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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
10900 Nuckols Road, 3rd Floor, Glen Allen, Virginia 23060
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (804) 217-5800
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Title of each class Name of each exchange on which registered
Series A 9.75% Cumulative Convertible Preferred Stock, Nasdaq National Market
$.01 par value
Series B 9.55% Cumulative Convertible Preferred Stock, $.01 Nasdaq National Market
par value
Series C 9.73% Cumulative Convertible Preferred Stock, $.01 Nasdaq National Market
par value
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 XX No___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
As of February 28, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $146,723,220 (46,030,814
shares at a closing price on The New York Stock Exchange of $3.1875). Common
stock outstanding as of February 28, 1998 was 46,030,814 shares.
Item 8. Financial Statements and Supplemental Data and Exhibits 23.1 and 23.2 of
this Form 10-K have been omitted and the Company will be filing such items by
amendment pursuant to SEC Rule 12b-25 within the required 15 days.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement to be filed pursuant to Regulation
14A within 120 days from December 31, 1998, are incorporated by reference into
Part III.
DYNEX CAPITAL, INC.
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
PART I
Item 1. BUSINESS......................................................................... 3
Item 2. PROPERTIES....................................................................... 16
Item 3. LEGAL PROCEEDINGS................................................................ 16
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................. 17
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.................................................. 17
Item 6. SELECTED FINANCIAL DATA.......................................................... 18
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................... 19
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK...................................................................... 46
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................................... 48
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE........................................... 48
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................... 49
Item 11. EXECUTIVE COMPENSATION........................................................... 49
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT............................................................ 49
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................... 49
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K.......................................................... 49
SIGNATURES ................................................................................. 51
Item 1. BUSINESS
GENERAL
Dynex Capital, Inc. (the "Company") was incorporated in the Commonwealth of
Virginia in 1987. The Company is a financial services company which uses its
production operations to create investments for its portfolio. The primary
production operations include commercial mortgage lending and manufactured
housing lending. The commercial mortgage loans are secured by multifamily and
commercial real estate properties (hereinafter referred to as "commercial
loans") and the manufactured housing loans are secured by manufactured homes and
often the land on which the home resides. Through its specialty finance
businesses, the Company also provides for the purchase and leaseback of single
family model homes to builders and for the purchase and management of property
tax receivables. With the exception of the purchase and leaseback of single
family model homes, the Company will securitize the assets funded as collateral
for collateralized bonds, providing long-term financing for the investment
portfolio while limiting credit, interest rate and liquidity risk.
The Company's principal source of earnings is net interest income from its
investment portfolio. The Company's investment portfolio consists primarily of
collateral for collateralized bonds, asset-backed securities and loans held for
securitization. The Company funds its investment portfolio with both borrowings
and funds raised from the issuance of equity. For the portion of the investment
portfolio funded with borrowings, the Company generates net interest income to
the extent that there is a positive spread between the yield on the
interest-earning assets and the cost of borrowed funds. The cost of the
Company's borrowings may be increased or decreased by interest rate swap, cap or
floor agreements. For the other portion of investment portfolio funded with
equity, net interest income is primarily a function of the yield generated from
the interest-earning asset.
References to "Dynex REIT" mean the parent company and its wholly-owned
subsidiaries, consolidated for financial reporting purposes, while references to
the "Company" mean the parent company, its wholly-owned subsidiaries and Dynex
Holding, Inc. ("DHI") and its subsidiaries, which are not consolidated for
financial reporting or tax purposes. All of the outstanding non-voting preferred
stock (which represents a 99% economic interest in DHI) is owned by Dynex REIT.
All of the outstanding voting common stock (which represents a 1% economic
interest in DHI) is owned by certain senior officers of Dynex REIT. In light of
these factors, DHI is accounted for under a method similar to the equity method.
Dynex REIT has elected to be treated as a real estate investment trust ("REIT")
for federal income tax purposes under the Internal Revenue Code of 1986, as
amended, and, as such, must distribute substantially all of its taxable income
to shareholders and will generally not be subject to federal income tax.
Business Focus and Strategy
The Company strives to create a diversified investment portfolio that in the
aggregate generates stable income for the Company in a variety of interest rate
environments and preserves the capital base of the Company. The Company seeks to
generate growth in earnings and dividends per share in a variety of ways,
including (i) adding investments to its portfolio when opportunities in the
market are favorable; (ii) developing production capabilities to originate and
acquire financial assets in order to create attractively priced investments for
its portfolio, as well as control the underwriting and servicing of such
financial assets; and (iii) increasing the efficiency with which the Company
utilizes its equity capital over time. To increase potential returns to
shareholders, the Company also employs leverage through the use of secured
borrowings and repurchase agreements to fund a portion of its investment
portfolio. The Company's specific strategies for its lending operations and
investment portfolio are discussed below.
Lending Strategies
The Company strives to be a vertically integrated lender by performing the
sourcing, underwriting, funding and servicing of loans to maximize efficiency
and provide superior customer service. The Company generally employs the
following business strategies in its lending operations:
- develop production capabilities to originate and acquire financial
assets in order to create attractively priced investments for its
portfolio, generally at a lower cost than if investments with
comparable risk profiles were purchased in the secondary market;
- focus on products that maximize the advantages of the REIT tax
election;
- emphasize direct relationships with the borrower and minimize, to the
extent practical, the use of origination intermediaries;
- use internally generated guidelines to underwrite loans for all
product types and maintain centralized loan pricing; and
- perform the servicing function for loans on which the Company has
credit exposure; emphasizing the use of early intervention, focused
collection and loss mitigation techniques in the servicing process to
manage delinquencies with the goal of reducing delinquencies and
minimizing losses in its securitized loan pools.
