shareholders rule
requires that the Company have at least 100 shareholders for 335 days of a
twelve-month taxable year. In the event that the Company failed to satisfy the
ownership requirements the Company would be subject to fines and required taking
curative action to meet the ownership requirements in order to maintain its REIT
status.
For federal income tax purposes, the Company is required to recognize
income on an accrual basis and to make distributions to its shareholders when
income is recognized. Accordingly, it is possible that income could be
recognized and distributions required to be made in advance of the actual
receipt of such funds by the Company. The nature of the Company's investments,
coupled with its tax loss carry-forwards, is such that the Company expects to
have sufficient assets to meet federal income tax distribution requirements.
Taxation of Distributions by the Company
Assuming that the Company maintains its status as a REIT, any
distributions that are properly designated as "capital gain dividends" will
generally be taxed to shareholders as long-term capital gains, regardless of how
long a shareholder has owned his shares. Any other distributions out of the
Company's current or accumulated earnings and profits will be dividends taxable
as ordinary income. Distributions in excess of the Company's current or
accumulated earnings and profits will be treated as tax-free returns of capital,
to the extent of the shareholder's basis in his shares and, as gain from the
disposition of shares, to the extent they exceed such basis. Shareholders may
not include on their own tax returns any of the Company's ordinary or capital
losses. Distributions to shareholders attributable to "excess inclusion income"'
of the Company will be characterized as excess inclusion income in the hands of
the shareholders. Excess inclusion income can arise from the Company's holdings
of residual interests in real estate mortgage investment conduits and in certain
other types of mortgage-backed security structures created after 1991. Excess
inclusion income constitutes unrelated business taxable income ("UBTI") for
tax-exempt entities (including employee benefit plans and individual retirement
accounts) and it may not be offset by current deductions or net operating loss
carryovers. In the event that the Company's excess inclusion income is greater
than its taxable income, the Company's distribution requirement would be based
on the Company's excess inclusion income. Dividends paid by the Company to
organizations that generally are exempt from federal income tax under Section
501(a) of the Code should not be taxable to them as UBTI except to the extent
that (i) purchase of shares of the Company was financed by "acquisition
indebtedness" or (ii) such dividends constitute excess inclusion income. In
2002, the Company paid a dividend on its preferred stocks equal to approximately
$1.2 million, representing the Company's excess inclusion income in 2001. The
Company estimates that excess inclusion income for 2002 was $1.4 million.
Taxable Income
The Company uses the calendar year for both tax and financial reporting
purposes. However, there may be differences between taxable income and income
computed in accordance with Generally Accepted Accounting Principles ("GAAP").
These differences primarily arise from timing differences in the recognition of
revenue and expense for tax and GAAP purposes. The principal difference relates
to reserves for loan losses and other-than-temporary impairment charges provided
for GAAP purposes, which are not deductible for tax purposes, versus actual
charge-offs on loans, which are deductible for tax purposes as ordinary losses.
The Company's estimated taxable income for 2002, excluding net operating losses
carried forward from prior years, was $5.5 million, comprised entirely of
ordinary income. Such amounts were fully offset by loss carry-forwards of a
similar amount.
REGULATION
The Company's existing consumer-related servicing activities consist of
collections on the delinquent property tax receivables. The Company believes
that such servicing operations are managed in compliance with the Fair Debt
Collections Practices Act.
The Company believes that it is in material compliance with all
material rules and regulations to which it is subject.
COMPETITION
The Company may compete with a number of institutions with greater
financial resources. In purchasing portfolio investments and in issuing
securities, the Company competes with investment banking firms, savings and loan
associations, commercial banks, mortgage bankers, insurance companies and
federal agencies and other entities purchasing investments and issuing
securities, many of which have greater financial resources and a lower cost of
capital than the Company.
EMPLOYEES
As of December 31, 2002, the Company had 81 employees.
Item 2. Properties
The Company's executive and administrative offices and operations
offices are both located in Glen Allen, Virginia, on properties leased by the
Company which consist of 11,194 square feet. The address is 4551 Cox Road, Suite
300, Glen Allen, Virginia 23060. The lease expires in 2005. The Company also
occupies space located in Cleveland, Ohio, and the Pittsburgh, Pennsylvania
metropolitan area. These locations consist of approximately 16,384 square feet,
and the leases associated with these properties expire in 2003 and 2007.
Item 3. 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"),
the appellate court of the state of Pennsylvania. Plaintiffs were two local
businesses seeking status to represent as a class, delinquent taxpayers in
Allegheny County whose delinquent tax liens had been assigned to GLS. 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, and whether the County had the right to assign the delinquent property
tax receivables to GLS and therefore employ procedures for collection enjoyed by
Allegheny County under state statute.. This lawsuit was related to the purchase
by GLS of delinquent property tax receivables from Allegheny County in 1997,
1998, and 1999. In July 2001, the Commonwealth Court issued a ruling that
addressed, among other things, (i) the right of GLS to charge to the delinquent
taxpayer a rate of interest of 12% per annum versus 10% per annum on the
collection of its delinquent property tax receivables, (ii) the charging of a
full month's interest on a partial month's delinquency; (iii) the charging of
attorney's fees to the delinquent taxpayer for the collection of such tax
receivables, and (iv) the charging to the delinquent taxpayer of certain other
fees and costs. The Commonwealth Court in its opinion remanded for further
consideration to the lower trial court items (i), (ii) and (iv) above, 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. The
Commonwealth Court further ruled that Allegheny County could assign its rights
in the delinquent property tax receivables to GLS, and that plaintiffs could
maintain equitable class in the action. In October 2001, GLS, along with
Allegheny County, filed an Application for Extraordinary Jurisdiction with the
Supreme Court of Pennsylvania, Western District appealing certain aspects of the
Commonwealth Court's ruling. In March 2003, the Supreme Court issued its opinion
as follows: (i) the Supreme Court determined that GLS can charge delinquent
taxpayers a rate of 12% per annum; (ii) the Supreme Court remanded back to the
lower trial court the charging of a full month's interest on a partial month's
delinquency; (iii) the Supreme Court revised the Commonwealth Court's ruling
regarding recouping attorney fees for collection of the receivables indicating
that the recoupment of fees requires a judicial review of collection procedures
used in each case; and (iv) the Supreme Court upheld the Commonwealth Court's
ruling that GLS can charge certain fees and costs, while remanding back to the
lower trial court for consideration the facts of each individual case. Finally,
the Supreme Court remanded to the lower trial court to determine if the
remaining claims can be resolved as a class action. No hearing date has been set
for the issues remanded back to the lower trial court.
The Company and Dynex Commercial, Inc. ("DCI"), formerly an affiliate
of the Company, are defendants in state court in Dallas County, Texas in the
matter of Basic Capital Management et al ("BCM") versus Dynex Commercial, Inc.
et al. The suit was filed in April 1999 originally against DCI, and in March
2000, BCM amended the complaint and added the Company. The current complaint
alleges that, among other things, DCI and the Company failed to fund tenant
improvement or other advances allegedly required on various loans made by DCI to
BCM, which loans were subsequently acquired by the Company; that DCI breached an
alleged $160 million "master" loan commitment entered into in February 1998 and
a second alleged loan commitment of approximately $9 million; that DCI and the
Company made negligent misrepresentations in connection with the alleged $160
million commitment; and that DCI and the Company fraudulently induced BCM into
canceling the alleged $160 million master loan commitment in January 1999.
Plaintiff BCM is seeking damages approximating $40 million, including
approximately $36.5 million for DCI's breach of the alleged $160 million master
loan commitment, approximately $1.6 million for alleged failure to make
additional tenant improvement advances, and approximately $1.9 million for DCI's
not funding the alleged $9 million commitment. DCI and the Company are
vigorously defending the claims on several grounds. The Company was not a party
to the alleged $160 million master commitment or the alleged $9 million
commitment. The Company has filed a counterclaim for damages approximating $11
million against BCM. Commencement of the trial of the case in Dallas, Texas is
anticipated in September 2003.
In November 2002, the Company received notice of a Second Amended
Complaint filed in the First Judicial District, Jefferson County, Mississippi in
the matter of Barbara Buie and Elizabeth Thompson versus East Automotive Group,
World Rental Car Sale of Mississippi, AutoBond Acceptance Corporation, Dynex
Capital, Inc. and John Does # 1-5. The Second Amended Complaint represents a
re-filing of the First Amended Complaint against the Company, which was
dismissed by the Court without prejudice in August 2001. The Second Amended
Complaint in reference to the Company alleges that Plaintiffs were the
beneficiaries of a contract entered into between AutoBond Acceptance Corporation
and the Company, and alleges that the Company breached such contract and that
such breach caused them to suffer economic loss. The Plaintiffs are seeking
compensatory damages of $1 million and punitive damages of $1 million.
Defendants East Automotive Group and World Rental Car Sale of Mississippi have
also filed cross complaints against the Company. In February 2003, both the
Second Amended Complaint and the cross complaint were dismissed with prejudice
by the Mississippi Court.
Although no assurance can be given with respect to the ultimate outcome
of the above litigation, the Company believes the resolution of these lawsuits,
or any other claims against the Company, will not have a material effect on the
Company's consolidated balance sheet, but could materially affect consolidated
results of operations in a given year.
Item 4. Submission Of Matters To A Vote Of Security Holders
None.
PART II
Item 5. Market For Registrant's Common Equity And Related Stockholder Matters
Dynex Capital, Inc.'s common stock is traded on the New York Stock
Exchange under the trading symbol DX. The common stock was held by approximately
3,662 holders of record as of February 28, 2003. During the last two years, the
high and low closing stock prices and cash dividends declared on common stock,
adjusted for the two-for-one stock split effective May 5, 1997 and the
one-for-four reverse stock split effective August 2, 1999, were as follows:
- -------------------------- ----------------------- ------------------------ -----------------------
Cash Dividends
High Low Declared
- -------------------------- ----------------------- ------------------------ -----------------------
2002:
First quarter $ 3.92 $ 2.02 $ -
Second quarter 5.40 3.30 -
Third quarter 5.20 3.91 -
Fourth quarter 4.84 4.06 -
2001:
First quarter $ 1.30 $ 0.64 $ -
Second quarter 2.45 0.89 -
Third quarter 2.48 1.91 -
Fourth quarter 2.45 1.86 -
- -------------------------- ----------------------- ------------------------ -----------------------
Dividends-in-arrears for the preferred stock must be fully paid before
dividends can be paid on common stock. Dividends-in-arrears on preferred stock
were $31.2 million at December 31, 2002.
Item 6. Selected Financial Data
- --------------------------------------------------------------------------------------------------------------------
Years ended December 31, 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------
(amounts in thousands except share data)
Net interest margin $ 15,186 $ 28,410 $ 2,377 $ 54,609 $ 72,774
Net loss on sales, impairment charges and (18,299) (20,954) (84,039) (107,470) (26,582)
litigation (2)
Equity in net loss of Dynex Holding, Inc. (3) - - (1,061) (19,927) (19,923)
Other income (expense) 848 104 (428) 1,673 2,852
General and administrative expenses (9,493) (10,526) (8,712) (7,740) (8,973)
Extraordinary item - gain (loss) on 221 2,972 - (1,517) (571)
extinguishment of debt
- --------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (14,844) $ (3,085) $ (91,863) $ (75,135) $ 19,577
- --------------------------------------------------------------------------------------------------------------------
Net (loss) income applicable to common $ (24,430) $ 4,632 $(104,774) $ (88,045) $ 6,558
shareholders
- --------------------------------------------------------------------------------------------------------------------
Total revenue $ 171,953 $ 222,864 $ 291,160 $ 345,625 $ 410,821
- --------------------------------------------------------------------------------------------------------------------
Total expenses $ 186,797 $ 228,921 $ 383,023 $ 423,420 $ 390,673
- --------------------------------------------------------------------------------------------------------------------
(Loss) income per common share before extraordinary item:
Basic & diluted(1) $ (2.27) $ 0.15 $ (9.15) $ (7.53) $ 0.62
Net (loss) income per common share:
Basic & diluted (1) $ (2.25) $ 0.41 $ (9.15) $ (7.67) $ 0.57
Dividends declared per share:
Common (1) $ - $ - $ - $ - $ 3.40
Series A Preferred 0.2925 0.2925 - 1.17 2.37
Series B Preferred 0.2925 0.2925 - 1.17 2.37
Series C Preferred 0.3651 0.3649 - 1.46 2.92
- --------------------------------------------------------------------------------------------------------------------
December 31, 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------
Investments $2,218,315 $2,549,579 $3,193,234 $4,136,563 $4,971,607
Total assets 2,238,304 2,569,859 3,239,921 4,217,723 5,193,790
Non-recourse debt 2,013,271 2,264,213 2,856,728 3,282,378 3,665,316
Recourse debt - 58,134 134,168 537,098 1,032,733
Total liabilities 2,014,883 2,327,749 3,002,465 3,867,444 4,726,044
Shareholders' equity 223,421 242,110 237,456 350,277 467,747
Number of common shares outstanding 10,873,903 10,873,853 11,446,206 11,444,099 46,027,426
Average number of common shares (1) 10,873,871 11,430,471 11,445,236 11,483,977 11,436,599
Book value per common share (1) $ 8.57 $ 11.06 $ 7.39 $ 18.38 $ 28.77
- --------------------------------------------------------------------------------------------------------------------
(1) Adjusted for two-for-one common stock split effective May 5, 1997 and the
one-for-four reverse common stock split effective August 2, 1999, and are
inclusive of the liquidation preference on the Company's preferred stock.
(2) Net loss on sale, write-downs, impairment charges and litigation for the
year ended December 31, 2000 and 1999 include several adjustments related
largely to non-recurring items. See Footnote 14 to the consolidated
financial statements included in the Annual Report on Form 10-K, as
amended, for the year ended December 31, 2001.
(3) Dynex Holding, Inc. was liquidated at the end of 2000.
Item 7. Management's Discussion And Analysis Of Financial Condition And
Results Of Operations
The Company is a financial services company, which invests in loans and
securities consisting of or secured by, principally single family mortgage
loans, commercial mortgage loans, manufactured housing installment loans and
delinquent property tax receivables. The loans and securities in which the
Company invests have generally been pooled and pledged (i.e. securitized) as
collateral for non-recourse bonds ("collateralized bonds"), which provides
long-term financing for such loans while limiting credit, interest rate and
liquidity risk.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the Company's financial condition and
results of operations are based in large part upon its consolidated financial
statements, which have been prepared in conformity with accounting principles
generally accepted in the United States of America. The preparation of the
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. Actual
results could differ from those estimates.
Critical accounting policies are defined as those that are reflective
of significant judgements or uncertainties, and which may result in materially
different results under different assumptions and conditions, or the application
of which may have a material impact on the Company's financial statements. The
following are the Company's critical accounting policies, summarized from
Footnote 2 to the consolidated financial statements.
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 securities within collateral for collateralized
bonds is determined by calculating the present value of the projected net cash
flows of the instruments, using discount rates, prepayment rate assumptions and
credit loss assumptions established by management. The discount rate used in the
determination of fair value of the collateral for collateralized bonds was 16%
at December 31, 2002 and 2001. The Company utilizes a discount rate of 16% in
determining the fair value of its financial instruments when the Company's
ownership interest in such financial instrument is generally represented by
interests rated `BBB' or below, and generally concentrated in the
overcollateralization or residual interest components. Prepayment rate
assumptions at December 31, 2002 and 2001 were generally at a "constant
prepayment rate," or CPR, ranging from 30%-45% for 2002, and 40%-60% for 2001,
for collateral for collateralized bonds consisting of securities backed by
single-family mortgage loans, and a CPR equivalent of 11% for 2002 and 10% for
2001, for collateral for collateralized bonds consisting of securities backed by
manufactured housing loans CPR assumptions for each year are based in part on
the actual prepayment rates experienced for the prior six-month period and in
part on management's estimate of future prepayment activity. The loss
assumptions utilized vary for each series of collateral for collateralized
bonds, depending on the collateral pledged. The cash flows for the collateral
for collateralized bonds were projected to the estimated date that the
collateralized bond security could be called and retired by the Company if there
is economic value to the Company in calling and retiring the collateralized bond
security. Such call date is typically triggered on the earlier of a specified
date or when the remaining collateralized bond security balance equals 35% of
the original balance (the "Call Date"). The Company estimates anticipated market
prices of the underlying collateral at the Call Date.
The Company estimated the fair value of certain other investments as
the present value of expected future cash flows, less costs to service such
investments, discounted at a rate of 12%. The Company utilizes a discount rate
of 12% in determining fair value of its financial instruments when the Company's
ownership interest in such financial instrument includes a combination of
investment grade and non-investment grade classes, on an actual rating or an
implied rating basis.
Allowance for Losses. The Company has credit risk on loans pledged as
collateral for collateralized bonds in its investment portfolio. An allowance
for losses has been estimated and established for current expected losses based
on certain performance factors associated with the collateral, including current
loan delinquencies, historical cure rates of delinquent loans, and historical
and anticipated loss severity of the loans as they are liquidated. The allowance
for losses is evaluated and adjusted periodically by management based on the
actual and projected timing and amount of probable credit losses, using the
above factors, as well as industry loss experience. Where loans are considered
homogeneous, the allowance for losses are established and evaluated on a pool
basis. Otherwise, the allowance for losses is established and evaluated on a
loan-specific basis. Provisions made to increase the allowance related to credit
risk are presented as provision for losses in the accompanying consolidated
statements of operations. The Company's actual credit losses may differ from
those estimates used to establish the allowance.
FINANCIAL CONDITION
Below is a discussion of the Company's financial condition.