During 1998, with the goal of potentially diversifying its lending operations,
the Company entered into a series of agreements with AutoBond Acceptance
Corporation ("AutoBond"), a specialty finance company engaged in underwriting,
acquiring and servicing automobile installment contracts to borrowers with
limited access to traditional sources of credit. In exchange for the Company
agreeing to purchase a limited amount of "funding notes" issued by a subsidiary
of AutoBond and secured by such automobile installment contracts, the Company
received an option to purchase approximately 85% of the common stock of AutoBond
from its three principal shareholders. However, due to the adverse results of a
compliance review conducted in January 1999, the Company ceased the purchase of
additional funding notes on February 3, 1999 and took a charge against its 1998
earnings of $17.6 million relating primarily to the funding notes and to a
lesser extent a convertible senior note, common stock, and preferred stock of
AutoBond that the Company had acquired. As a result of such adverse compliance
review, it is unlikely that the Company will exercise its option. The Company,
AutoBond, and the three principal shareholders of AutoBond are now in litigation
(see Item 3. Legal Proceedings).
Investment Portfolio Strategies
The Company generally employs the following business strategies in managing its
investment portfolio:
- use its loan origination capabilities to provide assets for its
investment portfolio, generally at a lower effective cost than if
investments of comparable risk profiles were purchased in the secondary
market;
- securitize its loan production to provide long-term financing for
its investment portfolio and to reduce the Company's liquidity,
interest rate and credit risk;
- utilize leverage to finance purchases of loans and investments in line
with prudent capital allocation guidelines which are designed to
balance the risk in certain assets, thereby increasing potential
returns to shareholders while seeking to protect the Company's equity
base; and
- structure borrowings to have interest rate adjustment indices and
interest rate adjustment periods that, on an aggregate basis,
generally correspond (within a range of one to six months) to the
interest rate adjustment indices and interest rate adjustment periods
of the related asset.
Lending Operations
The Company's primary lending activities include commercial mortgage lending and
manufactured housing lending. These lending activities are conducted through DHI
and its subsidiaries. Through DHI, the Company provides commercial mortgage
financing for apartment properties, assisted living and retirement housing,
limited service hotels/motels, urban and suburban office buildings, retail
shopping strips and centers and light industrial buildings. The Company's
manufactured housing production includes installment loans, land/home loans and
inventory financing to manufactured housing dealers. In addition to these
primary sources of loan production, the Company purchases model homes from
single family builders and simultaneously leases such homes back to the
applicable builder and purchases and manages real estate property tax
portfolios. Additionally, the Company has purchased and may continue to purchase
single family mortgage loans on a "bulk" basis, i.e. in pools aggregating $25
million or more, from time to time.
The main purposes of the Company's production operations are to enhance the
return on shareholders' equity ("ROE") by earning a favorable net interest
spread while assets are being accumulated for securitization and to create
investments for the Company's portfolio at a lower cost than if such investments
were purchased from third parties. The creation of such investments generally
involves the issuance of collateralized bonds or pass-through securities
collateralized by the loans generated from the Company's production activities,
and the retention of one or more classes of the collateralized bonds or
securities relating to such issuance. The securitization of loans as
collateralized bonds and pass-through securities generally limits the Company's
credit and interest rate risk in contrast to retaining loans in the portfolio in
whole-loan form.
The following table summarizes the production activity for the three years ended
December 31, 1998, 1997 and 1996.
Loan Production Activity
($ in thousands)
------------------------------------------------------------------------------------------------------------
For the Years Ended December 31
------------------------------------------------------------
1998 1997 1996
------------------------------------------------------------------------------------------------------------
Commercial (1) $ 674,086 $ 290,988 $ 201,496
Manufactured housing 482,979 265,906 41,031
Single family - - 499,288
Specialty finance 196,224 168,965 35,505
------------------------------------------------------------------------------------------------------------
Total fundings through direct production 1,353,289 725,859 777,320
Secured funding notes (2) 149,189 - -
Securities acquired through bond calls 455,714 493,152 -
Single family fundings through bulk purchases 562,045 1,271,479 731,460
------------------------------------------------------------------------------------------------------------
Total fundings $ 2,520,237 $ 2,490,490 $ 1,508,780
------------------------------------------------------------------------------------------------------------
Principal amount of loans and securities
securitized or sold $ 1,891,075 $ 2,278,633 $ 1,357,564
------------------------------------------------------------------------------------------------------------
(1) Included in commercial fundings were $228.6 million, $49.2 million and none
of multifamily construction loans closed during years ended December 31,
1998, 1997 and 1996, respectively. Only the amount drawn for these
loans of $46.1 million is included in the balance of the loans held for
securitization at December 31, 1998.
(2) Secured by automobile installment contracts.
During 1998, the Company funded $674.1 million of commercial loans consisting of
$415.0 million of multifamily loans (of which $228.6 million were
construction/permanent loans), and $259.1 million in other types of commercial
loans. The majority of the multifamily loans funded in 1998 consist of mortgage
loans on properties that have been allocated low income housing tax credits. The
Company initiated a construction/permanent lending program on multifamily
properties in the fourth quarter of 1997. The majority of such
construction/permanent loans is related to mortgage loans securing tax-exempt
bonds. Other types of commercial loans consist primarily of loans on office
buildings, retail centers, limited service hotels/motels, healthcare facilities
and light industrial space. As of December 31, 1998, commitments to fund
commercial loans were approximately $751.9 million. Additionally, the Company
securitized $433.7 million of its commercial loan production through a
collateralized bond issuance in December 1998.
During 1998, the Company funded $483.0 million of manufactured housing loans and
as of December 31, 1998, had commitments outstanding to fund $71.1 million of
such loans. The Company securitized a total of $323.3 million of its
manufactured housing production through the issuance of collateralized bonds
during 1998.
The Company's specialty finance businesses funded $196.2 million during 1998.
Such fundings principally included the purchase and leaseback of $129.1 million
of model homes and the acquisition of $62.7 million of property tax receivables.