- ------------------------------------------------------------------------------
(amounts in thousands except per share data) December 31,
2002 2001
- ----------------------------------------------------------- ------------------
Investments:
Collateral for collateralized bonds $2,148,497 $2,473,203
Other investments 54,322 63,553
Securities 6,208 9,037
Loans 9,288 3,786
Non-recourse debt - collateralized bonds 2,013,271 2,264,213
Recourse debt - 58,134
Shareholders' equity 223,421 242,110
Book value per common share (inclusive
of preferred stock liquidation preference) $8.57 $11.06
- ----------------------------------------------------------- ------------------
Collateral for Collateralized Bonds
Collateral for collateralized bonds includes loans and securities
consisting or, or secured by adjustable-rate and fixed-rate mortgage loans
secured by first liens on single family properties, fixed-rate loans secured by
first liens on multifamily and commercial properties, and manufactured housing
installment loans secured by either a UCC filing or a motor vehicle title.
Collateral for collateralized bonds in 2001 also included delinquent property
tax receivables. As of December 31, 2002, the Company had 22 series of
collateralized bonds outstanding. The collateral for collateralized bonds
decreased to $2.15 billion at December 31, 2002 compared to $2.47 billion at
December 31, 2001. This decrease of $325 million is primarily the result of $420
million in paydowns on the collateral, $29 million of increased provisions for
losses on collateral, $16 million of impairment losses on securities,
amortization of premiums and discounts of $6 million and market value
adjustments of $3 million offset by the addition of $147 million of new
collateral.
Other Investments
Other investments at December 31, 2002 and 2001 consist primarily of
delinquent property tax receivables and subsequent real estate owned. Other
investments decreased to $54.3 million at December 31, 2002 compared to $63.6
million at December 31, 2001. This decrease of $9.3 million resulted from
payments of $14.2 million received on delinquent property tax receivables, $2.2
million in sales of related real estate owned and $1.1 million of write-downs of
tax certificates and real estate owned. These decreases were partially offset by
$5.4 million amortization of unrealized losses and $2.9 million of additional
costs incurred in the collection of the tax receivables.
Securities
Securities decreased to $6.2 million at December 31, 2002, compared to
$9.0 million at December 31, 2001, primarily as a result of principal payments
of $6.0 million during the year, the call of the underlying pass-through
security resulting in the repayment and write-off of these classes and the
transfer of $2.0 million of derivative securities to SASCO 2002-9 and declines
in fair value of $0.7 million. These decreases were partially offset by the
purchase of two inverse floating securities, a fixed rate security and the call
of a collateralized bond structure amounting to $5.7 million which was
subsequently reclassified to securities.
Loans
Loans increased to $9.3 million at December 31, 2002 from $3.8 million
at December 31, 2001. In connection with the securitization completed in April
2002 as previously discussed, non-performing loans in the amount of $12.6
million were reclassified to loans from collateral for collateralized bonds.
This increase was partially offset by paydowns on the loans of $4.2 million,
impairment write-downs of $2.2 million, and $0.7 million of other net decreases.
Non-recourse Debt
Collateralized bonds issued by the Company are recourse only to the
assets pledged as collateral, and are otherwise non-recourse to the Company.
Collateralized bonds decreased to $2.01 billion at December 31, 2002 from $2.26
billion at December 31, 2001. This decrease was primarily a result of principal
pay-downs of $428.0 million and interest made during the year, from the
principal payments received from the associated collateral for collateralized
bonds and a net decrease of $0.9 million for accrued interest payable. These
decreases were partially offset by a net increase in bonds payable of $172.9
million and amortization of $5.1 million of discount on the collateralized
bonds.
Recourse Debt
During 2002, the Company repaid all of the Company's $57.9 million of
outstanding Senior Notes and a $0.2 million capital lease.
Shareholders' Equity
Shareholders' equity decreased from $242.1 million at December 31, 2001
to $223.4 million at December 31, 2002. This decrease resulted from the net loss
for the year of $14.8 million, a $2.6 million increase in accumulated other
comprehensive loss, and a payment of $1.2 million of preferred stock dividends.
The increase in accumulated other comprehensive loss resulted principally from
the decline in the fair value of debt securities of $3.9 million, and
mark-to-market losses of $4.5 million on interest-rate swap and synthetic
interest-rate swap contracts. These increases in accumulated other comprehensive
loss were offset by the amortization of $5.8 million of accumulated other
comprehensive loss recorded in 2001 as an adjustment to the carrying value of
certain debt securities reclassified from available-for-sale to held-to-maturity
in accordance with SFAS No. 115.
RESULTS OF OPERATIONS
- ----------------------------------------------------------------- ------------------------------------------------------
(amounts in thousands except per share information) For the Year Ended December 31,
------------------------------------------------------
2002 2001 2000
- ----------------------------------------------------------------- ----------------- ------------------ -----------------
Net interest margin before provision for losses $ 43,669 $ 48,082 $ 31,487
Provision for losses (28,483) (19,672) (29,110)
----------------- ------------------ -----------------
Net interest margin 15,186 28,410 2,377
Net (loss) gain on sales, impairment charges, and litigation:
Related to commercial production operations - (680) (50,940)
Related to sales of investments (303) (439) (15,872)
Impairment charges (18,543) (25,315) (22,135)
Litigation - 6,095 5,600
Related to sale of loan production operations - (755) (228)
Other 547 140 (464)
Trading losses (3,307) (3,091) -
Equity in losses of DHI - - (1,061)
General and administrative expenses (9,493) (10,526) (8,712)
Extraordinary item - gain on extinguishment of debt 221 2,972 -
Net loss (14,844) (3,085) (91,863)
Preferred stock (charges) benefit (9,586) 7,717 (12,911)
Net (loss) income applicable to common shareholders $ (24,430) $ 4,632 $ (104,774)
Basic & diluted net (loss) income per common share $ (2.25) $ 0.41 $ (9.15)
Dividends declared per share:
Common - - -
Series A and B Preferred 0.2925 0.2925 -
Series C Preferred 0.3651 0.3649 -
- ----------------------------------------------------------------- ----------------- ------------------ -----------------
2002 Compared to 2001
The increase in net loss during 2002 as compared to 2001 is primarily
the result of an decreases in net interest margin and gains from extinguishment
of debt, partially offset by an decrease in trading losses, general and
administrative expenses and net loss on sales, impairment charges and
litigation. Net income per common share decreased as a result of the increased
in net loss during 2002 and preferred stock charges in 2002 versus preferred
stock benefits in the prior year.
Net interest margin before provision for losses for the year ended
December 31, 2002 decreased to $43.7 million, from $48.1 million for the same
period in 2001. The decrease in net interest margin before provision for losses
of $4.4 million, or 9.1%, was the result of the decline in interest earning
assets, partially offset by an increase in the net interest spread on
interest-earning assets.
The Company provides for losses on its loans where it has retained
credit risk. Provision for losses for loans increased to $28.5 million in 2002,
from $19.7 million in 2001. The increase in provision for losses of $8.8 million
is primarily a result of additions for manufactured housing loans. The
continuing under-performance of these loans prompted the Company to revise its
estimate of losses to include a percentage of all loans with delinquencies
greater than 30 days. This revision, which was instituted during the fourth
quarter of 2002, resulted in an increase in provision for losses of $7.4 million
during the quarter. Loss severity on the manufactured housing loans continued to
remain high during 2002 as a result of the saturation in the market place with
both new and used (repossessed) manufactured housing units. Defaults in 2002 on
manufactured housing loans averaged 4.3%, versus 4.2% in 2001, and loss severity
continued at 77% during the year. "Loss Severity" is the cumulative loss
incurred on a loan, or sub-set of loans, divided by the unpaid principal balance
of such loan(s). While the Company has provided for reserves for losses based on
current delinquencies and loss severities, should these performance trends
continue for a protracted period, or decline further, the Company may need to
increase the provision for losses on loans in future periods above amounts
recorded during 2002.
Net loss on sales, impairment charges, and litigation decreased from an
aggregate net loss of $21.0 million in 2001 to an aggregate net loss of $18.3
million in 2002. Virtually all of the $18.3 million net loss in 2002 was related
to impairment charges. Such impairment charges included other-than-temporary
impairment of debt securities pledged as collateral for collateralized bonds of
$15.6 million for 2002. The impairment charges related to debt securities backed
by manufactured housing loans, which have experienced high default rates and
loss severeties as previously discussed. In addition, the Company incurred
impairment charges in 2002 related to a $2.1 million adjustment to the lower of
cost or market for certain delinquent single-family mortgage loans. Such loans
were included in securities called by the Company, the balances of which were
included in the SASCO Series 2002-9 securitization completed in April 2002.
During 2001, the Company incurred other-than-temporary impairments of debt
securities pledged as collateral for collateralized bonds of $15.8 million, and
recorded additional impairment charges of $7.7 million related to delinquent
property tax receivables and $1.8 million for property tax receivables that have
been foreclosed and represent real estate owned.
In June 2002, the Company entered into a $100 million notional short
position on 5-Year Treasury Notes futures contracts expiring in September 2002.
The Company entered into this position to, in effect, 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. In August 2002, the Company terminated these
contracts at a loss of $3.3 million.
The Company purchased and extinguished $11.7 million of its July 2002
Senior Notes at a net discount of 3% during 2002, resulting in an extraordinary
gain of $0.4 million in the first quarter of 2002.
2001 Compared to 2000
The decrease in net loss during 2001 as compared to 2000 is primarily
the result of an increase in net interest margin, a decrease in net loss on
sales, write-downs, and impairment charges, an increase in gains from
extinguishment of debt, partially offset by an increase in trading losses and
general and administrative expenses. The increase in net income per common share
during 2001 as compared to 2000 is primarily the result of the decrease in net
loss and a preferred stock benefit in 2001 versus preferred stock charges in the
prior year.
Net interest margin before provision for losses for the year ended
December 31, 2001 increased to $48.1 million, from $31.5 million for the same
period in 2000. The increase in net interest margin of $16.6 million, or 53%,
was the result of the reduction in the Company's average cost of funds, which
declined by approximately 0.70%, as a result of the overall decline in interest
rates during 2001 and a reduction in fees related to committed credit
facilities.
The Company provides for losses on its loans and recognizes other than
temporary impairment losses on its debt securities where it has retained credit
risk. Provision for losses for loans decreased to $19.7 million in 2001, from
$29.1 million in 2000 and impairment losses for debt securities increased to
$15.8 million in 2001 from $5.5 million in 2000. Provision for losses and
other-than-temporary impairment losses remained high in 2001 due to the
under-performance of the Company's manufactured housing loan portfolio. Loss
severity on the manufactured housing loans continued to increase during 2001 as
a result of the saturation in the market place with both new and used
(repossessed) manufactured housing units. In addition, the Company saw an
increase in overall default rates on its manufactured housing loans. Defaults in
2001 averaged 4.2% versus 3.4% in 2000, and loss severity increased from 70% to
77% during the year.
Net loss on sales, write-downs and impairment charges decreased from an
aggregate net loss of $84.0 million in 2000 to an aggregate net loss of $21.0
million in 2001. Net loss on sales, impairment charges and write-downs are
largely one-time items. During 2001, the Company settled various litigation for
a net benefit to the Company of $6.1 million. The Company incurred losses in
2001 related principally to impairment charges incurred on its delinquent
property tax lien portfolio. The Company adjusted the carrying value of such
portfolio by $7.7 million due to other-than-temporary valuation adjustments as a
result of the reclassification of this security from available-for-sale to
held-to-maturity, and $1.8 million for adjustments to net realizable value on
property tax liens that have been foreclosed and represent real estate owned.
Impairment charges also include other-than-temporary impairment of debt
securities pledged as collateral for collateralized bonds as discussed above.
The Company also wrote off $0.6 million of receivables related to the sale of
its manufactured housing and model home businesses in 1999.
During 2000, the Company incurred losses related to the phasing-out of
its commercial production operations, including the sales of substantially all
of the Company's remaining commercial and multifamily loan positions. In
addition, the Company recorded a loss of $30.3 million as a result of the
expiration of a Company owned option to purchase $167.8 million of tax-exempt
bonds secured by multifamily mortgage loans that expired in June 2000. The
Company did not exercise this option, as it did not have the ability to finance
this purchase, and the counter-party to the agreement retained $30.3 million in
cash collateral as settlement as provided for in the related agreements. The
Company recorded a charge against earnings of $30.3 million in 2000 as a result.
In 2001, the Company entered into three separate short positions
aggregating $1.3 billion on the June 2001, September 2001, and December 2001
ninety-day Eurodollar Futures Contracts. In addition, the Company entered into
two short positions on the one-month LIBOR futures contract. The Company entered
into these positions to, in effect, lock-in its borrowing costs on a forward
basis relative to its floating-rate liabilities. These instruments failed to
meet the hedge criteria of SFAS No. 133, and were accounted for on a trading
basis. Accordingly, any gains or losses recognized on these contracts were
included in current period results. During 2001, given the continued decline in
one-month LIBOR due to reductions in the targeted Federal Funds Rate, the
Company recognized $3.1 million in losses related to these contracts.
The Company purchased and extinguished $39.3 million of its July 2002
Senior Notes at a net discount of 9.5% during 2001, resulting in an
extraordinary gain of $3.6 million.
In June 2000, the Company settled litigation for a cash payment of $20
million. The Company had been purchasing debt securities from a special purpose
entity (referred to as an "SPE") backed by automobile loans. The Company had
been carrying these debt securities at estimated fair value. As a result of this
settlement in June 2000, the Company received 100% of the outstanding stock of
the SPE which issued the debt securities, and which owned all of the underlying
automobile installment contracts. As such, in June 2000 the Company began
consolidating the SPE on its books (as opposed to previously recording its
investment in the debt securities). The Company recorded an impairment charge in
June 2000 to reflect the initial valuation of the underlying automobile
installment contracts at their current fair market value. At the time of the
settlement, the Company was able to access more information as to the underlying
loans than it previously had when it owned only the debt securities. The Company
had accrued a reserve as of December 31, 1999, for $27 million related to the
litigation, and reversed $5.6 million of this reserve in 2000 as a result of the
settlement. In June 2000, the Company recorded permanent impairment charges of
$16.6 million on as a result of the valuation of the underlying automobile
contracts. During the fourth quarter 2000, the Company completed the sale of
substantially all of the remaining outstanding securities and loans related to
this SPE.
Also during 2000, the Company recorded impairment charges and loss on
sales of securities aggregating $8.5 million, relating to the write-down of
basis and then the sale of $33.9 million of securities. Such securities were
sold in order for the Company to pay-down its recourse debt outstanding. As a
result of the sale of securities, the Company either sold or terminated related
derivative hedge positions at an aggregate net loss of $7.3 million.
Average Balances and Effective Interest Rates
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. Assets that are on non-accrual status are
excluded from the table below for each period presented.
- ------------------------------------------ ------------------------------------------------------------------------
(amounts in thousands) Year ended December 31,
- ------------------------------------------ ------------------------------------------------------------------------
2002 2001 2000
------------------------- --------------------- ------------------------
Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate
- ------------------------------------------ ----------- ----------- ----------- ----------- ----------- ------------
Interest-earning assets (1):
Collateral for collateralized bonds $2,306,122 7.34% $2,827,177 7.61% $3,461,008 7.84%
(2) (3)
Other investments - -% 37,185 14.69% 42,188 13.03%
Securities 4,816 21.31% 8,830 9.60% 55,425 6.49%
Loans 9,706 4.54% 4,068 17.94% 134,673 7.99%
Cash Investments 19,207 1.48% 17,560 4.01% - -
----------- ----------- ----------- ----------- ----------- ------------
Total interest-earning assets $2,340,044 7.30% $2,894,820 7.70% $3,693,294 7.89%
=========== =========== =========== =========== =========== ============
Interest-bearing liabilities:
Non-recourse debt (3) $2,152,440 5.68% $2,568,716 6.41% $3,132,550 7.34%
Recourse debt secured by - - 17,016 6.28% 65,651 7.13%
collateralized bonds retained
----------- ----------- ----------- ----------- ----------- ------------
2,152,440 5.68% 2,585,732 6.40% 3,198,201 7.33%
Other recourse debt - secured (4) 26,112 8.14% 71,174 8.30% 119,939 5.61%
Other recourse debt - unsecured - - - - 101,242 8.54%
----------- ----------- ----------- ----------- ----------- ------------
Total interest-bearing liabilities $2,178,552 5.71% $2,656,906 6.46% $3,419,382 7.35%
=========== =========== =========== =========== =========== ============
Net interest spread (3) 1.59% 1.23% 0.54%
Net yield on average interest-earning
assets (3) 1.99% 1.76% 1.08%
- ------------------------------------------ ----------- ----------- ----------- ----------- ----------- ------------
(1) Average balances exclude adjustments made in accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," to record available for sale securities at
fair value.
(2) Average balances exclude funds held by trustees of $2,590, $507,and $862
for the years ended December 31, 2002, 2001, and 2000, respectively.
(3) Effective rates are calculated excluding non-interest related
collateralized bond expenses and provision for credit losses.
(4) The July 2002 Senior Notes are considered secured for all of 2002 for
purposes of this table.
2002 compared to 2001
The net interest spread for the year ended December 31, 2002 increased
to 1.59% from 1.23% for the year ended December 31, 2001. This increase was
primarily due to the reduction of short-term interest rates during 2001, which
benefited the Company's borrowing costs in 2002. A substantial portion of the
Company's interest-bearing liabilities reprice monthly, and are indexed to
one-month LIBOR, which on average decreased to 1.76% for 2002, versus 3.88% for
2001. The overall yield on interest-earnings assets, decreased to 7.30% for the
year ended December 31, 2002 from 7.70% for the same period in 2001, following
the falling-rate environment, yet lagging relative to the Company's liabilities.
The Company's net interest spread in 2002 also benefited from the repayment of
all remaining recourse debt outstanding.
2001 compared to 2000
The net interest spread for the year ended December 31, 2001 increased
to 1.23% from 0.54% for the year ended December 31, 2000. This increase was
primarily due to the reduction of short-term interest rates during 2001. A
substantial portion of the Company's interest-bearing liabilities reprice
monthly, and are indexed to one-month LIBOR, which on average decreased to 3.88%
for 2001, versus 6.41% for 2000. This decrease in one-month LIBOR accounts for a
substantial portion of the overall decrease in the cost of interest-bearing
liabilities. The overall yield on interest-earnings assets, decreased to 7.70%
for the year ended December 31, 2001 from 7.89% for the same period in 2000,
following the falling-rate environment, yet lagging relative to the Company's
liabilities.