The Company securitized a total of $86.0 million of its property tax receivables
through the issuance of collateralized bonds during 1998.
During 1998, the Company purchased $149.2 million of funding notes secured by
automobile installment contracts pursuant to its agreement with AutoBond.
At December 31, 1998, the Company owned the right to call $0.8 billion of
securities previously issued by the Company once the outstanding balance of such
securities reaches 10% or less of the original amount issued. During 1998, the
Company exercised its call rights on $455.7 million of such securities, of which
$452.1 million were included in new securitizations during 1998.
Additionally, during 1998, the Company purchased $562.0 million of single family
adjustable-rate ("ARM") loans through bulk purchases. The Company may continue
to purchase single family loans on a bulk basis to the extent, that upon
securitization, such purchases would generate a favorable return to the Company
on a proforma basis. All of the single family ARM loans purchased were
securitized through the issuance of collateralized bonds in 1998.
Commercial Mortgage Lending Operations
The Company originally entered the commercial market in 1992 as a multifamily
lender focused on multifamily mortgage loans secured by apartment properties
that qualified for low-income housing tax credits ("LIHTCs") under Section 42 of
the Internal Revenue Code. Since 1992, the Company has funded or provided loan
commitments for approximately $1.8 billion of LIHTC communities nationwide. The
Company believes that it is one of the country's leading LIHTC lenders, with an
estimated market share of 15%. In 1997, the Company broadened its commercial
mortgage lending beyond LIHTC apartment properties to include apartment
properties that have not received LIHTCs, assisted living and retirement
housing, limited service hotels/motels, office buildings, retail shopping strips
and centers and light industrial buildings. The Company's expansion into
non-multifamily commercial lending during 1997 was due to several factors: (i)
to increase volume to expedite securitizations, (ii) to capitalize on the
underwriting, closing and servicing infrastructure that the Company already had
in place, and (iii) to benefit in the securitization rating levels from a more
diversified pool of loans. Historically, the commercial loans have been combined
with the multifamily loans and securitized through the issuance of
collateralized bonds.
LIHTC Lending
For property owners to comply with the LIHTC regulations, owners must "set
aside" at least 20% of the units for rental to families with income of 50% or
less of the median income for the locality as determined by the Department of
Housing and Urban Development ("HUD"), or at least 40% of the units to families
with income of 60% or less of the HUD median income. Most owners elect the
"40-60 set-aside" and designate 100% of the units in the project as LIHTC units.
Additionally, rents cannot exceed 30% of the annual HUD median income adjusted
for the unit's designated "family size."
Generally, the LIHTCs are sold by the developers to investors prior to
construction in order to provide equity for the project. The sale of the LIHTCs
typically provides funds equal to approximately 50% of the construction costs of
the project. The multifamily loans made by the Company normally fund the
difference between the project cost (including a fee to the developer) and the
funds generated from the sale of the LIHTCs. The average principal balance of
LIHTC loans originated in 1998 was $3.6 million, ranging in size from $1.0
million to $8.0 million. The multifamily mortgage loans originated by the
Company are sourced through direct relationships with the developers and
syndicators of LIHTCs.
Multifamily Construction/Permanent Lending
As a part of its product expansion efforts during 1997, the Company began
offering a multifamily construction/permanent loan program for LIHTC properties.
The construction loans range in size from $1.0 million to $15.0 million with a
loan-to-value of 80% (85% in the case of a tax-exempt bond) or less of the
appraised property value. The Company underwrites each property to its required
debt service coverage and loan-to-value levels, and serves as the construction
loan administrator on each property.
Tax-exempt Bonds
The Company facilitates the issuance of tax-exempt multifamily housing bonds,
the proceeds of which are used to fund mortgage loans on multifamily properties.
The Company enters into standby commitment agreements whereby the Company is
required to pay principal and interest to the bondholders in the event there is
a payment shortfall on the underlying mortgage loans. In addition, the Company
is required to purchase the bonds if such bonds are not able to be remarketed by
the remarketing agent. The bonds are remarketed in the tax-exempt market
generally every seven days. The Company has obtained letters of credit to
support its obligations in amounts equal $144.2 million at December 31, 1998.
Other Commercial Lending
The Company sources commercial loans through direct relationships with
developers, property owners and on a selected basis from commercial mortgage
bankers. The Company's underwriting guidelines for other commercial mortgage
loans are generally consistent with rating agency and investor requirements. The
other commercial mortgages primarily have fixed interest rates with loan sizes
that generally vary from $2.0 million to $20 million. The product types include
mainly office buildings, limited service hotels/motels, industrial warehouse,
distribution centers, retirement homes and retail properties.
Underwriting Guidelines
The Company underwrites all commercial mortgage loans it originates. Among other
criteria, the Company underwrites each loan to a specific minimum debt service
coverage ratio relative to the property's net cash flow, with a maximum loan to
value of 80% of appraised value, except for multifamily properties relating to
tax-exempt bonds, which have a maximum loan-to-value of 85%. The Company's
underwriting criteria are designed to assess the particular property's current
and future capacity to make all debt service payments on a current basis and to
ensure that adequate collateral value exists to support the loan. With the
exception of LIHTC properties, an internal loan committee approves all loans,
with a majority of its members not directly related to the commercial loan
production function.
New Commitments
Due to the disruption in the commercial mortgage-backed securities market during
the fourth quarter of 1998, the Company has decided not to issue new commitments
for commercial loans for the foreseeable future unless such loan can be sold or
placed with an investor upon funding, with the Company retaining the servicing
rights. The Company still plans to securitize the majority of its commercial
loans held for securitization and those for which commitments have already been
issued.
Manufactured Housing Lending Operations
The Company has been funding manufactured housing loans since 1996. The Company
believes the manufactured housing lending market is growing as a result of
strong customer demand. The market for loans on new manufactured homes is
approximately $14 billion annually, and is expected to continue growing as
shipments of multi-section homes relative to single-section homes increases and
average loan size increases. The manufactured home is gaining greater market
acceptance as the product's quality improves and its affordability remains
attractive versus site built housing.
A manufactured home is distinguished from a traditional single family home in
that the housing unit is constructed in a plant, transported to the site and
secured to a pier or a foundation, whereas a single family home is built on the
site. The majority of the manufactured housing loans are in the form of a
consumer installment loan (i.e., a personal property loan) in which the borrower
rents or owns the land underlying the manufactured home. However, an increasing
percentage of these loans are in the form of a "land/home" loan, (i.e., a first
lien mortgage loan) in which the loan is secured by both the land and the
manufactured home. The Company offers both fixed and adjustable rate loans with
terms ranging from 7 to 30 years. As of December 31, 1998, the Company had
$197.1 million in principal balance of manufactured housing loans in inventory
and had commitments outstanding of approximately $71.1 million. During 1998, the
average funded amount per loan was approximately $45,100. To date, approximately
97% of the Company's loan fundings have been fixed interest rate loans.
The Company has two primary distribution channels -- its dealer network and
direct lending. Substantially all new manufactured homes are sold through
manufactured housing dealers. Approximately 90% of these homes are financed.
There are over 7,000 manufactured housing dealers operating in the United
States, many with multiple sales locations. As of December 31, 1998, the Company
had 1,460 approved dealers with 3,167 sales locations.
The Company services its dealer network through its home office in Virginia and
its five regional offices located in North Carolina, Georgia, Texas, Ohio and
Washington. The Company also has four district sales offices. Each regional
office supports three to four district sales managers who establish and maintain
relationships with manufactured housing dealers. By using the
home/regional/district office structure, the Company has created a decentralized
customer service and loan origination organization with centralized controls and
support functions. The Company believes that this approach also provides the
Company with a greater ability to maintain customer service, to respond to
market conditions, to enter and exit local markets and to test new products.
The Company established its direct lending operations in Glen Allen, Virginia
during 1998. Through this facility, the Company offers to owners of manufactured
homes the opportunity to refinance their existing manufactured home loan.
Potential borrowers are sourced in a variety of ways including direct mail,
telemarketing, advertising and relationships with park owners, developers of
manufactured housing communities, manufacturers of manufactured homes, brokers
and correspondents.
Inventory Financing.
The Company offers inventory financing, or "lines of credit," to retail dealers
for the purpose of purchasing manufactured housing inventory to display and sell
to customers. Under such arrangements, the Company will lend against the
dealer's line of credit when an invoice representing the purchase of a
manufactured home by a dealer is presented to the Company by the manufacturer of
the manufactured home. Prior to approval of the line of credit for the dealer,
the Company will perform a financial review of the manufacturer as well as the
dealer. The Company performs monthly inspections of the dealer's inventory
financed by the Company and annual reviews of both the dealer and the
manufacturer. The Company believes that offering this product will increase
market presence and will enable the Company to improve its positioning with the
dealers and manufacturers.
Underwriting Guidelines The Company underwrites 100% of the manufactured housing
loans it originates. The loans are underwritten at the regional offices based on
guidelines established by the home office. Home office approvals are required
when loan amounts exceed specified lines of credit authority. Turnaround for
approvals to the dealer is generally within four to twenty-four hours, with
fundings usually within twenty-four to forty eight hours of receipt of complete
documentation.
As the majority of the Company's manufactured housing loan production comes from
its dealer base, the Company has a dealer approval process that must be
completed before the Company can accept loan applications from a dealer. The
Company's dealer qualification criteria includes minimum equity requirements,
minimum years of experience for principal officers, acceptable historical
financial performance and various business references. The dealer application
package is submitted by the dealer to the regional office manager for review and
approval.
Because of the decentralized nature of the Company's manufactured housing
business, in addition to the Company's underwriting process and dealer approval
program, the Company also performs regional and district office reviews on a
frequent basis to ensure that required procedures are being followed. These
reviews include the collections area, the remarketing of foreclosed or
repossessed homes, underwriting, dealer performance and quality control. The
periodic regional quality control reviews are performed to ensure that the
underwriting guidelines are consistently applied. The Company also performs
audits on a sample of customers both before and after funding of the loan.
Specialty Finance
Model Home Sales/Leaseback.
The Company provides financing to single family home builders through a
sale/leaseback program in which the Company purchases single family homes from
builders and the builders simultaneously lease back the homes for use as models.
The Company has an appraisal performed on each home and limits the amount of the
loan or purchase price for the homes to a predetermined percentage of each
home's appraised value. Upon expiration of the lease period, the Company sells
the home to a third-party buyer. The lease terms are generally 12-24 months and
can be extended at the option of the builder upon approval of the Company.
During 1998, through a subsidiary of DHI, the Company purchased and
simultaneously leased to builders $129.1 million of model homes. At December 31,
1998, the Company had $183.0 million of model homes on lease to 28 builders
throughout the United States and Mexico.
Property Tax Receivables.
Since 1993, the Company has been involved in the purchase and management of
property tax receivables from various state and local jurisdictions. A property
tax receivable is a delinquent tax on real property that has a lien status
superior to any mortgage (and most other liens) on the property. As a result,
the property tax receivables generally have a very low "lien-to-value". Various
jurisdictions sell these property tax receivables to investors, as the private
sector is more efficient and better equipped to collect the taxes and to get the
properties back on the tax rolls. The Company offers payment plans to taxpayers
in order to assist them in bringing their property taxes current. In the event
the taxpayer does not pay the property tax receivable, the Company has the right
to foreclose on the property to recover the amount of the tax and associated
costs. Over 80% of the property tax receivables are on single family residential
properties. The Company has established local offices responsible for collecting
the property tax receivables, and if necessary, foreclosing on the properties in
the event that the collection efforts fail. During 1998, the Company purchased
$62.7 million of property tax receivables. At December 31, 1998, the Company had
$7.1 million of property tax receivables held for securitization.