The following tables summarize the amount of change in interest income
and interest expense due to changes in interest rates versus changes in volume:
- --------------------------------------------------------------------------------------------------------------------
2002 to 2001 2001 to 2000
- --------------------------------------------------------------------------------------------------------------------
Rate Volume Total Rate Volume Total
- --------------------------------------------------------------------------------------------------------------------
Collateral for $ (7,333) $ (38,459) $ (45,792) $ (8,028) $ (48,417) $ (56,445)
collateralized bonds
Other investments (3,500) (2,475) (5,975) (633) 1,461 828
Securities 691 (513) 178 1,199 (3,946) (2,747)
Loans (810) 521 (289) 6,096 (16,132) (10,036)
- --------------------------------------------------------------------------------------------------------------------
Total interest income (10,952) (40,926) (51,878) (1,366) (67,034) (68,400)
- --------------------------------------------------------------------------------------------------------------------
Non-recourse debt (17,564) (24,909) (42,473) (26,842) (38,311) (65,153)
Recourse debt (682) (4,144) (4,826) (1,120) (13,470) (14,590)
- --------------------------------------------------------------------------------------------------------------------
Total interest expense (18,246) (29,053) (47,299) (27,962) (51,781) (79,743)
- --------------------------------------------------------------------------------------------------------------------
Net margin on portfolio $ 7,294 $ (11,873) $ (4,579) $ 26,596 $ (15,253) $ 11,343
- --------------------------------------------------------------------------------------------------------------------
Note:The change in interest income and interest expense due to changes in both
volume and rate, which cannot be segregated, has been allocated
proportionately to the change due to volume and the change due to rate.
This table excludes non-interest related collateralized bond expense, other
interest expense and provision for credit losses.
Interest Income and Interest-Earning Assets
Approximately $1.6 billion of the investment portfolio as of December
31, 2002, or 76%, is comprised of loans or securities that pay a fixed-rate of
interest. Also at December 31, 2002, approximately $515 million, or 24%, 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 adjustable-rate
mortgage (ARM) loans underlying the collateral for collateralized bonds are
indexed to and reset based upon the level of six-month LIBOR; approximately 14%
are indexed to and reset based upon the level of the one-year Constant Maturity
Treasury (CMT) index. The following table presents a breakdown, by principal
balance, of the Company's collateral for collateralized bonds and ARM and fixed
mortgage securities by type of underlying loan as of December 31, 2002, December
31, 2001 and December 31, 2000. The percentage of fixed-rate loans to all loans
increased from 72% at December 31, 2001, to 76% at December 31, 2002, as most of
the prepayments in the Company's investment portfolio have occurred in the
single-family ARM portion. The table below excludes various investments in the
Company's portfolio, including securities such as derivative and residual
securities and other securities, and non-securitized investments including other
investments and loans. Most of these excluded investments would be considered
fixed-rate, and amounted to approximately $69.0 million at December 31, 2002.
Investment Portfolio Composition (1)
($ in millions)
- ------------------ ------------------ -------------------- --------------------- --------------- ---------------
Other Indices Based
LIBOR Based ARM CMT Based ARM Loans ARM Loans Fixed-Rate
December 31, Loans Loans Total
- ------------------ ------------------ -------------------- --------------------- --------------- ---------------
2000 $758.6 $309.9 $97.4 $1,926.3 $3,092.2
2001 $472.4 $144.6 $73.6 $1,765.8 $2,456.4
2002 $384.6 $73.2 $57.0 $1,647.0 $2,161.8
- ------------------ ------------------ -------------------- --------------------- --------------- ---------------
(1) Includes only the principal amount of collateral for collateralized
bonds, ARM securities and fixed securities.
The average asset yield is reduced for the amortization of premiums,
net of discounts on the investment portfolio. As indicated in the table below,
premiums, net of discounts on the collateral for collateralized bonds and
securities at December 31, 2002 were $16.2 million, or approximately 0.75% of
the aggregate balance of the related investments. Approximately $23.0 million of
this net premium relates to multifamily and commercial mortgage loans, with a
principal balance of $778.6 million at December 31, 2002, and have prepayment
lockouts or yield maintenance provisions generally at least through 2007. The
remaining net discount of $6.8 million relates principally to discounts on
manufactured housing loans and securities. Amortization expense as a percentage
of principal pay-downs increased to 1.45% for the year ended December 31, 2002
from 1.37% in 2001 as the Company experienced higher prepayment activity during
2002 on its securitized single-family loan portfolio which it owns above par,
and higher prepayment activity for manufactured housing loans (generally as a
result of increased defaults) owned at a discount. The principal repayment rate
(indicated in the table below as "CPR Annualized Rate") was 19% for the year
ended December 31, 2002. CPR or "constant prepayment rate" is a measure of the
annual prepayment rate on a pool of loans.
Net Premium Basis and Amortization on Investments
($ in millions)
- -----------------------------------------------------------------------------------------------------
Amortization
Net CPR Annualized Expense as a %
Remaining Amortization Rate Principal of Principal
Premium Expense Paydowns Paydowns
- -----------------------------------------------------------------------------------------------------
2000 $30.1 $8.1 20% $523.0 1.55%
2001 $22.4 $8.2 24% $600.8 1.37%
2002 $16.2 $6.1 19% $417.9 1.45%
- -----------------------------------------------------------------------------------------------------
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 structures. In most instances, the Company
retained the "first-loss" credit risk on pools of loans and securities that it
has securitized.
The following table summarizes the aggregate principal amount of
collateral for collateralized bonds and ARM and fixed-rate mortgage pass-through
securities outstanding; the direct credit exposure retained by the Company
(represented by the amount of over-collateralization pledged and subordinated
securities owned by the Company), net of the credit reserves and discounts
maintained by the Company for such exposure; and the actual credit losses
incurred for each year. For 2001 and 2002, the table includes any subordinated
security retained by the Company, whereas in 2000 the table included only
subordinated securities rated below "BBB" by one of the nationally recognized
rating agencies. The Company's credit exposure, net of credit reserves, has
declined from 2000 as the result of actual credit losses, and for 2002, due to
the call and resecuritization of certain collateral for collateralized bonds in
April 2002. The Company was able to reduce the amount of over-collateralization
pledged when the collateral was resecuritized.
The table excludes other forms of credit enhancement from which the
Company benefits, and based upon the performance of the underlying loans, may
provide additional protection against losses as discussed above in Investment
Portfolio Risks. This table also excludes any risks related to representations
and warranties made on single-family loans funded by the Company and securitized
in mortgage pass-through securities generally funded prior to 1995. This table
also excludes any credit exposure on loans and other investments.
Credit Reserves And Actual Credit Losses
($ in millions)
- ---------------------------------------------------------------------------------------------------------
Credit Exposure, Actual Credit Exposure, Net of
Outstanding Loan Net of Credit Credit Credit Reserves to
Principal Balance Reserves Losses Outstanding Loan Balance
- ---------------------------------------------------------------------------------------------------------
2000 $3,245.3 $186.6 $26.6 5.75%
2001 $2,588.4 $153.5 $32.6 5.93%
2002 $2,246.9 $91.8 $26.7 4.09%
- ---------------------------------------------------------------------------------------------------------
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 structures in which
Dynex has retained a portion of the direct credit risk included in the table
above. The delinquencies as a percentage of the outstanding collateral increased
to 2.71% at December 31, 2002, from 1.78% at December 31, 2001, primarily from
increasing delinquencies in the Company's manufactured housing loan and
commercial mortgage loan portfolios and a declining overall outstanding
collateral balance as a result of prepayments. The Company monitors and
evaluates its exposure to credit losses and has established reserves based upon
anticipated losses, general economic conditions and trends in the investment
portfolio. As of December 31, 2002, management believes the level of credit
reserves is sufficient to cover any losses that may occur as a result of current
delinquencies presented in the table below.
Delinquency Statistics
- -----------------------------------------------------------------------------------------------------
60 to 89 days 90 days and over
December 31, delinquent delinquent (1) Total
- -----------------------------------------------------------------------------------------------------
2000 0.37% 1.59% 1.96%
2001 0.28% 1.50% 1.78%
2002 0.64% 2.07% 2.71%
- -----------------------------------------------------------------------------------------------------
(1) Includes foreclosures, repossessions and REO.
General and Administrative Expense
The following tables present a breakdown of general and administrative
expense by business unit.
- ------------------------ --------------------------- ------------------------
Servicing Corporate/Investment Total
Portfolio Management
- ------------------------ --------------------------- ------------------------
2001 $3,718.1 $6,807.8 $10,525.9
2002 $4,274.0 $5,218.7 $ 9,492.7
- ------------------------ --------------------------- ------------------------
General and administrative expense decreased $1.0 million from $10.5
million in 2001 to $9.5 million in 2002. General and administrative expenses for
servicing has increased as the Company has increased staffing in connection with
collection of delinquent property tax receivables, while Corporate/Investment
Portfolio Management expenses have declined as a result of reductions in staff
and declining litigation expenses. Litigation expenses incurred in 2002 amount
to $1.4 million versus $2.7 million in 2001.
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 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 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
has not yet assessed the impact of this statement on its financial position or
results of operations.
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 does not believe the adoption of SFAS No. 146
will have a significant impact on the financial position, results of operations
or cash flows of the Company.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions," which amends SFAS No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets," and FASB Interpretation No. 9,
"Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a
Similar Institution is Acquired in a Business Combination Accounted for by the
Purchase Method." With the exception of transactions between two or more mutual
enterprises, this Statement removes acquisitions of financial institutions from
the scope of both SFAS No. 72 and Interpretation 9 and requires that those
transactions be accounted for in accordance with SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." In
addition, the carrying amount of an unidentifiable intangible asset shall
continue to be amortized as required in SFAS No. 72, unless the transaction to
which that asset arose was a business combination. In that case, the carrying
amount of that asset is to be reclassified to goodwill as of the later of the
date of acquisition or the date SFAS No. 142 is applied in its entirety. Thus,
those intangible assets are subject to the same undiscounted cash flow
recoverability test and impairment loss recognition and measurement provisions
that SFAS No. 144 requires for other long-lived assets that are held and used.
Also, this Statement amends SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions. The effective
date for this provision is on October 1, 2002, with earlier application
permitted. The adoption of SFAS No. 147 has not had an impact on the financial
position, results of operations, or cash flows of the Company.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure." Effective after December
15, 2003, this Statement amends FASB Statement No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of Statement 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
Company has not yet assessed the impact of this statement on its financial
position or results of operations.
On November 25, 2002, the FASB issued FASB Interpretation ("FIN") No.
45, "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, an interpretation of
FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34."
FIN No. 45 clarifies the requirements of FASB Statement No. 5, "Accounting for
Contingencies," relating to the guarantor's accounting for, and disclosure of,
the issuance of certain types of guarantees. The disclosure requirements of FIN
No. 45 are effective for financial statements of interim or annual periods that
end after December 15, 2002. The disclosure provisions have been implemented and
no disclosures were required at year-end 2002. The provisions for initial
recognition and measurement are effective on a prospective basis for guarantees
that are issued or modified after December 31, 2002, irrespective of the
guarantor's year-end. FIN No. 45 requires that upon issuance of a guarantee, the
entity must recognize a liability for the fair value of the obligation it
assumes under that guarantee. The Company's adoption of FIN 45 in 2003 has not
and is not expected to have a material effect on the Company's results of
operations, cash flows or financial position.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities - an interpretation of ARB No. 51," which addresses
consolidation of variable interest entities. FIN No. 46 expands the criteria for
consideration in determining whether a variable interest entity should be
consolidated by a business entity, and requires existing unconsolidated variable
interest entities (which include, but are not limited to, Special Purpose
Entities, or SPEs) to be consolidated by their primary beneficiaries if the
entities do not effectively disperse risks among parties involved. This
interpretation applies immediately to variable interest entities created after
January 31, 2003, and to variable interest entities in which an enterprise
obtains an interest after that date. It applies in the first fiscal year or
interim period beginning after June 15, 2003, to variable interest entities in
which an enterprise holds a variable interest that it acquired before February
1, 2003. The adoption of FIN No. 46 is not expected to have a material effect on
the Company's results of operations, cash flows or financial position.
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 actively originating loans for its
investment portfolio, the Company funded these operations through 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 its July
2002 Senior Notes, the Company has 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. 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.
The Company's cash flow from its investment portfolio for the year and
quarter ended December 31, 2002 was approximately $76 million and $13 million,
respectively. Such cash flow is after payment of principal and interest on the
associated collateralized bonds (i.e., non-recourse debt) outstanding. From the
cash flow on its investment portfolio, the Company funds its operating overhead
costs, including the servicing of its delinquent property tax receivables, and
repays any remaining recourse debt. Excluding any cash flow derived from the
sale or re-securitization of assets, and assuming that short-term interest rates
remain stable, the Company anticipates that the cash flow from its investment
portfolio will decline in 2003 versus 2002 as the investment portfolio continues
to pay down. The Company anticipates, however, that it will have sufficient cash
flow from its investment portfolio to meet all of its obligations on both a
short-term and long-term basis.
In February 2003, the Company completed a partial tender offer for
shares of its Series A, Series B and Series C Preferred Stock. The Company
purchased for cash 188,940 shares of its Series A Preferred Stock, 272,977
shares of its Series B Preferred Stock and 268,792 shares of its Series C
Preferred Stock for a total cash payment of $19.3 million. In addition, the
Company exchanged 9.50% Senior Notes totaling $32.1 million, due February 28,
2005, for an additional 309,503 shares of Series A Preferred Stock, 417,541
shares of Series B Preferred Stock and 429,847 shares of Series C Preferred
Stock. The Company utilized cash flow generated from its investment portfolio to
fund the cash portion of the tender offer.
Recourse Debt
During 2002, the Company repaid all of its remaining outstanding
recourse debt. The table below sets forth the recourse debt and recourse debt to
equity ratio of the Company as of December 31, 2002, 2001, and 2000.
Total Recourse Debt
($ in millions)
- --------------------------------------------------------------------------------
Total Recourse Debt, Total Recourse
December 31, Net of Issuance Costs Debt to Equity Ratio
- --------------------------------------------------------------------------------
2000 $134.2 85%
2001 58.1 34%
2002 - -%
- -------------------------------------------------------------------------------
As a result of the amendment to the indenture governing the Senior
Notes entered into in March 2001 and a settlement agreement entered into in
October 2001 by and between the Company and ACA Financial Guaranty Corporation
(ACA) as a result of an action which ACA brought against the Company in the
United States District Court for the Southern District of New York (the
amendment to the indenture and the settlement agreement, collectively the
"Senior Note Agreements"), the Company was required to call and re-securitize
certain of its existing collateralized bond and securities for which it owned
the call rights by April 30, 2002, and if such re-securitization was not
completed, to sell certain other securities. If the Company had failed to close
the re-securitization by April 30, 2002 and sell certain securities by May 31,
2002, ACA had the right, at its option, to cause the sale of certain securities
owned by the Company pursuant to a durable power of attorney granted to it by
the Company. As the Company met all such obligations, ACA was prevented from
acting upon the durable power of attorney. The durable power of attorney
terminated in July 2002.
In February 2003, in connection with a tender offer on the Company's
preferred stock, the Company issued the February 2005 Notes in the amount of
$32.1 million. The February 2005 Notes bear interest at a rate of 9.50%, and are
payable in quarterly installments until their final maturity of February 28,
2005.
Non-recourse Debt
The Company, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds to fund the majority of
its investment portfolio. The obligations under the collateralized bonds are
payable solely from the collateral for collateralized bonds and are otherwise
non-recourse to the Company. Collateral for collateralized bonds is not subject
to margin calls. The maturity of each class of collateralized bonds is directly
affected by the rate of principal prepayments on the related collateral. Each
series is also subject to redemption according to specific terms of the
respective indentures, generally when the remaining balance of the bonds equals
35% or less of the original principal balance of the bonds. At December 31,
2002, the Company had $2.0 billion of collateralized bonds outstanding.
Summary of Selected Quarterly Results (unaudited)
(amounts in thousands except share data)
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
First Second Quarter Third Quarter Fourth Quarter
Year ended December 31, 2002 Quarter
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
Operating results:
Total revenues $ 42,940 $ 44,968 $ 42,321 $ 40,655
Net interest margin 3,857 7,013 5,432 (1,116)
Income (loss) before extraordinary items 104 937 (3,254) (12,852)
Net income (loss) 481 398 (2,862) (12,861)
Basic & diluted loss per common share before
extraordinary item (0.21) (0.13) (0.52) (1.40)
Basic & diluted loss per common share (0.18) (0.18) (0.48) (1.40)
Cash dividends declared per common share - - - -
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
Average interest-earning assets 2,385,865 2,437,214 2,316,094 2,221,003
Average borrowed funds 2,243,081 2,280,447 2,145,200 2,045,480
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
Net interest spread on interest-earning assets 1.42% 1.76% 1.57% 1.62%
Average asset yield 7.20% 7.38% 7.29% 7.34%
Net yield on average interest-earning assets (1) 1.77% 2.12% 1.99% 2.07%
Cost of funds 5.96% 5.74% 5.87% 5.78%
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
First Second Quarter Third Quarter Fourth Quarter
Year ended December 31, 2001 Quarter
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
Operating results:
Total revenues $ 63,505 $ 58,487 $ 52,395 $ 48,373
Net interest margin 5,624 8,194 1,231 13,361
Income (loss) before extraordinary items 9,378 2,199 (3,254) (11,161)
Net income (loss) 11,650 2,772 (7,483) (10,024)
Basic & diluted income (loss) per common share
before extraordinary item 0.54 1.11 (0.81) (0.69)
Basic and diluted net income (loss) per common share 0.74 1.16 (0.90) (0.59)
Cash dividends declared per common share - - - -
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
Average interest-earning assets 3,168,001 2,976,415 2,778,377 2,634,014
Average borrowed funds 2,911,595 2,731,636 2,595,238 2,389,154
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
Net interest spread on interest-earning assets 0.87% 1.34% 1.39% 1.50%
Average asset yield 8.03% 7.85% 7.54% 7.35%
Net yield on average interest-earning assets (1) 1.45% 1.84% 1.80% 2.05%
Cost of funds 7.29% 6.66% 6.25% 5.95%
- ----------------------------------------------------- --------------- --------------- ---------------- ---------------
(1) Computed as net interest margin excluding non-interest collateralized bond
expenses
Changes in quarterly average interest earning assets from those
previously reported in each respective Quarterly Report on Form 10-Q, result
primarily from the exclusion from the average interest earning assets of
non-accrual assets.
The Company purchased and extinguished $11.7 million of its July 2002
Senior Notes at a net discount of 3% during 2002, resulting in an extraordinary
gain of $0.4 million. This was partially offset by a net extraordinary loss of
$0.2 million associated with the extinguishment of debt for several securities.
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-K made by the Company, that
are not historical fact, constitute "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Such forward-looking
statements may involve factors that could cause the actual results of the
Company to differ materially from historical results or from any results
expressed or implied by such forward-looking statements. The Company cautions
the public not to place undue reliance on forward-looking statements, which may
be based on assumptions and anticipated events that do not materialize. The
Company does not undertake, and the Securities Litigation Reform Act
specifically relieves the Company from, any obligation to update any
forward-looking statements.
Factors that may cause actual results to differ from historical results
or from any results expressed or implied by forward-looking statements include
the following:
Economic Conditions. The Company is affected by general economic
conditions. The risk of defaults and credit losses could increase during an
economic slowdown or recession. This could have an adverse effect on the
Company's financial performance and the performance on the Company's securitized
loan pools.
Capital Resources. 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 $254 million of which is variable rate. In addition, a
significant amount of the investments held by the Company is adjustable-rate
collateral for collateralized bonds. These investments are financed through
non-recourse long-term collateralized bonds. The net interest spread for these
investments could decrease during a period of rapidly rising short-term interest
rates, since the investments generally have interest rates which reset on a
delayed basis and have periodic interest rate caps; the related borrowing have
no delayed resets or such interest rate caps.
Defaults. Defaults by borrowers on loans retained by the Company may
have an adverse impact on the Company's financial performance, if actual credit
losses differ materially from estimates made by the Company. The allowance for
losses is calculated on the basis of historical experience and management's best
estimates. Actual default rates or loss severity may differ from the Company's
estimate as a result of economic conditions. In particular, the default rate and
loss severity on the Company's portfolio of manufactured housing loans has been
higher than initially estimated. Actual defaults on ARM loans may increase
during a rising interest rate environment. The Company believes that its
reserves are adequate for such risks on loans that were delinquent as of
December 31, 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. In
addition, third-party servicers are generally obligated to advance scheduled
principal and interest on a loan if such loan is securitized, and to the extent
the third-party servicer fails to make this advance, the Company may be required
to make the advance.
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 continue 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 December 31, 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 7A. Quantitative And Qualitative Disclosures About Market Risk
Market risk generally represents the risk of loss that may result from
the potential change in the value of a financial instrument due to fluctuations
in interest and foreign exchange rates and in equity and commodity prices.
Market risk is inherent to both derivative and non-derivative financial
instruments, and accordingly, the scope of the Company's market risk management
extends beyond derivatives to include all market risk sensitive financial
instruments. As a financial services company, net interest margin comprises the
primary component of the Company's earnings. Additionally, cash flow from the
investment portfolio represents the primary component of the Company's incoming
cash flow. The Company is subject to risk resulting from interest rate
fluctuations to the extent that there is a gap between the amount of the
Company's interest-earning assets and the amount of interest-bearing liabilities
that are prepaid, mature or re-price within specified periods.
The Company monitors the aggregate cash flow, projected net yield and
market value of its investment portfolio under various interest rate and
prepayment assumptions. While certain investments may perform poorly in an
increasing or decreasing interest rate environment, other investments may
perform well, and others may not be impacted at all.
The Company focuses on the sensitivity of its cash flow, and measures
such sensitivity to changes in interest rates. Changes in interest rates are
defined as instantaneous, parallel, and sustained interest rate movements in 100
basis point increments. The Company estimates its net interest margin cash flow
for the next twenty-four months assuming interest rates over such time period
follow the forward LIBOR curve (based on 90-day Eurodollar futures contracts) as
of December 31, 2002. Once the base case has been estimated, cash flows are
projected for each of the defined interest rate scenarios. Those scenario
results are then compared against the base case to determine the estimated
change to cash flow.
The following table summarizes the Company's net interest margin cash
flow sensitivity analysis as of December 31, 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
December 31, 2002. At December 31, 2002, One-month LIBOR and Six-month LIBOR
were both 1.38%. The analysis is heavily dependent upon the assumptions used in
the model. The "Base" case model uses estimates of appropriate prepayment rates
and credit loss assumptions. Prepayment rate assumptions used were generally at
a "constant prepayment rate," or CPR, ranging from 26%-50%, for collateral for
collateralized bonds consisting of single-family mortgage loans and securities,
and a CPR equivalent ranging from 11% - 12% for collateral for collateralized
bonds consisting of manufactured housing loans and securities collateral.
Commercial mortgage loan collateral was generally assumed to repay in accordance
with their contractual terms. The loss assumptions utilized vary for each series
of collateral for collateralized bonds, depending on the collateral pledged.
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 (10.3)%
+100 (5.1)%
Base
-100 6.6%
-200 14.2%
Approximately $515 million of the Company's investment portfolio as of
December 31, 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 14%
of the ARM loans underlying the Company's 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 collateral for collateralized bonds relative to the
rate resets on the associated borrowings and (ii) rate resets on the ARM loans
which are generally limited to 1% every six months or 2% every twelve months and
subject to lifetime caps, while the associated borrowings have no such
limitation. As short-term interest rates stabilize and the ARM loans reset, the
net interest margin may be restored to its former level as the yields on the ARM
loans adjust to market conditions. Conversely, net interest margin may increase
following a fall in short-term interest rates. This increase may be temporary as
the yields on the ARM loans adjust to the new market conditions after a lag
period. In each case, however, the Company expects that the increase or decrease
in the net interest spread due to changes in the short-term interest rates to be
temporary. The net interest spread may also be increased or decreased by the
proceeds or costs of interest rate swap, cap or floor agreements, to the extent
that the Company has entered into such agreements.
The remaining portion of the Company's investment portfolio as of
December 31, 2002, approximately $1.7 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 $1.2 billion as of December
31, 2002, and (ii) equity, which was $223.4 million. Overall, the Company's
interest rate risk is related both to the rate of change in short term interest
rates, and to the level of short-term interest rates.
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. An additional
approximate $67 million of floating-rate liabilities are being converted to a
fixed rate through an amortizing synthetic swap created by the short sale of a
string of Eurodollar futures contract in October, 2002. The synthetic swap has
an estimated duration of 1.5 years. As of December 31, 2002, the
weighted-average fixed rate cost of the synthetic swap to the Company is 2.5%.
Item 8. Financial Statements And Supplementary Data
The consolidated financial statements of the Company and the related
notes, together with the Independent Auditors' Reports thereon are set forth on
pages F-1 through F-28 of this Form 10-K.
Item 9. Changes In And Disagreements With Accountants On Accounting
And Financial Disclosure
None.
PART III
Item 10. Directors and executive officers of the registrant
The information required by Item 10 as to directors and executive
officers of the Company is included in the Company's proxy statement for its
2002 Annual Meeting of Stockholders (the 2002 Proxy Statement) in the Election
of Directors and Management of the Company sections and is incorporated herein
by reference.
In March 2003, Mr. Thomas H. Potts resigned as Chairman of the Board.
Mr. Eric P. Von der Porten was elected to serve as Chairman of the Board until
the next Annual Meeting of Stockholders.
Item 11. Executive Compensation
The information required by Item 11 is included in the 2002 Proxy
Statement in the Management of the Company section and is incorporated herein by
reference.
Item 12. Security ownership of certain beneficial owners and management
The information required by Item 12 is included in the 2002 Proxy
Statement in the Ownership of Common Stock section and is incorporated herein by
reference.
Item 13. Certain relationships and related transactions
The information required by Item 13 is included in the 2002 Proxy Statement
in the Compensation Committee Interlocks and Insider Participation section and
is incorporated herein by reference.
PART IV
Item 14. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
As required by Rule 13a-15 under the Exchange Act, within 90 days prior
to the filing date of this annual report (the "Evaluation Date"), the Company
carried out an evaluation of the effectiveness of the design and operation of
the Company's disclosure controls and procedures. This evaluation was carried
out under the supervision and with the participation of the Company's
management. Based upon that evaluation, the Company's management concluded that
the Company's disclosure controls and procedures are effective. Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed in the Company's reports filed
or submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in the
Company's reports filed under the Exchange Act is accumulated and communicated
to management, including the Company's management, as appropriate, to allow
timely decisions regarding required disclosures.
(b) Changes in internal controls.
There were no significant changes in the Company's internal controls or
in other factors that could significantly affect the Company's internal controls
subsequent to the Evaluation Date, nor any significant deficiencies or material
weaknesses in such internal controls requiring corrective actions.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-k
(a) Documents filed as part of this report:
1. and 2. Financial Statements
The information required by this section of Item 15
is set forth in the Consolidated Financial Statements
and Independent Auditors' Report beginning at page
F-1 of this Form 10-K. The index to the Financial
Statements and Schedule is set forth at page F-2 of
this Form 10-K.
3. Exhibits
Number Exhibit
3.1 Articles of Incorporation of the Registrant, as amended, effective as of February 4,
1988. (Incorporated herein by reference to the Company's Amendment No. 1 to the
Registration Statement on Form S-3 (No. 333-10783) filed March 21, 1997.)
3.2 Amended Bylaws of the Registrant
(Incorporated by reference to the Company's
Annual Report on Form 10-K for the year
ended December 31, 1992, as amended.)
3.4 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 (filed herewith)
10.1 Dividend Reinvestment and Stock Purchase Plan (Incorporated herein by reference to
the Company's Registration Statement on Form S-3 (No. 333-35769).)
10.2 Executive Deferred Compensation Plan
(Incorporated by reference to the Company's
Annual Report on Form 10-K for the year
ended December 31, 1993 (File No. 1-9819)
dated March 21, 1994.)
10.6 The Directors Stock Appreciation Rights
Plan (Incorporated herein by reference to
the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997.)
10.7 1992 Stock Incentive Plan as amended
(Incorporated herein by reference to the
Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1997.)
21.1 List of consolidated entities of the Company (filed herewith)
23.1 Consent of Deloitte & Touche LLP (filed herewith)
99.1 Certification of Principal Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Current report on Form 8-K as filed with the Commission on October 7,
2002, regarding Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 Item 9 Regulation FD disclosure for in
connection with the Quarterly Report of Dynex Capital, Inc. on Form 10-Q/A for
the quarter ended March 31, 2002.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DYNEX CAPITAL, INC.
(Registrant)
March 31, 2003 /s/ Stephen J. Benedetti
----------------------------------------------
Stephen J. Benedetti, Executive Vice President
(Principal Executive Officer)
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature Capacity Date
Director March 31, 2003
/s/ J. Sidney Davenport, IV
J. Sidney Davenport, IV
/s/ Leon A. Felman Director March 31, 2003
- -------------------------------------------------
Leon A. Felman
/s/ Barry Igdaloff Director March 31, 2003
- -------------------------------------------------
Barry Igdaloff
/s/ Thomas H. Potts
Thomas H. Potts Director March 31, 2003
/s/ Barry S. Shein Director March 31, 2003
- -------------------------------------------------
Barry S. Shein
/s/ Donald B. Vaden Director March 31, 2003
- -------------------------------------------------
Donald B. Vaden
/s/ Eric P. Von der Porten Director March 31, 2003
- -------------------------------------------------
Eric P. Von der Porten
CERTIFICATION
PURSUANT TO 17 CFR 240.13a-14
PROMULGATED UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Stephen J. Benedetti, certify that:
1. I have reviewed this annual report on Form 10-K of Dynex Capital, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 31, 2003 /s/ Stephen J. Benedetti
--------------------------------------------------
Stephen J. Benedetti
Principal Executive Officer
CERTIFICATION
PURSUANT TO 17 CFR 240.13a-14
PROMULGATED UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Stephen J. Benedetti, certify that:
1. I have reviewed this annual report on Form 10-K of Dynex Capital, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 31, 2003 /s/ Stephen J. Benedetti
----------------------------------------------------
Stephen J. Benedetti
Chief Financial Officer
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Dynex Capital, Inc. (the
"Company") on Form 10-K for the year ending December 31, 2002, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Stephen
J. Benedetti, the Principal Executive Officer of the Company, certify, pursuant
to and for purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Date: March 31, 2003 /s/ Stephen J. Benedetti
---------------------------------------------
Stephen J. Benedetti
Principal Executive Officer
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Dynex Capital, Inc. (the
"Company") on Form 10-K for the year ending December 31, 2002, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Stephen
J. Benedetti, the Principal Executive Officer of the Company, certify, pursuant
to and for purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents,
in all material respects, the financial condition and
results of operations of the Company.
Date: March 31, 2003 /s/ Stephen J. Benedetti
-----------------------------------------------
Stephen J. Benedetti
Chief Financial Officer
DYNEX CAPITAL, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
INDEPENDENT AUDITORS' REPORT
For Inclusion in Form 10-K
Annual Report Filed with
Securities and Exchange Commission
December 31, 2002
DYNEX CAPITAL, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
Financial Statements:
Page
Independent Auditors' Report for the Years Ended
December 31, 2002, 2001, and 2000..................................................F-3
Consolidated Balance Sheets
December 31, 2002 and 2001.........................................................F-4
Consolidated Statements of Operations -- Years ended
December 31, 2002, 2001 and 2000...................................................F-5
Consolidated Statements of Shareholders' Equity -- Years ended
December 31, 2002, 2001 and 2000...................................................F-6
Consolidated Statements of Cash Flows -- Years ended
December 31, 2002, 2001 and 2000...................................................F-7
Notes to Consolidated Financial Statements --
December 31, 2002, 2001, and 2000..................................................F-8
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Dynex Capital, Inc.
We have audited the accompanying consolidated balance sheets of Dynex Capital,
Inc. and subsidiaries (the "Company") as of December 31, 2002 and 2001, and the
related consolidated statements of operations, shareholder's equity, and cash
flows for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Dynex Capital, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
DELOITTE & TOUCHE LLP
Richmond, Virginia
March 20, 2003
CONSOLIDATED BALANCE SHEETS
DYNEX CAPITAL, INC.
December 31, 2002 and 2001
(amounts in thousands except share data)
2002 2001
------------------ -----------------
ASSETS
Cash and cash equivalents (including restricted cash of $165 and $4,334,
respectively) $ 15,242 $ 11,463
Other assets 4,747 8,817
------------------ -----------------
19,989 20,280
Investments:
Collateral for collateralized bonds 2,148,497 2,473,203
Other investments 54,322 63,553
Securities 6,208 9,037
Loans 9,288 3,786
------------------ -----------------
2,218,315 2,549,579
------------------ -----------------
$ 2,238,304 $ 2,569,859
================== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Non-recourse debt - collateralized bonds $ 2,013,271 $ 2,264,213
Recourse debt - 58,134
-------------- -------------
2,013,271 2,322,347
Accrued interest payable - 2,099
Accrued expenses and other liabilities 1,612 3,303
-------------- -----------------
2,014,883 2,327,749
-------------- -----------------
Commitments and Contingencies (Note 16) - -
SHAREHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 50,000,000 shares authorized:
9.75% Cumulative Convertible Series A,
992,038 issued and outstanding 22,658 22,658
($31,353 and $29,322 aggregate liquidation preference,
respectively)
9.55% Cumulative Convertible Series B,
1,378,707 and 1,378,807 issued and outstanding, respectively 32,273 32,275
($44,263 and $41,443 aggregate liquidation preference,
respectively)
9.73% Cumulative Convertible Series C,
1,383,532 issued and outstanding 39,655 39,655
($54,634 and $51,101 aggregate liquidation preference,
respectively)
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 (17,472) (14,825)
Accumulated deficit (218,545) (202,502)
------------------ -----------------
223,421 242,110
------------------ -----------------
$ 2,238,304 $ 2,569,859
================== =================
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
DYNEX CAPITAL, INC.
Years ended December 31, 2002, 2001 and 2000
(amounts in thousands except share data)
2002 2001 2000
-------------------- --------------------- --------------------
Interest income:
Collateral for collateralized bonds $ 169,227 $ 215,018 $ 271,463
Other investments 189 6,164 5,336
Securities 1,026 848 3,595
Loans 441 730 10,766
-------------------- --------------------- --------------------
170,883 222,760 291,160
-------------------- --------------------- --------------------
Interest and related expense:
Non-recourse debt 124,996 167,098 232,916
Recourse debt 2,132 6,975 21,595
Other 86 605 5,162
-------------------- --------------------- --------------------
127,214 174,678 259,673
-------------------- --------------------- --------------------
Net interest margin before provision for losses 43,669 48,082 31,487
Provision for losses (28,483) (19,672) (29,110)
-------------------- --------------------- --------------------
Net interest margin 15,186 28,410 2,377
Net loss on sales, impairment charges and
litigation (18,299) (20,954) (84,039)
Equity in net loss of Dynex Holding, Inc. - - (1,061)
Trading losses (3,307) (3,091) -
Other income (expense) 848 104 (428)
General and administrative expenses (9,493) (10,526) (8,712)
-------------------- --------------------- --------------------
Loss before extraordinary item (15,065) (6,057) (91,863)
Extraordinary item - gain on extinguishment
of debt 221 2,972 -
-------------------- ------------------ ------------------
Net loss (14,844) (3,085) (91,863)
Preferred stock (charges) benefits (9,586) 7,717 (12,911)
-------------------- --------------------- --------------------
Net (loss) income applicable to common
shareholders $ (24,430) $ 4,632 $ (104,774)
==================== ===================== ====================
(Loss) income per common share before
extraordinary item:
Basic and diluted $ (2.27) $ 0.15 $ (9.15)
==================== ===================== ====================
Net (loss) income per common share :
Basic and diluted $ (2.25) $ 0.41 $ (9.15)
==================== ===================== ====================
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
DYNEX CAPITAL, INC.