Single Family Lending
Pursuant to the terms of the sale of the Company's single family mortgage
operations to a subsidiary of Dominion Resources, Inc. during the second quarter
of 1996, the Company is precluded from originating or purchasing certain types
of single family loans through a wholesale or correspondent network through
April, 2001. However, the Company may purchase any type of single family loans
on a bulk basis, i.e., in blocks of $25 million or more, and may originate loans
on a retail basis. During 1998, the Company purchased $562.0 million of single
family, "A" quality loans through such bulk loan purchases and securitized the
entire amount.
Asset Servicing
During 1996, the Company established the capability to service both commercial
and manufactured housing loans funded through its production operations. The
purpose of servicing the loans funded through the production operations is to
manage the Company's credit exposure more effectively while the loans are held
for securitization, as well as to limit the credit exposure that is usually
retained when the Company securitizes the pool of loans. The commercial
servicing function is located in Glen Allen, Virginia and includes collection
and remittance of principal and interest payments, administration of tax and
insurance accounts, management of the replacement reserve funds, collection of
certain insurance claims and, in the event of default, the workout of such
situations through either a modification of the loan or the foreclosure and sale
of the property. As of December 31, 1998, the Company had a commercial servicing
portfolio totaling $1.1 billion. There were no delinquencies in the commercial
loan servicing portfolio as of December 31, 1998.
The manufactured housing servicing function is operated in Fort Worth, Texas. As
the servicer of manufactured housing loans, the Company is responsible for the
collection and remittance of monthly principal and interest payments,
administration of taxes and insurance for land/home loans, and if the loan
defaults, the resolution of the defaulted loan through either a modification of
the loan or the repossession/foreclosure and sale of the related property. With
manufactured housing loans, minimizing the time between the date the loan goes
in default and the time that the manufactured home is repossessed/foreclosed and
sold is critical to mitigating losses on these loans. The Company's servicing
portfolio of manufactured housing loans totaled $714.0 million at December 31,
1998. On such date, 60 day and over delinquencies, including
repossessions/foreclosures, were 1.3%.
The Company services the model homes it purchases and leases back to the
applicable builder. At December 31, 1998, 3.0% of the model homes had been off
lease for greater than 60 days.
During 1997, the Company established a servicing function in Pittsburgh,
Pennsylvania, to manage the collection of the Company's property tax
receivables. The Company's responsibilities as servicer include contacting
property owners, collecting voluntary payments, and foreclosing, rehabilitating
and selling remaining properties if collection efforts fail. As of December 31,
1998, the Company had a servicing portfolio of $77.3 million of property tax
receivables in seven states.
The Company has acquired pools of mortgage loans from other companies who have
retained the rights to service those loans purchased by the Company. As
servicer, these companies are required to collect and remit loan payments, make
required advances, account for principal and interest, hold escrows, make
required inspections of properties, contact delinquent borrowers and supervise
the foreclosures and property dispositions. If a servicer breaches certain of
its representations or warranties to the Company, the Company has the right to
terminate the servicing rights of such servicer and assign those rights to
another servicer.
Securitization Strategy
The Company primarily uses funds provided by its senior notes, bank borrowings,
repurchase agreements and equity to finance loan production when loans are
initially funded. When a sufficient volume of loans is accumulated, generally
between $300 million and $1 billion in principal amount, the loans are
securitized through the issuance of mortgage or asset-backed securities in the
form of collateralized bonds. The length of time between when the Company
commits to fund the loan and when it securitizes the loan varies depending on
certain factors, including the length of the loan commitment (the Company has
committed to fund various commercial and multifamily loans on a forward-basis),
the loan volume by product type, market forces (e.g., whether there exists in
the market place sufficient purchasers of these types of mortgage or
asset-backed securities), and variations in the securitization process. In a
worst case scenario, the Company may be unable to securitize the loans as a
result of adverse market conditions. Though the Company utilizes primarily
committed facilities to finance its loan production prior to securitization, in
such a scenario, the Company may have to sell loans at losses in order to repay
these facilities.
The Company is also subject to various risks due to potential interest rate
fluctuations during the period of time after the Company commits to fund a loan
at a pre-determined interest rate until such loan is ultimately securitized.
Relative to its current loan fundings which are predominantly fixed-rate, the
Company is exposed to an increase in absolute rates, as well as a change in the
market spread to the index on which such loans were priced at origination
("spread risk"). Generally, the Company attempts to mitigate the risk of an
increase in absolute rates through the use of hedging strategies. The Company
does not attempt to hedge spread risk. The Company seeks to utilize interest
rate agreements whose price sensitivity has very close inverse correlation to
the price sensitivity of the related loans resulting from changes in interest
rates. For manufactured housing loans and the commercial loans, the instrument
which has historically demonstrated close inverse correlation is forward sales
of similar duration Treasury securities and futures on Treasury securities
(collectively, "Treasury securities"). Although, Treasury securities may protect
the Company's portfolio of manufactured housing and commercial loans against
fluctuation of short-term interest rates, such hedging activities may not always
result in precise inverse correlation to changes in values of the underlying
loans. The lack of exact inverse correlation is due to such factors as changes
in the relative pricing discount between mortgage or asset backed securities and
Treasury securities, and perceived credit risks between the instruments. To the
extent any changes in the value of the instruments used to hedge the risk of
interest rate fluctuations do not inversely correlate precisely to the risks
affecting the value of the Company's loan portfolio, the financial performance
of the Company could be positively or negatively impacted.