Years ended December 31, 2002, 2001, and 2000
(amounts in thousands except share data)
========================================================================================================================
Accumulated Retained
Additional Other Earnings
Preferred Common Paid-in Comprehensive (Accumulated
Stock Stock Capital (Loss) Income Deficit) Total
- ------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 $127,408 $114 $351,995 $(23,301) $(105,939) $350,277
Comprehensive loss:
Net loss - 2000 - - - - (91,863) (91,863)
Change in net unrealized loss on
investments classified as
available for sale during the - - - (20,962) - (20,962)
period
------------
Total comprehensive loss (112,825)
Issuance of common stock - - 4 - - 4
------------------------------------------------------------------------------------
Balance at December 31, 2000 127,408 114 351,999 (44,263) (197,802) 237,456
Comprehensive loss:
Net loss - 2001 - - - - (3,085) (3,085)
Change in net unrealized loss on
investments classified as
available for sale during the - - - 29,438 - 29,438
period
------------
Total comprehensive income 26,353
Repurchase of preferred stock (32,820) - 12,735 - - (20,085)
Dividends on preferred stock - - - - (1,615) (1,615)
Retirement of common stock - (5) 6 - - 1
------------------------------------------------------------------------------------
Balance at December 31, 2001 94,588 109 364,740 (14,825) (202,502) 242,110
Comprehensive loss:
Net loss - 2002 - - - - (14,844) (14,844)
Change in net unrealized loss on:
Investments classified as
available for sale during the - - - 1,784 - 1,784
period
Hedge Instruments - - - (4,431) - (4,431)
------------
Total comprehensive income - - - - (17,491)
Conversion of preferred to common
stock (2) - 3 - - 1
Dividends on preferred stock - - - - (1,199) (1,199)
------------------------------------------------------------------------------------
Balance at December 31, 2002 $94,586 $109 $364,743 $(17,472) $(218,545) $223,421
========================================================================================================================
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
DYNEX CAPITAL, INC.
Years ended December 31, 2002, 2001 and 2000
(amounts in thousands except share data)
2002 2001 2000
---------------- ---------------- ----------------
Operating activities:
Net loss $ (14,844) $ (3,085) $ (91,863)
Adjustments to reconcile net loss to cash provided
by operating activities:
Provision for losses 28,483 19,672 29,110
Net loss on sales, impairment charges and litigation 18,299 20,954 84,039
Equity in net loss of Dynex Holding, Inc. - - 680
Extraordinary item - gain on extinguishment of debt (221) (2,972) -
Amortization and depreciation 6,446 12,278 16,117
Decrease in accrued interest receivable 2,668 4,028 2,132
(Payment) receipt of litigation settlements (863) 7,095 (20,000)
(Decrease) increase in accrued interest payable (3,090) (1,209) 780
Decrease in restricted cash 4,169 18,954 8,014
Net change in other assets and other liabilities (3,793) (3,345) (5,629)
---------------- ---------------- ----------------
Net cash and cash equivalents provided by operating activities 37,254 72,370 23,380
---------------- ---------------- ----------------
Investing activities:
Principal payments on collateral 417,200 595,822 521,355
Net (increase) decrease in funds held by trustee (269) 125 774
Net (increase) decrease in loans (2,323) 9,622 198,785
Purchase of securities and other investments (150,928) (7,865) (9,476)
Payments received on securities and other investments 19,320 15,609 24,891
Proceeds from sales of securities and other investments 2,191 3,662 24,579
Payments for sale of tax-exempt bond obligations - - (30,284)
Investment in and advances to Dynex Holding, Inc. - - 4,134
Proceeds from sale of loan production operations - 8,820 9,500
Capital expenditures (175) (109) (92)
---------------- ---------------- ----------------
Net cash and cash equivalents provided by investing activities 285,016 625,686 744,166
---------------- ---------------- ----------------
Financing activities:
Proceeds from issuance of bonds 172,898 507,586 140,724
Principal payments on bonds (428,027) (1,107,247) (524,040)
Repayment of recourse debt borrowings, net (57,994) (73,050) (403,880)
Net proceeds from issuance of stock - - 4
Retirement of preferred stock - (20,084) -
Dividends paid (1,199) (1,617) -
---------------- ---------------- ----------------
Net cash and cash equivalents used for financing activities (314,322) (694,412) (787,192)
---------------- ---------------- ----------------
Net increase (decrease) in cash and cash equivalents 7,948 3,644 (19,646)
Cash and cash equivalents (excluding restricted cash) at
beginning of period 7,129 3,485 23,131
---------------- ---------------- ----------------
Cash and cash equivalents (excluding restricted cash) at end of $ 15,077 $ 7,129 $ 3,485
period
Restricted cash 165 4,334 23,288
---------------- ---------------- ----------------
Total cash and cash equivalents $ 15,242 $ 11,463 $ 26,773
================ ================ ================
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
December 31, 2002, 2001, and 2000
(amounts in thousands except share data)
NOTE 1 - BASIS OF PRESENTATION
Basis of Presentation
The consolidated financial statements include the accounts of Dynex
Capital, Inc., its qualified real estate investment trust ("REIT") subsidiaries
and taxable REIT subsidiary (together, the "Company"). Prior to December 31,
2000, the Company operated the majority of its lending and servicing activities
out of a taxable affiliate, Dynex Holding, Inc. (DHI), in which the Company
owned 100% of the preferred stock outstanding. As the Company owned only
non-voting preferred stock, DHI and its subsidiaries were not consolidated for
financial reporting or tax purposes, but were accounted for in the Company's
financial statements using the equity method. In November 2000, certain
subsidiaries of DHI were sold to the Company, and on December 31, 2000, DHI was
liquidated in a taxable transaction into the Company. As a result of the
liquidation, effectively all of the assets and liabilities of DHI were
transferred to the Company as of December 31, 2000. All significant
inter-company balances and transactions with the Company's consolidated
subsidiaries have been eliminated in consolidation.
Reclassifications
Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Federal Income Taxes
The Company believes it has complied with the requirements for
qualification as a REIT under the Internal Revenue Code (the "Code"). To the
extent the Company qualifies as a REIT for federal income tax purposes, it
generally will not be subject to federal income tax on the amount of its income
or gain that is distributed as dividends to shareholders. The Company uses the
calendar year for both tax and financial reporting purposes. There may be
differences between taxable income and income computed in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). These differences primarily arise from timing differences in the
recognition of revenue and expense for tax and GAAP purposes. The Company's
estimated taxable income for 2002, excluding net operating losses carried
forward from prior years, was $5,491, comprised entirely of ordinary income.
Such amounts will be fully offset by tax loss carry-forwards of a similar
amount. After utilizing the $5,491 the Company's remaining tax operating loss
carry-forwards will be approximately $120,880. Included in the $5,491 in
ordinary income is excess inclusion income of $1,376 which is required to be
distributed by the Company by the time the Company files its consolidated income
tax return in order to maintain its REIT status. The Company intends to make
such distribution in accordance with the prescribed requirements.
Investments
Pursuant to the requirements of Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," the Company is required to classify certain of its
investments considered debt securities as either trading, available-for-sale or
held-to-maturity. In certain instances the Company may reclassify investments
from available-for-sale to held-to-maturity, but only when it has the intent and
the ability to hold such investments to maturity. At the time of the
reclassification, the carrying value of the investment is adjusted to its
estimated fair market value with a corresponding adjustment to accumulated other
comprehensive income. In accordance with SFAS No. 115, such adjustment is
amortized as an adjustment to earnings on the associated investment using the
effective yield method.
Collateral for Collateralized Bonds. Collateral for collateralized
bonds consists of collateral pledged to support the repayment of non-recourse
collateralized bonds issued by the Company. Collateral for collateralized bonds
includes loans and debt securities consisting of, or secured by adjustable-rate
and fixed-rate mortgage loans secured by first liens on single family
properties, fixed-rate loans secured by first liens on multifamily and
commercial properties, and manufactured housing installment loans secured by
either a UCC filing or a motor vehicle title. Collateral for collateralized
bonds in 2001 also included delinquent property tax receivables. Loans included
in collateral for collateralized bonds are reported at amortized cost. An
allowance has been established for expected losses on such loans. Debt
securities included in collateral for collateralized bonds are considered
available-for-sale and are reported at fair value, with unrealized gains and
losses excluded from earnings and reported as accumulated other comprehensive
income. Any decline in the fair value of these debt securities below their
amortized cost that is deemed to be other than temporary is charged to earnings.
The basis of any debt securities sold is computed using the specific
identification method. Collateral for collateralized bonds can be sold only
subject to the lien of the respective collateralized bond indenture, unless the
related bonds have been redeemed.
Other Investments. Other investments includes unsecuritized delinquent
property tax receivables, securities backed by delinquent property tax
receivables, and real estate owned. The unsecuritized delinquent property tax
receivables are carried at amortized cost. Securities backed by delinquent
property tax receivables are classified as held-to-maturity pursuant to the
provisions of SFAS No. 115, and are carried at amortized cost. Other investments
include real estate owned acquired through, or in lieu of foreclosure in
connection with the servicing of the delinquent tax lien receivables portfolio.
Such investments are considered held for sale and are initially recorded at fair
value at the date of foreclosure, establishing a new cost basis. Subsequent to
foreclosure, management periodically performs valuations and the investments are
carried at the lower of carrying amount or fair value less cost to sell. Revenue
and expenses from operations and changes in the valuation allowance related to
real estate owned are included in other income (expense).
Securities. Included in this balance are debt securities which are
considered available-for-sale under SFAS No. 115 and are reported at fair value,
with unrealized gains and losses excluded from earnings and reported as
accumulated other comprehensive income. Also included in securities are debt
securities which were reclassified as held-to-maturity and are carried at
amortized cost. The basis of any debt securities sold is computed using the
specific identification method.
Loans. Loans are carried at amortized cost.
Interest Income. Interest income is recognized when earned according to
the terms of the underlying investment and when, in the opinion of management,
it is collectible. For loans, the accrual of interest is discontinued when, in
the opinion of management, the interest is not collectible in the normal course
of business, when the loan is past due and when the primary servicer of the loan
fails to advance the interest and/or principal due on the loan. For securities
and other investments, the accrual of interest is discontinued when, in the
opinion of management, it is possible that all amounts contractually due will
not be collected. Loans are considered past due when the borrower fails to make
a timely payment in accordance with the underlying loan agreement, inclusive of
all applicable cure periods. All interest accrued but not collected for
investments that are placed on non-accrual status or charged-off is reversed
against interest income. Interest on these investments is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual.
Investments are returned to accrual status when all the principal and interest
amounts contractually due are brought current and future payments are reasonably
assured.
Premiums and Discounts
Premiums and discounts on investments and obligations are amortized
into interest income or expense, respectively, over the life of the related
investment or obligation using the effective yield method, or a method that
approximates the effective yield method. Hedging basis adjustments on associated
investments and obligations are included in premiums and discounts.
Deferred Issuance Costs
Costs incurred in connection with the issuance of non-recourse debt and
recourse debt are deferred and amortized over the estimated lives of their
respective debt obligations using a method that approximates the effective yield
method.
Derivative Financial Instruments
On occasion the Company may enter into interest rate swap agreements,
interest rate cap agreements, interest rate floor agreements, financial
forwards, financial futures and options on financial futures ("Interest Rate
Agreements") to manage its sensitivity to changes in interest rates. These
Interest Rate Agreements are intended to provide income and cash flow to offset
potential reduced net interest income and cash flow under certain interest rate
environments. At the inception of the hedge, these instruments are designated as
either hedge positions or trading positions using criteria established in SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities".
For Interest Rate Agreements designated as cash flow hedges, the
Company evaluates the effectiveness of these hedges against the financial
instrument being hedged under various interest rate scenarios. The effective
portion of the gain or loss on an Interest Rate Agreement designated as a cash
flow hedge is reported in accumulated other comprehensive income, and the
ineffective portion of such hedge is reported in income.
As a part of the Company's interest rate risk management process, the
Company may be required periodically to terminate hedge instruments. Any
realized gain or loss resulting from the termination of a hedge is amortized
into income or expense of the corresponding hedged instrument over the remaining
period of the original hedge or hedged instrument.
If the underlying asset, liability or commitment is sold or matures,
the hedge is deemed partially or wholly ineffective, or the criteria that was
executed at the time the hedge instrument was entered into no longer exists, the
Interest Rate Agreement is no longer accounted for as a hedge. Under these
circumstances, the accumulated change in the market value of the hedge is
recognized in current income to the extent that the effects of interest rate or
price changes of the hedged item have not offset the hedge results or otherwise
previously been recognized in income.
For Interest Rate Agreements entered into for trading purposes,
realized and unrealized changes in fair value of these instruments are
recognized in the consolidated statements of operations as trading activities in
the period in which the changes occur or when such trade instruments are
settled. Amounts payable to or receivable from counter-parties, if any, are
included on the consolidated balance sheets in other assets.
Cash - Restricted
At December 31, 2002, cash in the amount of $165 was held in trust to
cover losses on securities not otherwise covered by insurance. At December 31,
2001, $3,094 of cash, was held in trust to cover losses on securities not
otherwise covered by insurance. In addition, at December 31, 2001, cash in the
amount of $1,240 was held in a restricted account managed by the trustee of the
July 2002 Senior Notes for purposes of repayment of principal and interest on
the July 2002 Senior Notes at their maturity date. On July 15, 2002, the Company
fully repaid the July 2002 Senior Notes, and all restricted cash previously held
and related to the July 2002 Senior Notes was released to the Company.
Cash Equivalents
The Company considers investments with original maturities of three
months or less to be cash equivalents.
Net (Loss) Income Per Common Share
Net (loss) income per common share is presented on both a basic net
loss per common share and diluted net loss per common share basis. Diluted net
loss per common share assumes the conversion of the convertible preferred stock
into common stock, using the if-converted method, and stock appreciation rights,
using the treasury stock method, but only if these items are dilutive. The
preferred stock is convertible into one share of common stock for two shares of
preferred stock.
Use of Estimates
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reported period. Actual results could differ from those
estimates. The primary estimates inherent in the accompanying consolidated
financial statements are discussed below.
Fair Value. The Company uses estimates in establishing fair value for
its financial instruments. Estimates of fair value for financial instruments may
be based on market prices provided by certain dealers. Estimates of fair value
for certain other financial instruments are determined by calculating the
present value of the projected cash flows of the instruments using appropriate
discount rates, prepayment rates and credit loss assumptions. Collateral for
collateralized bonds make up a significant portion of the Company's investments.
The estimate of fair value for securities within collateral for collateralized
bonds is determined by calculating the present value of the projected net cash
flows of the instruments, using discount rates, prepayment rate assumptions and
credit loss assumptions established by management. The discount rate used in the
determination of fair value of the collateral for collateralized bonds was 16%
at December 31, 2002 and 2001. The Company utilizes a discount rate of 16% in
determining the fair value of its financial instruments when the Company's
ownership interest in such financial instrument is generally represented by
interests rated `BBB' or below, and generally concentrated in the
overcollateralization or residual interest components. Prepayment rate
assumptions at December 31, 2002 and 2001 were generally at a "constant
prepayment rate," or CPR, ranging from 30%-45% for 2002, and 40%-60% for 2001,
for collateral for collateralized bonds consisting of securities backed by
single-family mortgage loans, and a CPR equivalent of 11% for 2002 and 10% for
2001, for collateral for collateralized bonds consisting of securities backed by
manufactured housing loans CPR assumptions for each year are based in part on
the actual prepayment rates experienced for the prior six-month period and in
part on management's estimate of future prepayment activity. The loss
assumptions utilized vary for each series of collateral for collateralized
bonds, depending on the collateral pledged. The cash flows for the collateral
for collateralized bonds were projected to the estimated date that the
collateralized bond security could be called and retired by the Company if there
is economic value to the Company in calling and retiring the collateralized bond
security. Such call date is typically triggered on the earlier of a specified
date or when the remaining collateralized bond security balance equals 35% of
the original balance (the "Call Date"). The Company estimates anticipated market
prices of the underlying collateral at the Call Date.
As discussed in Note 5, the Company estimates 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%. The Company utilizes a
discount rate of 12% in determining fair value of its financial instruments when
the Company's ownership interest in such financial instrument includes a
combination of investment grade and non-investment grade classes, on an actual
rating or an implied rating basis.
Estimates of fair value for other financial instruments are based
primarily on management's judgment. Since the fair value of Company's financial
instruments is based on estimates, actual gains and losses recognized may differ
from those estimates recorded in the consolidated financial statements. The fair
value of all on- and off-balance sheet financial instruments is presented in
Note 11.
Allowance for Losses. The Company has credit risk on loans pledged as
collateral for collateralized bonds in its investment portfolio. An allowance
for losses has been estimated and established for current expected losses based
on certain performance factors associated with the collateral, including current
loan delinquencies, historical cure rates of delinquent loans, and historical
and anticipated loss severity of the loans as they are liquidated. The allowance
for losses is evaluated and adjusted periodically by management based on the
actual and projected timing and amount of probable credit losses, using the
above factors, as well as industry loss experience. Where loans are considered
homogeneous, the allowance for losses are established and evaluated on a pool
basis. Otherwise, the allowance for losses is established and evaluated on a
loan-specific basis. Provisions made to increase the allowance related to credit
risk are presented as provision for losses in the accompanying consolidated
statements of operations. The Company's actual credit losses may differ from
those estimates used to establish the allowance.