Since late 1995, the Company's predominate securitization structure has been
collateralized bonds. Generally, for accounting and tax purposes, the loans and
securities financed through the issuance of collateralized bonds are treated as
assets of the Company, and the collateralized bonds are treated as debt of the
Company. The Company earns the net interest spread between the interest income
on the securities and the interest and other expenses associated with the
collateralized bond financing. The net interest spread is directly impacted by
the levels of prepayments of the underlying mortgage loans and, to the extent
collateralized bond classes are variable-rate, may be affected by changes in
short-term rates. The Company retains an investment in the collateralized bonds,
typically referred to as the overcollateralization.
Master Servicing
The Company performs the function of master servicer for certain of the
securities it has issued, including all of the securities it has issued since
1995. The master servicer's function typically includes monitoring and
reconciling the loan payments remitted by the servicers of the loans,
determining the payments due on the securities and determining that the funds
are correctly sent to a trustee or investors for each series of securities.
Master servicing responsibilities also include monitoring the servicers'
compliance with its servicing guidelines. As master servicer, the Company is
paid a monthly fee based on the outstanding principal balance of each such loan
master serviced or serviced by the Company as of the last day of each month. As
of December 31, 1998, the Company master serviced $4.0 billion in securities.
Investment Portfolio
The core of the Company's earnings is derived from its investment portfolio. The
Company's strategy for its investment portfolio is to create a diversified
portfolio of high quality assets that in the aggregate generates stable income
in a variety of interest rate and prepayment environments and preserves the
Company's capital base. In many instances, the investment strategy involves not
only the creation of the asset, but also structuring the related securitization
or borrowing to create a stable yield profile and reduce interest rate and
credit risk.
The Company continuously monitors the aggregate cash flow, projected net yield
and market value of its investment portfolio under various interest rate and
prepayment environments. While certain investments may perform poorly in an
increasing or decreasing interest rate environment, certain investments may
perform well, and others may not be impacted at all. Generally, the Company adds
investments to its portfolio which are designed to increase the diversification
and reduce the variability of the yield produced by the portfolio in different
interest rate environments.
Credit Quality. Excluding certain securities where the risk is primarily the
rate of prepayments and not credit, 92% of the Company's investments relate to
securities rated AA or AAA by at least one rating agency. These ratings are
based on AAA rated bond insurance, mortgage pool insurance or subordination. On
securities where the Company has retained a portion of the credit risk below the
investment grade level (BBB), the Company's exposure to credit losses (net of
discounts, reserves and third party guarantees) million below investment grade
level was $159.7 as of December 31, 1998.
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, 1998 and 1997.
- - ----------------------------------------------------------------------------------------------------------
As of December 31
1998 1997
-------------------------------------------------------------
(amounts in thousands) Balance % of Total Balance % of Total
- - ----------------------------------------------------------------------------------------------------------
Investments:
Collateral for collateralized bonds $ 4,293,528 86% $ 4,375,561 84%
Securities:
Funding notes 122,009 3 - -
Adjustable-rate mortgage securities 47,728 1 387,910 7
Fixed-rate mortgage securities 28,981 1 23,065 -
Derivative and residual securities 18,894 - 104,526 2
Other investments 56,743 1 85,989 2
Loans held for securitization 388,782 8 233,958 5
- - ---------------------------------------------------------------------------------------------------------
Total investments $ 4,956,665 100% $ 5,211,009 100%
- - ---------------------------------------------------------------------------------------------------------
Collateral for collateralized bonds. Collateral for collateralized bonds
represents the single largest investment in the Company's portfolio. Collateral
for collateralized bonds is composed primarily of debt securities backed
primarily by adjustable-rate and fixed-rate mortgage loans secured by first
liens on single family homes, fixed-rate mortgage loans secured by multifamily
residential housing properties and commercial properties, manufactured housing
installment loans secured by either a UCC filing or a motor vehicle title, and
property tax receivables. Interest margin on the net investment in
collateralized bonds (defined as the principal balance of collateral for
collateralized bonds less the principal balance of the collateralized bonds
outstanding) is derived primarily from the difference between (i) the cash flow
generated from the collateral pledged to secure the collateralized bonds and
(ii) the amounts required for payment on the collateralized bonds and related
insurance and administrative expenses. Collateralized bonds are generally
non-recourse to the Company. The Company's yield on its net investment in
collateralized bonds is affected primarily by changes in interest rates and
prepayment rates and, to a lesser extent, credit losses on the underlying loans.
The Company may retain for its investment portfolio certain classes of the
collateralized bonds issued and pledge such classes as collateral for repurchase
agreements.
Funding notes. Funding notes consist of fixed-rate securities secured by fixed
rate automobile installment contracts made to borrowers with limited access to
traditional sources of credit. Such funding notes were purchased from a limited
purpose subsidiary of AutoBond . The Company finances a portion of the funding
notes through the use of a committed credit facility. The Company may securitize
the funding notes in the future.
ARM securities. Another segment of the Company's portfolio is the investments in
ARM securities. The interest rates on the majority of the Company's ARM
securities reset every six months and the rates are subject to both periodic and
lifetime limitations. Generally, the Company finances a portion of its ARM
securities with repurchase agreements, which have a fixed rate of interest over
a term that ranges from 30 to 90 days and, therefore, are not subject to
repricing limitations. As a result, the net interest margin on the ARM
securities could decline if the spread between the yield on the ARM security
versus the interest rate on the repurchase agreement was to be reduced.
Fixed-rate mortgage securities. Fixed-rate mortgage securities consist of
securities that have a fixed-rate of interest for specified periods of time. The
Company's yields on these securities are primarily affected by changes in
prepayment rates. Such yields will decline with an increase in prepayment rates
and will increase with a decrease in prepayment rates. The Company generally
borrows against its fixed-rate mortgage securities through the use of repurchase
agreements.