Mortgage-related Securities. Income on certain mortgage-related
securities is accrued using the effective yield method based upon estimates of
future cash flows to be received over the estimated remaining lives of the
related securities. Reductions in carrying value are made when the total
projected cash flow is less than the Company's basis, based on either the
dealers' prepayment assumptions or, if it would accelerate such adjustments,
management's expectations of interest rates and future prepayment rates. In some
cases, derivative securities may also be placed on non-accrual status.
Stock-Based Compensation
In accordance with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-based Compensation", the Company has elected to account
for stock-based compensation under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". Stock options granted by the Company
are in the form of Stock Appreciation Rights (SARs). The strike price of the SAR
equals the market price of the Company's common stock at the time of the grant.
Compensation expense is recorded to the extent that the market price of the
common stock of the Company exceeds the strike price of the SARs. Compensation
expense is adjusted from period-to-period as the market price of the common
stock changes.
Securitization Transactions
The Company follows the provisions of SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,"
in determining whether securitizations of financial instruments should be
accounted for as a financing or as a sale transaction. The Company securitizes
loans and securities by transferring these assets to a wholly-owned trust, and
the trust issues non-recourse collateralized bonds pursuant to an indenture.
Generally, the Company retains some form of control over the transferred assets,
and/or the trust is not deemed to be a qualified special purposes entity. In
instances where the trust is deemed not to be a qualified special purpose
entity, the trust is included in the consolidated financial statements of the
Company. For accounting and tax purposes, the loans and securities financed
through the issuance of collateralized bonds are treated as assets of the
Company, and the collateralized bonds are treated as debt of the Company. The
Company may retain certain of the bonds issued by the trust, and the Company
generally will transfer collateral in excess of the bonds issued. This excess is
typically referred to as over-collateralization.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued 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 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
has not yet assessed the impact of this statement on its financial position or
results of operations.
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 does not believe the adoption of SFAS No. 146
will have a significant impact on the financial position, results of operations
or cash flows of the Company.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions," which amends SFAS No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets," and FASB Interpretation No. 9,
"Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a
Similar Institution is Acquired in a Business Combination Accounted for by the
Purchase Method." With the exception of transactions between two or more mutual
enterprises, this Statement removes acquisitions of financial institutions from
the scope of both SFAS No. 72 and Interpretation 9 and requires that those
transactions be accounted for in accordance with SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." In
addition, the carrying amount of an unidentifiable intangible asset shall
continue to be amortized as required in SFAS No. 72, unless the transaction to
which that asset arose was a business combination. In that case, the carrying
amount of that asset is to be reclassified to goodwill as of the later of the
date of acquisition or the date SFAS No. 142 is applied in its entirety. Thus,
those intangible assets are subject to the same undiscounted cash flow
recoverability test and impairment loss recognition and measurement provisions
that SFAS No. 144 requires for other long-lived assets that are held and used.
Also, this Statement amends SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions. The effective
date for this provision is on October 1, 2002, with earlier application
permitted. The adoption of SFAS No. 147 has not had an impact on the financial
position, results of operations, or cash flows of the Company.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure." Effective after December
15, 2003, this Statement amends FASB Statement No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of Statement 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
Company has not yet assessed the impact of this statement on its financial
position or results of operations.
On November 25, 2002, the FASB issued FASB Interpretation No. 45 (FIN
45), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, an interpretation of
FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34."
FIN 45 clarifies the requirements of FASB Statement No. 5, "Accounting for
Contingencies," relating to the guarantor's accounting for, and disclosure of,
the issuance of certain types of guarantees. The disclosure requirements of FIN
45 are effective for financial statements of interim or annual periods that end
after December 15, 2002. The disclosure provisions have been implemented and no
disclosures were required at year-end 2002. The provisions for initial
recognition and measurement are effective on a prospective basis for guarantees
that are issued or modified after December 31, 2002, irrespective of the
guarantor's year-end. FIN 45 requires that upon issuance of a guarantee, the
entity must recognize a liability for the fair value of the obligation it
assumes under that guarantee. The Company's adoption of FIN 45 in 2003 has not
and is not expected to have a material effect on the Company's results of
operations, cash flows or financial position.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities - an interpretation of ARB No. 51," which addresses
consolidation of variable interest entities. FIN 46 expands the criteria for
consideration in determining whether a variable interest entity should be
consolidated by a business entity, and requires existing unconsolidated variable
interest entities (which include, but are not limited to, Special Purpose
Entities, or SPEs) to be consolidated by their primary beneficiaries if the
entities do not effectively disperse risks among parties involved. This
interpretation applies immediately to variable interest entities created after
January 31, 2003, and to variable interest entities in which an enterprise
obtains an interest after that date. It applies in the first fiscal year or
interim period beginning after June 15, 2003, to variable interest entities in
which an enterprise holds a variable interest that it acquired before February
1, 2003. The adoption of FIN 46 is not expected to have a material effect on the
Company's results of operations, cash flows or financial position.
NOTE 3 - SUBSEQUENT EVENTS
On February 28, 2003, the Company completed a tender offer for shares
of its Series A, Series B and Series C Preferred Stock. The Company purchased
for cash 188,940 shares of its Series A Preferred Stock, 272,977 shares of its
Series B Preferred Stock and 268,792 shares of its Series C Preferred Stock for
a total cash payment of $19,286. In addition, the Company exchanged 9.50% Senior
Notes totaling $32,079, due February 28, 2005, for an additional 309,503 shares
of Series A Preferred Stock, 417,541 shares of Series B Preferred Stock and
429,847 shares of Series C Preferred Stock. The tender offer will result in a
preferred stock benefit of $12,581 comprised of a premium paid to book value of
$3,894 and the elimination of dividends-in-arrears of $16,475 for the shares
tendered. In addition, until the Senior Notes have been fully repaid, the
company is effectively prohibited from engaging in any future tender offers for
its Preferred Stock and from making any distributions with respect to the
Preferred Stock except as required for the Company to maintain its status as a
real estate investment trust.
NOTE 4 - COLLATERAL FOR COLLATERALIZED BONDS
The following table summarizes the components of collateral for
collateralized bonds as of December 31, 2002 and 2001.
- --------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------
Loans, at amortized cost $ 1,844,025 $ 2,027,619
Allowance for loan losses (25,448) (21,454)
- --------------------------------------------------------------------------------
Loans, net 1,818,577 2,006,165
Debt securities, at fair value 329,920 467,038
- --------------------------------------------------------------------------------
$ 2,148,497 $ 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 December 31, 2002 and 2001.
- ----------------------------------------- ------------------------------
2002 2001
Debt securities, at amortized cost $ 329,621 $463,666
Gross unrealized gains 322 3,372
Gross unrealized losses (23) -
Estimated fair value $ 329,920 $467,038
- ----------------------------------------- ------------------------------
The components of collateral for collateralized bonds at December 31,
2002 and 2001 are as follows:
- ------------------------------- ------------------------------------------ -----------------------------------------
2002 2001
- ------------------------------- ------------------------------------------ -----------------------------------------
Loans, net Debt Total Loans, net Debt Total
Securities Securities
- ------------------------------- -------------- ------------ -------------- -------------- ----------- --------------
Collateral $ 1,791,679 $ 325,819 $ 2,117,498 $1,971,893 $ 458,075 $2,429,968
Funds held by trustees 140 515 655 132 259 391
Accrued interest receivable 11,741 2,120 13,861 13,510 3,084 16,594
Unamortized premiums and
discounts, net 15,017 1,167 16,184 20,630 2,248 22,878
Unrealized gain, net - 299 299 - 3,372 3,372
- ------------------------------- -------------- ------------ -------------- -------------- ----------- --------------
$ 1,818,577 $ 329,920 $ 2,148,497 $2,006,165 $467,038 $2,473,203
- ------------------------------- -------------- ------------ -------------- -------------- ----------- --------------
NOTE 5 - OTHER INVESTMENTS
The following table summarizes the Company's other investments for the
years ended December 31, 2002 and 2001:
- ------------------------------------------------------------------ ----------------------- ------------------------
December 31, 2002 December 31, 2001
- ------------------------------------------------------------------ ----------------------- ------------------------
Delinquent property tax receivables and securities $ 61,572 $ 75,806
Discount recorded as adjustment to other comprehensive loss (12,640) (18,452)
----------------------- ------------------------
Amortized cost basis of receivables, net 48,932 57,354
Real estate owned 5,251 5,928
Other 139 271
- ------------------------------------------------------------------ ----------------------- ------------------------
$ 54,322 $ 63,553
- ------------------------------------------------------------------ ----------------------- ------------------------
The debt security backed by delinquent tax receivables is classified as
held-to-maturity pursuant to the provisions of SFAS No. 115, and is carried at
amortized cost. This security was reclassified as `held-to-maturity' from
`available-for-sale' in 2001. Prior to its reclassification, the Company had
marketed for sale this debt security but the Company was unable to generate
reasonable interest in the security. The Company subsequently determined that
the value of the security would be maximized by retaining such security and
continuing to service the security's underlying collateral for its remaining
life. As the underlying collateral is delinquent property tax receivables, the
collateral cannot be prepaid. Accordingly, the Company has both the intent and
the ability to hold this security to its maturity. At the time of
reclassification, the carrying value of the security's fair value adjustment was
determined to be other than temporary, resulting in an impairment charge of
$6,774 for the portion of the adjustment that was deemed an other-than-temporary
impairment, and a charge of $18,452 to accumulated other comprehensive loss. The
aggregate fair value of such securities was determined based on the present
value of the cash flows expected to be received from these securities, less
costs to service, at a discount rate of 12%. In accordance with the provisions
of SFAS No. 115, the $18,452 in adjustment to accumulated other comprehensive
loss is being amortized in accordance with the level yield method. At December
31, 2002, the Company has real estate owned with a current carrying value of
$5,251 resulting from foreclosures on delinquent property tax receivables. At
December 31, 2002, delinquent property tax receivables and securities backed by
delinquent property tax receivables are on non-accrual status. Cash collections
on these delinquent property tax receivables amounted to $16,602 during 2002.
NOTE 6 - SECURITIES
The following table summarizes the Company's amortized cost basis and
fair value of securities, all of which are classified as available-for-sale, as
of December 31, 2002 and 2001, and the related average effective interest rates:
- --------------------------------------------- ---------------------------------- ----------------------------------
2002 2001
Fair Effective Fair Effective
Value Interest Rate Value Interest Rate
- --------------------------------------------- ---------------- ----------------- ---------------- -----------------
Securities:
Adjustable-rate mortgage securities $ - - $ 600 7.3%
Fixed-rate securities 2,911 44.8% 3,880 20.9%
Mortgage-related securities 3,770 8.4% 4,358 (0.2)%
- --------------------------------------------- ---------------- ----------------- ---------------- -----------------
Amortized cost, net 6,681 8,838
Gross unrealized gains 935 2,218
Gross unrealized losses (1,408) (2,019)
- --------------------------------------------- ---------------- ----------------- ---------------- -----------------
Fair Value $ 6,208 $ 9,037
- --------------------------------------------- ---------------- ----------------- ---------------- -----------------
Sensitivity analysis. The Company owned interest-only and
principal-only securities, some of which were pledged to support certain of the
Company's collateralized bond securities, and purchased from an affiliate during
the period 1992-1995. These interest-only and principal-only securities had an
investment basis of $1,443 and $650, respectively, and estimated fair values of
$130 and $620, respectively at December 31, 2002. The Company estimated fair
value based on projected cash flows discounted at a rate of 16%. The majority of
these interest-only and principal-only securities are rated `AAA' by at least
one nationally recognized ratings agency, and have very little sensitivity to
the credit risk of the underlying single-family mortgage loans. The majority of
the risk associated with the Company's investment in these securities relates to
the prepayment speeds of the underlying single-family mortgage loans. In
estimating fair value, the Company used average prepayment speed assumptions of
36% CPR for the interest-only and principal-only securities. In determining
average prepayment speed assumptions, the Company utilizes the last six month's
prepayment experience and market and Company expectations of prepayment speeds
based on the forward LIBOR curve.
The Company performed a sensitivity analysis on the CPR assumptions for
the interest-only securities by increasing the CPR 10% and 20%, and performed a
sensitivity analysis on the principal-only securities by reducing CPR by 10% and
20%. In addition, the Company performed a sensitivity analysis on the discount
rate assumptions used by increasing and decreasing the respective discount rates
by 100 basis points and 150 basis points. In all cases, the changes in value
were immaterial to the overall value of the investment portfolio.
These sensitivity analyses are based on management estimates and are
hypothetical in nature. Actual results will differ from projected results.
NOTE 7 - LOANS
The following table summarizes the Company's carrying basis in loans at
December 31, 2002 and 2001, respectively.
- --------------------------------------------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------------------------------------------
Single-family mortgage loans $ 6,386 $ 907
Multifamily and commercial mortgage loans 2,769 2,792
Consumer installment contracts 24 72
- --------------------------------------------------------------------------------------------------------------------
9,179 3,771
Unamortized premiums and discounts, net 133 15
Allowance for loan losses (24) -
- --------------------------------------------------------------------------------------------------------------------
Total loans $ 9,288 $ 3,786
- --------------------------------------------------------------------------------------------------------------------
NOTE 8 - ALLOWANCE FOR LOAN LOSSES
The Company reserves for credit risk where it has exposure to losses on
loans in its investment portfolio. The following table summarizes the aggregate
activity for the allowance for loan losses of principal on investments for the
years ended December 31, 2002, 2001 and 2000:
- ------------------------------------------------- --------------------- --------------------- ----------------------
2002 2001 2000
- ------------------------------------------------- --------------------- --------------------- ----------------------
Allowance at beginning of year $ 21,508 $ 26,903 $ 17,053
Provision for losses 28,483 19,672 29,110
Credit losses, net of recoveries (24,519) (25,067) (19,260)
- ------------------------------------------------- --------------------- --------------------- ----------------------
Allowance at end of year $ 25,472 $ 21,508 $ 26,903
- ------------------------------------------------- --------------------- --------------------- ----------------------
Collateral for collateralized bonds. The Company has exposure to credit
risk retained on loans that it has securitized through the issuance of
collateralized bonds. The aggregate loss exposure is generally limited to the
amount of loan collateral in excess of the related investment-grade
collateralized bonds issued (commonly referred to as "over-collateralization"),
excluding price premiums and discounts and hedge gains and losses. In some
cases, the aggregate loss exposure may be increased by the use of surplus cash
or cash reserve funds contained within the security structure to cover losses.
The allowance for loan losses on the over-collateralization totaled $25,448 and
$21,508 at December 31, 2002 and 2001 respectively, and is included in
collateral for collateralized bonds in the accompanying consolidated balance
sheets.
Loans. The Company has credit risk on certain other loans not
securitized. The allowance for loan losses for these loans was $24 at December
31, 2002.
The following table presents the loans that the Company has determined to
be impaired in accordance with SFAS No. 114 "Accounting by Creditors for
Impairment of Loans."
- ------------------------------- --------------------------------------------------------------------------------------
Amount for Which There is Amount for Which There is
Total Recorded Investment A Related Allowance for No Related Allowance for
December 31 In Impaired Loans Credit Losses Credit Losses
- ------------------------------- ---------------------------- ---------------------------- ----------------------------
2002 $160,563 $4,748 $155,815
2001 167,588 6,090 161,498
- ------------------------------- ---------------------------- ---------------------------- ----------------------------
Of the amount included in the Recorded Investment in Impaired loans in the
table above, approximately $91,690 and $100,783 for 2002 and 2001, respectively,
are covered by loss guarantees from a "AAA-rated" third-party insurance company.
The aggregate amount of losses covered by these guarantees is $28,739.
NOTE 9 - NON-RECOURSE DEBT - COLLATERALIZED BONDS
The Company, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds. Each series of
collateralized bonds may consist of various classes of bonds, either at fixed or
variable rates of interest. Payments received on the collateral for
collateralized bonds and any reinvestment income thereon are used to make
payments on the collateralized bonds (see Note 4). The obligations under the
collateralized bonds are payable solely from the collateral for collateralized
bonds and are otherwise non-recourse to the Company. The stated maturity date
for each class of bonds is generally calculated based on the final scheduled
payment date of the underlying collateral pledged. The actual maturity of each
class will be directly affected by the rate of principal prepayments on the
related collateral. Each series is also subject to redemption according to
specific terms of the respective indentures, generally when the remaining
balance of the bonds equals 35% or less of the original principal balance of the
bonds, or on a specific date. As a result, the actual maturity of any class of a
series of collateralized bonds is likely to occur earlier than its stated
maturity.
The Company may retain certain classes of collateralized bonds issued,
including investment grade classes, financing these retained collateralized
bonds with equity. Total investment grade retained bonds at December 31, 2002
and 2001 were $20,000, respectively, and carried a rating of `BBB' as rated by a
nationally recognized ratings agency. As these limited-purpose finance
subsidiaries are included in the consolidated financial statements of the
Company, such retained bonds are eliminated in the consolidated financial
statements, while the associated repurchase agreements outstanding, if any, are
included as recourse debt.
The components of collateralized bonds along with certain other
information at December 31, 2002 and 2001 are summarized as follows:
- ------------------------------------------- ----------------------------------- -----------------------------------
2002 2001
- ------------------------------------------- ----------------------------------- -----------------------------------
Bonds Range of Bonds Range of
Outstanding Interest Rates Outstanding Interest Rates
- ------------------------------------------- ----------------- ----------------- ----------------- -----------------
Variable-rate classes $ 766,403 1.7% - 3.0% $ 937,973 2.5% - 5.6%
Fixed-rate classes 1,212,738 6.2% - 11.5% 1,294,751 6.2% - 11.5%
Accrued interest payable 7,944 8,935
Deferred bond issuance costs (7,522) (7,840)
Unamortized net bond premium 33,708 30,394
- ------------------------------------------- ----------------- ----------------- ----------------- -----------------
$ 2,013,271 $ 2,264,213
- ------------------------------------------- ----------------- ----------------- ----------------- -----------------
Range of stated maturities 2009-2033 2009-2033
Number of series 22 23
- ------------------------------------------- ----------------- ----------------- ----------------- -----------------
The variable rate classes are based on one-month London InterBank
Offered Rate (LIBOR). At December 31, 2002, the weighted-average effective rate
of the variable-rate classes was 1.9%, and the weighted-average effective rate
of fixed rate classes was 7.2%. The average effective rate of interest for
non-recourse debt was 5.7%, 6.4%, and 7.3% for the years ended December 31,
2002, 2001, and 2000, respectively.