Derivative and residual securities. Derivative and residual securities consist
primarily of interest-only securities ("I/Os"), principal-only securities
("P/Os") and residual interests which were either purchased or were created
through the Company's production operations. An I/O is a class of a
collateralized bond or a mortgage pass-through security that pays to the holder
substantially all interest. A P/O is a class of a collateralized bond or a
mortgage pass-through security that pays to the holder substantially all
principal. Residual interests represent the excess cash flows on a pool of
mortgage collateral after payment of principal, interest and expenses of the
related mortgage-backed security or repurchase arrangement. Residual interests
may have little or no principal amount and may not receive scheduled interest
payments. Included in the residual interests at December 31, 1998 was $21.9
million of equity ownership in residual trusts which own collateral financed
with repurchase agreements, which had a fair value of $8.3 million. The
Company's borrowings against its derivative and residual securities is limited
by certain loan covenants to 3% of shareholders' equity. The yields on these
securities are affected primarily by changes in prepayment rates and by changes
in short-term interest rates.
Other investments. Other investments consists primarily of corporate bonds, an
installment note receivable received in connection with the sale of the
Company's single family mortgage operations in May 1996, property tax
receivables, and manufactured housing inventory lines of credit.
Loans held for securitization. Loans held for securitization consist primarily
of loans originated or purchased through the Company's production operations.
During the accumulation period, the Company is exposed to risks of interest rate
fluctuations and may enter into hedging transactions to reduce the change in
value of such loans caused by changes in interest rates. The Company is also at
risk for credit losses on these loans during accumulation. This risk is managed
through the application of loan underwriting and risk management standards and
procedures and the establishment of reserves.
Risks
The Company is exposed to several types of risks inherent in its investment
portfolio. These risks include credit risk (inherent in the loans before
securitization and the security structure after securitization),
prepayment/interest rate risk (inherent in the underlying loan) and margin call
risk (inherent in the security if it is used as collateral for recourse
borrowings).
Credit Risk. Credit risk is the risk of loss to the Company from the failure by
a borrower (or the proceeds from the liquidation of the underlying collateral)
to fully repay the principal balance and interest due on a loan. A borrower's
ability to repay, or the value of the underlying collateral, could be negatively
influenced by economic and market conditions. Such conditions could be global,
national, regional or local in nature. When a loan is funded and becomes part of
the Company's investment portfolio, the Company has all of the credit risk on
the loan should it default. Upon securitization of the pool of loans, the credit
risk retained by the Company is generally limited to the net investment in
collateralized bonds and subordinated securities; however, if losses are
experienced more rapidly due to market conditions than the Company has provided
for in its reserves, the Company may be required to provide for additional
amounts of reserves for such losses.
The Company began to retain a portion of the credit risk on securitized mortgage
loans in 1994 as mortgage pool insurance became less available in the market and
as the Company diversified into other products. To the extent the Company has
credit exposure on a pool of loans after securitization, the Company will
generally utilize its servicing capabilities in an effort to better manage its
credit exposure. The Company evaluates and monitors its exposure to credit
losses and has established reserves and discounts for probable credit losses
based upon anticipated future losses on the loans, general economic conditions
and historical trends in the portfolio. As of December 31, 1998, the Company's
credit exposure (net of discounts, reserves and guarantees from a third party)
on securities rated below investment grade or as to overcollateralization
(excluding funding notes, other investments and loans held for securitization)
was $159.7 million or 35% of total equity. The reserve relating to loans held
for securitization was $0.4 million or 0.11% of total loans held for
securitization at December 31, 1998.
Prepayment/Interest Rate Risk. The interest rate environment may also impact the
Company. For example, in a rapidly rising rate environment, the Company's net
interest margin may be reduced, as the interest cost for its funding sources
(collateralized bonds, repurchase agreements, and committed lines of credit)
could increase more rapidly than the interest earned on the associated asset
financed. The Company's funding sources are substantially based on one-month
LIBOR and reprice monthly, while the associated assets are principally six-month
LIBOR or one-year Constant Maturity Treasury ("CMT") based and generally reprice
every six-to-twelve months. In a declining rate environment, net interest margin
may be enhanced for the opposite reasons. However, in a period of declining
interest rates, loans in the investment portfolio will generally prepay more
rapidly (to the extent that such loans are not prohibited from prepayment),
which may result in additional amortization expense of asset premium. In a flat
yield curve environment (i.e., when the spread between the yield on the one-year
Treasury and the yield on the ten-year Treasury is less than 1.0%),
single-family ARM loans tend to rapidly prepay, causing additional amortization
of asset premium. In addition, the spread between the Company's funding costs
and asset yields would most likely compress, causing a further reduction in the
Company's net interest margin. Lastly, the Company's investment portfolio may
shrink, or proceeds returned from prepaid assets may be invested in lower
yielding assets. The severity of the impact of a flat yield curve to the Company
would depend on the length of time the yield curve remained flat.
The Company strives to structure its investment portfolio to provide stable
spread income in a variety of prepayment and interest rate scenarios. To manage
prepayment risk (i.e. from a decline in long-term rates on fixed rate assets, or
a flattening or inverse yield curve as to ARM assets), the Company minimizes the
amount of "interest-only" investments or premium on assets. The Company has, in
aggregate, $33.2 million of asset premium relating to assets with prepayment
lockouts or yield maintenance provision for at least seven years, and $33.0
million of asset premium on its remaining assets. In addition, future earnings
may be lower as a result of the reduction in the interest earning assets from
increased prepayment speeds.