NOTE 10 - RECOURSE DEBT
The Company utilizes repurchase agreements, secured credit facilities
and notes payable (together, "recourse debt") to finance certain of its
investments. The following table summarizes the Company's recourse debt
outstanding and the weighted-average annual rates at December 31, 2002 and 2001:
- ----------------------- ----------------------------------------------------------- -----------------------------
2002 2001
- ----------------------- ----------------------------------------------------------- -----------------------------
Weighted- Market Weighted- Market
Average Value Average Value
Amount Annual of Amount Annual of
Outstanding Rate Collateral Outstanding Rate Collateral
7.875% Senior Notes $ - - $ - $ 57,969 7.88% See below
Capitalized lease - - - 244 7.81% 234
obligations
Capitalized costs - - (79) -
- ----------------------- --------------- ------------- -------------- -------------- -------------- --------------
$ - $ - $ 58,134 $ 234
- ----------------------- --------------- ------------- -------------- -------------- -------------- --------------
In March 2001, the Company entered into an amendment to the related
indenture governing the July 2002 Senior Notes whereby the Company pledged to
the Trustee of the July 2002 Senior Notes substantially all of the Company's
unencumbered assets in its investment portfolio and the stock of its material
subsidiaries. In consideration of this pledge, the indenture was further amended
to provide for the release of the Company from certain covenant restrictions in
the indenture, and specifically provided for the Company's ability to make
distributions on its capital stock in an amount not to exceed the sum of (i)
$26,000, (ii) the cash proceeds of any "permitted subordinated indebtedness",
(iii) the cash proceeds of the issuance of any "qualified capital stock", and
(iv) any distributions required in order for the Company to maintain its REIT
status. In addition, in March 2001, the Company entered into a Purchase
Agreement with holders of 50.1% of the July 2002 Senior Notes which required the
Company to purchase, and such holders to sell, their respective July 2002 Senior
Notes at various discounts prior to maturity based on a computation of the
Company's available cash. Through December 31, 2001, the Company had retired
$39,281 of Senior Notes for $35,549 in cash, excluding accrued interest, under
the Purchase Agreement. The difference of $3,554, reduced for unamortized
discounts and deferred costs, was recorded as a gain on extinguishment of debt.
In January 2002, the Company purchased for $8,296 the remaining amount available
of $8,642 to be purchased under the Purchase Agreement, with the difference of
$334, reduced for discounts and deferred costs, recorded as a gain on
extinguishment of debt. On July 15, 2002, the Company redeemed all of its
remaining outstanding July 2002 Senior Notes.
NOTE 11 - FAIR VALUE AND ADDITIONAL INFORMATION ABOUT FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments"
requires the disclosure of the estimated fair value of on-and off-balance-sheet
financial instruments. The following table presents the amortized cost and
estimated fair values of the Company's financial instruments as of December 31,
2002 and 2001:
- ---------------------------------------- ------------------------------------- -------------------------------------
2002 2001
------------------------------------- -------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- ---------------------------------------- ------------------ ------------------ ------------------ ------------------
Assets:
Collateral for collateralized bonds
Loans $ 1,844,025 $ 1,781,719 $ 2,027,619 $ 2,006,165
Debt securities 329,621 329,920 463,666 467,038
------------------ ------------------ ------------------ ------------------
Collateral for collateralized bonds 2,173,646 2,111,639 2,491,285 2,473,203
Other investments 49,071 40,701 57,625 50,997
Securities 6,681 6,208 8,838 9,037
Loans 9,312 9,328 3,786 3,891
Liabilities:
Non-recourse debt 2,013,271 2,013,271 2,264,213 2,264,213
Recourse debt:
Senior Notes - - 57,890 55,650
- ---------------------------------------- ------------------ ------------------ ------------------ ------------------
Amortized costs excludes the allowance for loan losses. The fair value
of collateral for collateralized bonds, securities, other investments, and loans
is based on actual market price quotes, or by determining the present value of
the projected future cash flows using appropriate discount rates, credit losses
and prepayment assumptions. Non-recourse debt is both floating and fixed, and is
considered within the security structure along with the associated collateral
for collateralized bonds. For the Senior Notes, the fair value was determined by
calculating the present value of the projected cash flows using appropriate
discount rates.
Derivative Financial Instruments
In June 2002, the Company entered into an interest rate swap which
matures on June 28, 2005, to mitigate its interest rate risk exposure on
$100,000 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. During the year ended December 31, 2002, the Company recognized a net
$3,984 in comprehensive loss on this position and incurred $1,018 of additional
interest expense.
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 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. In August 2002, the Company terminated these contracts at a
loss of $3,307.
In October 2002, the Company entered into a synthetic three-year
amortizing interest-rate swap (four packs of Eurodollar Futures contracts) with
an initial notional balance of approximately $80,000 to mitigate its exposure to
rising interest rates on a portion of its variable rate collateralized bonds,
which finance a like amount of fixed rate assets. This contract is accounted for
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. At
December 31, 2002, the current notional balance of the amortizing synthetic swap
was $67,000, and the remaining weighted-average fixed-rate payable by the
Company under the terms of the synthetic swap was 2.50%. During 2002, the
Company recognized $29 of interest expense and $447 in other comprehensive loss
for the synthetic interest-rate swap.
The following tables summarize the Company's derivative positions at
December 31, 2002:
December 31, 2002
Notional Net Realized Gross Unrealized Market Average
------------------------
Amount Gains/(Losses) Gains Losses Value in Years
------------- ---------------- ------------ ----------- ------------- ----------
Interest Rate Swap $ 100,000 $ (1,018) $ - $ 3,984 $ (3,984) 2.41
Eurodollar Futures 67,000 (29) - 447 (447) 2.24
- ----------------------- ------------- ---------------- ------------ ----------- ------------- ----------
Total derivatives $ 167,000 $ (1,047) $ - $ 4,431 $ (4,431) 2.34
- ----------------------- ------------- ---------------- ------------ ----------- ------------- ----------
The Company estimates that during 2003, $2,319 of the $3,984 net market
value losses on the interest rate swap will be recognized in income. Of the $447
net market value losses on the Eurodollar futures contracts, the Company
estimates that $230 will be recognized in income in 2003.
- -------------------------------------- ----------------------------------------------------------------------------
December 31, 2002
----------------------------------------------------------------------------
1 Year or Less 1 to 2 Years 2 to 3 Years Total
------------------ ------------------ ------------------ -------------------
Notional Amount Expiration
Interest Rate Swap $ - $ - $ 100,000 $ 100,000
Eurodollar Futures 27,000 20,000 20,000 67,000
- -------------------------------------- ------------------ ------------------ ------------------ -------------------
Weighted Average Pay Rate
Interest Rate Swap 3.73% 3.73% 3.73% 3.73%
Eurodollar Futures 1.94% 3.07% 3.76% 2.50%
- -------------------------------------- ------------------ ------------------ ------------------ -------------------
NOTE 12 - EARNINGS (LOSS) PER SHARE
The following table reconciles the numerator and denominator for both
the basic and diluted EPS for the years ended December 31, 2002, 2001, and 2000.
- ------------------------------- --------------------------- --------------------------- -------------------------------
2002 2001 2000
- ------------------------------- ------------- -------------- ------------- ------------- ------------- ----------------
Weighted-Average Weighted-Average Weighted-Average
Number of Number of Number of
Income Shares Income Shares Income Shares
(loss) (loss) (loss)
- ------------------------------- ------------- -------------- ------------- ------------- ------------- ----------------
(Loss) before extraordinary $(15,065) $ (6,057) $ (91,863)
item
Extraordinary item - gain 221 2,972 -
(loss) on extinguishment
of debt
------------- ------------- -------------
Net (Loss) (14,844) (3,085) (91,863)
Preferred stock (charges) (9,586) 7,717 (12,911)
benefit
------------- -------------- ------------- ------------- ------------- ----------------
Net (loss) income available $(24,430) 10,873,871 $ 4,632 11,430,471 $(104,774) 11,445,236
to common shareholders
Effect of dividends and - - - - - -
additional shares of
Series A, Series B, and
Series C preferred stock
------------- -------------- ------------- ------------- ------------- ----------------
$(24,430) 10,873,871 $ 4,632 11,430,471 $(104,774) 11,445,236
============= ============== ============= ============= ============= ================
Income (loss) per share before
extraordinary item:
Basic and diluted EPS $(2.27) $0.15 $(9.15)
============== ============= ================
Extraordinary item per share 0.02 0.26 -
============== ============= ================
Net income (loss) per share:
Basic and diluted EPS $(2.25) $0.41 $(9.15)
============== ============= ================
Dividends and potentially
anti-dilutive common
shares assuming conversion
of preferred stock: Shares Shares Shares
-------------- ------------- ----------------
Series A $ 2,321 496,019 $ 1,301 591,535 $ 3,063 654,531
Series B 3,226 689,354 1,510 845,827 4,475 956,217
Series C 4,039 691,766 2,207 835,986 5,373 920,000
Expense and incremental - 15,346 - 15,346 - -
shares of stock
appreciation rights
------------- -------------- ------------- ------------- ------------- ----------------
$ 9,586 1,892,485 $ 5,018 2,288,694 $ 12,911 2,530,748
- ------------------------------- ------------- -------------- ------------- ------------- ------------- ----------------
In 2002 and 2001, respectively, the Company did not issue any shares of
common stock. In 2000, the Company issued 107 shares of common stock. In 2002
and 2000, respectively, the Company did not retire any shares of common stock.
In 2001, the Company retired 570,246 shares received in connection with the
termination of a merger agreement with a third-party.
NOTE 13 - PREFERRED STOCK
The following table presents a summary of the Company's issued and
outstanding preferred stock:
- --------------------------------------------------------------------------------------------------------------------
Issue Price Dividends Paid Per Share
Per share 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------
Series A 9.75% Cumulative Convertible Preferred $24.00 $0.2925 $0.2925 $ -
Stock ("Series A")
Series B 9.55% Cumulative Convertible Preferred $24.50 $0.2925 $0.2925 $ -
Stock ("Series B")
Series C 9.73% Cumulative Convertible Preferred $30.00 $0.3651 $0.3649 $ -
Stock ("Series C")
- --------------------------------------------------------------------------------------------------------------------
The Company is authorized to issue up to 50,000,000 shares of preferred
stock. For all series issued, dividends are cumulative from the date of issue
and are payable quarterly in arrears. The dividends are equal, per share, to the
greater of (i) the per quarter base rate of $0.585 for Series A and Series B,
and $0.73 for Series C, or (ii) one-half times the quarterly dividend declared
on the Company's common stock. Two shares of Series A, Series B and Series C are
convertible at any time at the option of the holder into one share of common
stock. Each series is redeemable by the Company at any time, in whole or in
part, (i) two shares of preferred stock for one share of common stock, plus
accrued and unpaid dividends, provided that for 20 trading days within any
period of 30 consecutive trading days, the closing price of the common stock
equals or exceeds two-times the issue price, or (ii) for cash at the issue
price, plus any accrued and unpaid dividends. In April 2002, 100 shares of
Series B Preferred Stock were converted into 50 Shares of Common Stock resulting
in a $1 decrease in dividends-in-arrears and a like increase in Shareholders
Equity. No other shares of Series A, B or C preferred stock were converted
during 2002 or 2001.
In the event of liquidation, the holders of all series of preferred
stock will be entitled to receive out of the assets of the Company, prior to any
such distribution to the common shareholders, the issue price per share in cash,
plus any accrued and unpaid dividends. Preferred Stock charges includes the
current period dividend accrual amount for the Preferred Stock outstanding for
the year ended December 31, 2002 of $9,586. As of December 31, 2002, the total
amount of dividends-in-arrears was $31,157. Individually, the amount of
dividends-in-arrears on the Series A, the Series B and the Series C was $7,544
($7.60 per Series A share), $10,485 ($7.60 per Series B share) and $13,128
($9.49 per Series C share), respectively.
In 2001, the Company completed two separate tender offers on its Series
A, Series B, and Series C Preferred Stock, resulting in the purchase by the
Company of 1,307,118 shares of the Preferred Stock, consisting of 317,023 shares
of Series A, 533,627 shares of Series B and 456,468 shares of Series C, for an
aggregate purchase price of $19,998 and which had an aggregate issue price of
$34,376, a book value of $32,819, and including dividends in arrears, a
liquidation preference of $40,854. The difference of $12,735 between the
repurchase price and the book value has been included in the accompanying
financial statements as an addition to net income available to common
shareholders in the line item captioned Preferred Stock benefit (charges) as
required by EITF's D-42 and D-53. Also included in Preferred Stock benefit
(charges) is the cumulative dividend in arrears of $6,736 related to those
shares tendered, and which were effectively cancelled at such time they were
tendered. In addition, Preferred Stock benefit (charges) for the year ended
December 31, 2001 includes the current period dividend accrual amount for the
Preferred Stock outstanding for the year. There were no tender offers completed
in 2000 or 2002.
NOTE 14 - NET LOSS ON SALES, WRITE-DOWNS AND IMPAIRMENT CHARGES
The following table sets forth the composition of net loss on sales,
write-downs and impairment charges for the years ended December 31, 2002, 2001,
and 2000.
- -------------------------------------------------------------------------------------------------------------------
For the years ended,
----------------------------------------------------------------
2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
Impairment charges $ 18,544 $ 25,315 $ 22,135
Sales of investments 303 439 15,872
Phase-out of commercial production operations - 680 50,940
Litigation - (6,095) (5,600)
Sales of loan production operations - 755 228
Other (548) (140) 464
- -------------------------------------------------------------------------------------------------------------------
$ 18,299 $ 20,954 $ 84,039
- -------------------------------------------------------------------------------------------------------------------
Impairment charges include other-than-temporary impairment of debt
securities pledged as collateral for collateralized bonds of $15,563, $15,840
and $5,523 for 2002, 2001 and 2000, respectively. Impairment charges for 2002
also included $2,053 for the adjustment to the lower of cost or market for
certain delinquent single-family mortgage loans acquired in 2002 which at that
time were considered as held-for-sale. During 2002 and 2001, the Company
incurred other-than-temporary impairment charges of none and $7,678,
respectively, on its investment in delinquent property tax receivables and
valuation adjustments of $927 and $1,797, respectively, for related real estate
owned.
During each of the years ended December 31, 2001 and 2000, the Company
incurred losses related to the phasing-out of its commercial production
operations, including the sale of substantially all of the Company's remaining
commercial and multifamily loans not previously securitized. During 2000, the
Company sold substantially all of its remaining loans held for sale, and
including the lower of cost or market adjustment for those loans held for sale
remaining at December 31, 2000, incurred losses aggregating $20,656. The Company
also incurred losses of $30,284 related to a conditional repurchase option to
purchase $167,800 of tax-exempt bonds secured by multifamily mortgage loans, and
which the Company did not exercise. The counter-party to the option agreement
retained $30,284 of cash in collateral as a result.
The Company incurred gross gains of $359, $291, and none and gross
losses of $662, $730, and $15,872 related to the sales of investments in 2002,
2001, and 2000, respectively. Gross losses included write-downs and impairment
charges recorded in anticipation of the sale of such investments.
During 2000, the Company settled outstanding litigation for $20,000.
The Company had accrued a reserve in 1999 for $27,000 related to the litigation,
and reversed $5,600 of this reserve during the year ended December 31, 2000. As
a condition to the settlement, the Company received all of the outstanding
capital stock of entities from which the Company had previously purchased
securities, and such entities were included in the Company's consolidated
financial statements from that point forward. The Company recorded permanent
impairment charges of $16,612 in 2000, resulting from write-downs required on
securities that the Company owned that it had previously purchased in 1998 and
1999 from entities. In 2000, the Company completed the sale of substantially all
of the remaining outstanding securities and loans issued or owned by the
entities. In February 2001, the Company resolved a matter related to this
litigation to the mutual satisfaction of the parties involved. In connection
with the resolution of this matter, the Company received $7,500, and recorded a
gain of $7,095, net of expenses. During 2001, the Company also settled
litigation for a net $1,000 charge related to a failed merger of the Company
with a third-party. The Company received in connection with this litigation
570,246 shares of its common stock which it subsequently retired.
NOTE 15 - EMPLOYEE BENEFITS
Stock Incentive Plan
Pursuant to the Company's 1992 Stock Incentive Plan, as amended on
April 24, 1997 (the "Employee Incentive Plan"), the Company may grant to
eligible employees stock options, stock appreciation rights ("SARs") and
restricted stock awards. An aggregate of 2,400,000 shares of common stock is
available for distribution pursuant to the Employee Incentive Plan. The Company
may also grant dividend equivalent rights ("DERs") in connection with the grant
of options or SARs.
The Company issued 30,000 SARs to an executive during 2001 at an
exercise price of $2.00 and which vested 100% at the earlier of (i) June 30,
2002 or (ii) the termination of the executive by the Company without cause.
Those SARs were not exercised in 2002.
The Company incurred expense of $85, none and $276 for SARs and DERs
related to the Employee Incentive Plan during 2002, 2001 and 2000, respectively.
Stock Incentive Plan for Outside Directors
In 1995, the Company adopted a Stock Incentive Plan for its Board of
Directors (the "Board Incentive Plan") with terms similar to the Employee
Incentive Plan. The maximum number of shares of common stock encompassed by the
SARs granted under the Board Incentive Plan is 200,000.
The Company expensed $14 for SARs and DERs related to the Board
Incentive Plan during 2000 and there was no expense during 2002 and 2001.
In 2000, the Company redeemed for cash all SARs and related DERs
outstanding at such time, valuing the SARs and related DERs pursuant to a
commonly used option-valuation model and using consideration for the common
stock to be paid by a potential acquirer of the Company at that time. The
following table presents a summary of the SARs activity for both the Employee
Incentive Plan and the Board Incentive Plan.
- ----------------------------------------- -----------------------------------------------------------------------
Years ended December 31,
2002 2001
- -----------------------------------------------------------------------------------------------------------------
Weighted- Weighted-
Number Average Number Average
Of Exercise Of Exercise
Shares Price Shares Price
- -----------------------------------------------------------------------------------------------------------------
SARs outstanding at beginning of year 30,000 $ 2.00 - $ -
SARs granted - - 30,000 2.00
SARs forfeited or redeemed - - - -
SARs exercised - - - -
SARs outstanding at end of year 30,000 2.00 30,000 2.00
SARs vested and exercisable 30,000 $ 2.00 - $ -
- ----------------------------------------- ------------------ ----------------- ------------------ ---------------
Employee Savings Plan
The Company provides an Employee Savings Plan under Section 401(k) of
the Internal Revenue Code. The Employee Savings Plan allows eligible employees
to defer up to 12% of their income on a pretax basis. The Company matches the
employees' contribution, up to 6% of the employees' eligible compensation. The
Company may also make discretionary contributions based on the profitability of
the Company. The total expense related to the Company's matching and
discretionary contributions in 2002, 2001, and 2000 was $127, $91 and $130,
respectively. The Company does not provide post employment or post retirement
benefits to its employees.
401(k) Overflow Plan
During 1997, the Company adopted a non-qualifying overflow plan which
covers employees who have contributed to the Employee Savings Plan the maximum
amount allowed under the Internal Revenue Code. The excess contributions are
made to the overflow plan on an after-tax basis. However, the Company partially
reimburses employees for the effect of the contributions being made on an
after-tax basis. The Company matches the employee's contribution up to 6% of the
employee's eligible compensation. The total expense related to the Company's
reimbursements in 2002, 2001, and 2000 was $11, $21, and $8, respectively.
NOTE 16 - COMMITMENTS AND CONTINGENCIES
The Company makes various representations and warranties relating to
the sale or securitization of loans. To the extent the Company were to breach
any of these representations or warranties, and such breach could not be cured
within the allowable time period, the Company would be required to repurchase
such loans, and could incur losses. In the opinion of management, no material
losses are expected to result from any such representations and warranties.
As of December 31, 2002, the Company is obligated under non-cancelable
operating leases with expiration dates through 2007. Rent and lease expense
under those leases was $442, $444 and $442, respectively in 2002, 2001, and
2000. The future minimum lease payments under these non-cancelable leases are as
follows: 2003--$465, 2004--$414, 2005--$211, 2006--$119 and 2007--$79,
thereafter---$0; aggregate----$1,288.
NOTE 17 - LITIGATION
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"),
the appellate court of the state of Pennsylvania. Plaintiffs were two local
businesses seeking status to represent as a class, delinquent taxpayers in
Allegheny County whose delinquent tax liens had been assigned to GLS. 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, and whether the County had the right to assign the delinquent property
tax receivables to GLS and therefore employ procedures for collection enjoyed by
Allegheny County under state statute.. This lawsuit was related to the purchase
by GLS of delinquent property tax receivables from Allegheny County in 1997,
1998, and 1999. In July 2001, the Commonwealth Court issued a ruling that
addressed, among other things, (i) the right of GLS to charge to the delinquent
taxpayer a rate of interest of 12% per annum versus 10% per annum on the
collection of its delinquent property tax receivables, (ii) the charging of a
full month's interest on a partial month's delinquency; (iii) the charging of
attorney's fees to the delinquent taxpayer for the collection of such tax
receivables, and (iv) the charging to the delinquent taxpayer of certain other
fees and costs. The Commonwealth Court in its opinion remanded for further
consideration to the lower trial court items (i), (ii) and (iv) above, 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. The
Commonwealth Court further ruled that Allegheny County could assign its rights
in the delinquent property tax receivables to GLS, and that plaintiffs could
maintain equitable class in the action. In October 2001, GLS, along with
Allegheny County, filed an Application for Extraordinary Jurisdiction with the
Supreme Court of Pennsylvania, Western District appealing certain aspects of the
Commonwealth Court's ruling. In March 2003, the Supreme Court issued its opinion
as follows: (i) the Supreme Court determined that GLS can charge delinquent
taxpayers a rate of 12% per annum; (ii) the Supreme Court remanded back to the
lower trial court the charging of a full month's interest on a partial month's
delinquency; (iii) the Supreme Court revised the Commonwealth Court's ruling
regarding recouping attorney fees for collection of the receivables indicating
that the recoupment of fees requires a judicial review of collection procedures
used in each case; and (iv) the Supreme Court upheld the Commonwealth Court's
ruling that GLS can charge certain fees and costs, while remanding back to the
lower trial court for consideration the facts of each individual case. Finally,
the Supreme Court remanded to the lower trial court to determine if the
remaining claims can be resolved as a class action. No hearing date has been set
for the issues remanded back to the lower trial court.
The Company and Dynex Commercial, Inc. ("DCI"), formerly an affiliate
of the Company and now known as DCI Commercial, Inc., are defendants in state
court in Dallas County, Texas in the matter of Basic Capital Management et al
("BCM") versus Dynex Commercial, Inc. et al. The suit was filed in April 1999
originally against DCI, and in March 2000, BCM amended the complaint and added
the Company. The current complaint alleges that, among other things, DCI and the
Company failed to fund tenant improvement or other advances allegedly required
on various loans made by DCI to BCM, which loans were subsequently acquired by
the Company; that DCI breached an alleged $160,000 "master" loan commitment
entered into in February 1998 and a second alleged loan commitment of
approximately $9,000; that DCI and the Company made negligent misrepresentations
in connection with the alleged $160,000 commitment; and that DCI and the Company
fraudulently induced BCM into canceling the alleged $160,000 master loan
commitment in January 1999. Plaintiff BCM is seeking damages approximating
$40,000, including approximately $36,500 for DCI's breach of the alleged
$160,000 master loan commitment, approximately $1,600 for alleged failure to
make additional tenant improvement advances, and approximately $1,900 for DCI's
not funding the alleged $9,000 commitment. DCI and the Company are vigorously
defending the claims on several grounds. The Company was not a party to the
alleged $160,000 master commitment or the alleged $9,000 commitment. The Company
has filed a counterclaim for damages approximating $11,000 against BCM.
Commencement of the trial of the case in Dallas, Texas is anticipated in
September 2003.
In November 2002, the Company received notice of a Second Amended
Complaint filed in the First Judicial District, Jefferson County, Mississippi in
the matter of Barbara Buie and Elizabeth Thompson versus East Automotive Group,
World Rental Car Sale of Mississippi, AutoBond Acceptance Corporation, Dynex
Capital, Inc. and John Does # 1-5. The Second Amended Complaint represents a
re-filing of the First Amended Complaint against the Company, which was
dismissed by the Court without prejudice in August 2001. The Second Amended
Complaint in reference to the Company alleges that Plaintiffs were the
beneficiaries of a contract entered into between AutoBond Acceptance Corporation
and the Company, and alleges that the Company breached such contract and that
such breach caused them to suffer economic loss. The Plaintiffs are seeking
compensatory damages of $1,000 and punitive damages of $1,000. Defendants East
Automotive Group and World Rental Car Sale of Mississippi have also filed cross
complaints against the Company. In February 2003, both the Second Amended
Complaint and the cross complaint were dismissed with prejudice by the
Mississippi Court.
Although no assurance can be given with respect to the ultimate outcome
of the above litigation, the Company believes the resolution of these lawsuits,
or any other claims against the Company, 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 18 - SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS INFORMATION
- ---------------------------------------------------------- ----------------------------------------------------
Years ended December 31,
- ---------------------------------------------------------- ----------------------------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------
Cash paid for interest $130,654 $177,674 $249,699
Supplemental disclosure of non-cash activities:
Collateral for collateralized bonds owned, 453,400 - -
subsequently securitized
Securities owned subsequently securitized 2,020 - 71,209
- ------------------------------------------------------------ -------------- -- --------------- -- ---------------
NOTE 19 - RELATED PARTY TRANSACTIONS
Prior to the liquidation of DHI in December 2000, the Company had a
credit arrangement with DHI whereby DHI and any of DHI's subsidiaries could
borrow funds from Company to finance its operations. Under this arrangement, the
Company could also borrow funds from DHI. The terms of the agreement allowed DHI
and its subsidiaries to borrow up to $50,000 from the Company at a rate of Prime
plus 1.0%. The Company could borrow up to $50,000 from DHI at a rate of
one-month LIBOR plus 1.0%. As of December 31, 2000, as a result of the
liquidation, amounts due to DHI under the borrowing arrangement were forgiven.
Net interest expense under this agreement was $1,403 for the year ended December
31, 2000.
The Company had a funding agreement with DCI, formerly an operating
subsidiary of DHI and formerly known as Dynex Commercial, Inc., whereby the
Company paid DCI a fee for commercial mortgage loans transferred to the Company
from DCI. The Company paid DCI none, none and $288, respectively under this
agreement for the years ended December 31, 2002, 2001, and 2000, respectively.
Effective December 31, 2000, DCI is no longer an operating subsidiary of the
Company or DHI and is now owned by certain officers of the Company. The Company
and DCI have been jointly named in litigation regarding the activities of DCI
while it was an operating subsidiary of DHI. The Company and DCI entered into a
Litigation Cost Sharing Agreement whereby the parties set forth how the costs of
defending against litigation would be shared, and whereby the Company agreed to
fund all costs of such litigation, including DCI's portion. DCI has no assets
but has asserted counterclaims in the litigation. DCI's portion of costs
associated with the litigation and funded by the Company is $2,146 and is
secured by the proceeds of any counterclaims that DCI may receive in the
litigation. DCI costs funded by the Company are considered loans, and bear
simple interest at the rate of Prime plus 8.0% per annum. At December 31, 2002,
the amount due the Company under the Litigation Cost Sharing Agreement was
$2,394, which has been fully reserved by the Company.
During 1999, the Company made a loan to Thomas H. Potts, president of
the Company, as evidenced by a promissory note in the aggregate principal amount
of $935 (the "Potts Note"). The Potts note was repaid in full in 2002.
NOTE 20 - NON-CONSOLIDATED AFFILIATES
The following tables summarizes the financial condition and result of
operations of all entities for which the Company accounts for by use of the
equity method.
- ----------------------------------------------------------------------------------------------------------------------
Condensed Statement of Operations
- ----------------------------------------------------------------------------------------------------------------------
2002 2001 2000
---------------------------- ---------------------------- ----------------------------
Total revenues $2,538 $2,538 $6,697
Total expenses 2,048 2,127 7,053
Net income (loss) 490 411 (357)
- ----------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Condensed Balanced Sheet
- --------------------------------------------------------------------------------
December 31,
--------------------------------------------------------------
2002 2001
-------------------------------------- -----------------------
Total assets $17,560 $18,053
Total liabilities 15,801 16,783
Total equity 1,759 1,270
- ----------------- -------------------------------------- -----------------------
During 2000 the Company owned a 99% preferred stock interest in DHI
which it accounted for using the equity method. Effective December 31, 2000, DHI
was liquidated pursuant to Internal Revenue Code Sections 331 and 336 in a
taxable liquidation.
The Company has a 99% limited partnership interest in a partnership that
owns a commercial office building located in St. Paul, Minnesota. The building
is leased pursuant to a triple-net master lease to a single-tenant, and the
second mortgage lender has a bargain purchase option to purchase the building in
2007. Rental income derived from the master lease for the term of the lease
exactly covers the operating cash requirements on the building, including the
payment of debt service. The Company, through its consolidated subsidiary
Commercial Capital Access One, Inc., has made a first mortgage loan secured by
the commercial office building with an unpaid principal balance as of December
31, 2002 of $24,597. The Company accounts for the partnership using the equity
method. The partnership had net income of $490, $411 and $324 for the years
ended December 31, 2002, 2001 and 2000, respectively. Due to the bargain
purchase option any increase in basis of the investment due to the accrual of
its share of earnings of the partnership is immediately reduced by a charge of a
like amount to the same account, given the probability of exercise of the option
by the second mortgage lender. The Company's investment in this partnership
amounted to $11 on December 31, 2002 and 2001.
As a result of the liquidation of DHI into the Company in December
2000, at December 31, 2002 the Company owned a 1% limited partnership interest
in a partnership which owns a low income housing tax credit multifamily housing
property located in Texas. In May 2001, the Company sold a ninety-eight percent
limited partnership interest in partnership to a director for a purchase price
of $198, which was equal to its estimated fair value. By reason of the
director's investment in the partnership, the Company has guaranteed to the
director the use of the low-income housing tax credits associated with the
property, proportionate to his investment, that are reported annually to the
Internal Revenue Service. During 2002 and 2001, the Company loaned the
partnership $17 and $232, respectively, and the Company through its subsidiary,
Commercial Capital Access One, Inc., has made a first mortgage loan to the
partnership secured by the Property, with a current unpaid principal balance of
$1,908. As the Company does not have control or exercise significant influence
over the operations of this partnership, its investment and advances of $250 at
December 31, 2002 is accounted for using the cost method.
NOTE 21 - SECURITIZATION
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.
Approximately $12 million of delinquent loans were not included in the
securitization and were retained by the Company. As the residual interest holder
in the collateral, the Company has the option to redeem the collateral at the
earlier of April 2007 or the month when the principal balance reaches 35% of the
original balance of the loans at the time of closing. The Company retains an
interest in a servicing strip in exchange for advancing responsibilities on a
balance of $88,567 as of December 31, 2002.
NOTE 22 - SUMMARY OF FOURTH QUARTER RESULTS
The following table summarizes selected information for the quarter ended
December 31, 2002:
- --------------------------------------------------------------------------------
Operating results:
Net interest margin before provision for losses $ 11,075
Provision for losses (12,191)
---------
Net interest margin (1,116)
Net losses on impairment charges (8,691)
Net loss (12,861)
Basic & diluted loss per common share (1.40)
- ------------------------------------------------------------------------------
The continuing under-performance of the Company's manufactured housing loan
and securities portfolio prompted the company to revise its estimate of losses
to include a percentage of all loans with delinquencies greater than 30 days.
This revision, which was instituted during the fourth quarter of 2002, resulted
in an increase in provision for loan losses of $7,347. The Company recorded
impairment charges during the fourth quarter of $8,691 which was entirely
related to its manufactured housing debt security portfolio for the same
reasons.
EXHIBIT INDEX
Exhibit Sequentially
Numbered Page
3.12 Amendments to Bylaws I
21.1 List of consolidated entities II
23.1 Consent of Deloitte & Touche LLP III
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 unanimous vote
of the Board of Directors at a meeting duly held, the Company's Amended and
Restated Bylaws ("Bylaws") was amended as follows:
(1) By deleting the second paragraph of Section 2.05 of Article II of
the Bylaws was deleted in its entirety and inserting in lieu thereof the
following:
"In the absence of a quorum, the Chairman of the meeting or
the stockholders present in person or by proxy acting by a majority
vote and without notice other than by announcement at the meeting may
adjourn the meeting from time to time but not for a period exceeding
120 days after the original meeting date, until a quorum shall attend."
(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,
neither of whom will be an officer of the Company, unless so designated
by the Board."
(3) By deleting paragraph four of Section 3.07 of Article III of the
Bylaws in its entirety and inserting in lieu thereof the following:
"Notice of the place and time of every meeting of the Board of
Directors shall be delivered by the Secretary to each director
personally, by first-class mail, or by telephone, which shall also
include voice-mail, telegram or telegraph, or by electronic mail to any
electronic address of the director or by any other electronic means, or
by leaving the same at his residence or usual place of business at
least twenty-four hours before the time at which such meeting is to be
held, or if by first class mail, at least four days before the day on
which such meeting is to be held. If mailed, such notice shall be
deemed to be given when deposited in the United States mail addressed
to the director at his post office address as it appears on the records
of the Corporation, with postage thereon prepaid."
Dated: March 31, 2003 /s/ Stephen J. Benedetti
------------------------------------------
Stephen J. Benedetti, Secretary
Exhibit 21.1
Dynex Capital, Inc.
List of Consolidated Entities
As of December 31, 2002
Dynex Commercial Services, Inc.
Dynex Securities, Inc.
GLS Capital Services, Inc.
GLS Development, Inc.
SMFC Funding Corporation
MSC I L.P.
Issuer Holding Corp.
Commercial Capital Access One, Inc.
Resource Finance Co. One
Resource Finance Co. Two
ND Holding Co.
Merit Securities Corporation
Financial Asset Securitization, Inc.
GLS Capital, Inc.
GLS Properties, LLC
Allegheny Commercial Properties I, LLC
Allegheny Income Properties I, LLC
Allegheny Special Properties, LLC
GLS Capital Services - Marlborough, Inc.
GLS Capital - Cuyahoga, Inc.
GLS-Cuyahoga Lien Pool One, Inc.
SHF Corp.
NOTE: All companies were incorporated in Virginia except for GLS Properties,
LLC, Allegheny Commercial Properties I, LLC, Allegheny Income Properties I, LLC,
and Allegheny Special Properties, LLC (Pennsylvania).
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
333-22859, 333-10783, 333-10587 and 333-35769 of Dynex Capital, Inc. on Form S-3
and Registration Statement No. 333-32663 of Dynex Capital, Inc. on Form S-8 of
our report dated March 20, 2003, appearing in this Annual Report on Form 10-K of
Dynex Capital, Inc., for the year ended December 31, 2002.
DELOITTE & TOUCHE LLP
Richmond, Virginia
March 28, 2003