The Company also views its hedging activities as a tool to manage interest rate
risk. As mentioned previously, the Company finances its adjustable-rate assets,
which primarily reprice typically every six months based on six-month LIBOR and
one-year CMT and typically are limited to an interest rate adjustment of 1%
increase every six months or a 2% increase every twelve months, with borrowings
that reprice monthly indexed to one-month LIBOR and have no periodic caps. To
manage the periodic interest rate risk associated with the Company's borrowings
to the extent that interest rates rise more than 1% in a six-month period, the
Company has entered into an interest rate swap agreement that has effectively
capped the increase in the borrowing costs on $1.02 billion of borrowings to 1%
during any six-month period. The terms of the swap are such that the Company
pays the lesser of current six-month LIBOR, or six-month LIBOR, in effect 180
days prior plus 1%, and receives current six-month LIBOR. As this is an interest
rate swap agreement, the Company recognizes the net additional interest income
or expense from the interest rate swap as an adjustment to interest expense
recognized on the borrowings. As the adjustable-rate assets also have lifetime
interest rate caps, the Company has also purchased $1.6 billion in interest rate
cap agreements (with contracted rates between 8% and 11.5% based on one-month
LIBOR, six-month LIBOR and one-year CMT) to provide the Company with additional
cash flow should short-term rates rise significantly.
Margin Call Risk. The Company uses repurchase agreements to finance a portion of
its investment portfolio. Margin call risk is the risk that the Company will be
required to provide additional collateral to the counterparties of its secured
recourse borrowings should the value of the asset pledged as collateral for the
recourse borrowings decline. Generally, the Company pledges only investment
grade rated securities or whole loans as collateral for recourse borrowings. The
value of the pledged security or loan is impacted by a variety of factors,
including the perceived credit risk of the security or loan, the type and
performance of the underlying loans in the security, current market volatility,
and the general amount of liquidity in the market place for the asset financed.
In instances where market volatility is high, there are credit issues on the
collateral, or where overall liquidity in the market has been reduced, the
Company may experience margin calls from its lenders. Depending on the Company's
current liquidity position, the Company may be forced to sell assets to meet
margin calls, which may result in losses. The Company attempts to manage its
margin call risk, and thereby limit is liquidity risk, by limiting the amount of
its recourse borrowings to less than 2.5 times equity, and maintaining what it
believes historically to be sufficient liquidity. Occasionally recourse
borrowings will exceed 2.5 times equity based on loan production and the
Company's timing relating to a loan securitization.
The Company has established a target equity requirement for each type of
investment to take into account the price volatility and liquidity of each such
investment. The Company models and plans for the margin call risk related to its
repurchase borrowings through the use of an option-adjusted spread model to
calculate the projected change in market value of its investments that are
pledged as collateral for repurchase borrowings under various adverse scenarios.
The Company generally strives to maintain enough immediate or available
liquidity to meet margin call requirements if short-term interest rates
increased up to 300 basis points over a one-year period. As of December 31,
1998, the Company had total repurchase agreements outstanding of $528.3 million,
secured by collateralized bonds retained, ARM securities, fixed-rate mortgage
securities, derivative and residual securities, other investments and loans held
for securitization at their market values of $348.5 million, $49.5 million,
$26.8 million, $6.1 million, $25.0 million and $157.9 million, respectively.
The Company also has liquidity risk inherent to its investment in certain
residual trusts. These trusts are subject to margin calls and the Company, at
its option, may provide additional equity to the trust to meet the margin call.
Should the Company not provide the additional equity, the assets of the trust
could be sold to meet the trusts' obligations, resulting in a potential loss to
the Company. At December 31, 1998, the total amount of such investments was
$21.9 million.
Since 1996, the Company has structured all of its securitizations as
non-recourse collateralized bonds, with the financing, in effect, incorporated
into the bond structure. This structure eliminates the need for repurchase
agreements on such collateral, and consequently eliminates the margin call risk
and to a lesser degree the interest rate risk. During 1998 and 1997, the Company
issued approximately $2.0 billion and $2.6 billion, respectively, in
collateralized bonds. The Company plans to continue to use collateralized bonds
as its primary securitization vehicle.
FEDERAL INCOME TAX CONSIDERATIONS
General
Dynex REIT believes it has complied and, intends to comply in the future, with
the requirements for qualification as a REIT under the Internal Revenue Code
(the Code). To the extent that Dynex REIT qualifies as a REIT for federal income
tax purposes, it generally will not be subject to federal income tax on the
amount of its income or gain that is distributed to shareholders. DHI and its
subsidiaries, which conduct the production operations, are not qualified REIT
subsidiaries and are not consolidated with Dynex REIT for either tax or
financial reporting purposes. Consequently, DHI and subsidiaries' taxable income
is subject to federal and state income taxes. Dynex REIT will include in taxable
income amounts earned by DHI only when DHI remits its after-tax earnings in the
form of a dividend to Dynex REIT.
The REIT rules generally require that a REIT invest primarily in real
estate-related assets, that its activities be passive rather than active and
that it distribute annually to its shareholders substantially all of its taxable
income. Dynex REIT could be subject to income tax if it failed to satisfy those
requirements or if it acquired certain types of income-producing real property.
Although no complete assurances can be given, Dynex REIT does not expect that it
will be subject to material amounts of such taxes.
Failure to satisfy certain Code requirements could cause Dynex REIT to lose its
status as a REIT. If Dynex REIT failed to qualify as a REIT for any taxable
year, it would be subject to federal income tax (including any applicable
alternative minimum tax) at regular corporate rates and would not receive
deductions for dividends paid to shareholders. As a result, the amount of
after-tax earnings available for distribution to shareholders would decrease
substantially. While the Board of Directors intends to cause Dynex REIT to
operate in a manner that will enable it to qualify as a REIT in future taxable
years, there can be no certainty that such intention will be realized.
Qualification of the Company as a REIT
Qualification as a REIT requires that Dynex REIT satisfy a variety of tests
relating to its income, assets, distributions and ownership. The significant
tests are summarized below.
Sources of Income. To continue qualifying as a REIT, Dynex REIT must satisfy two
distinct tests with respect to the sources of its income: the "75% income test"
and the "95% income test". The 75% income test requires that Dynex REIT derive
at least 75% of its gross income (excluding gross income from prohibited
transactions) from certain real estate-related sources. In order to satisfy the
95% income test, 95% Dynex REIT's gross income for the taxable year must consist
either of income that qualifies under the 75% income test or certain other types
of passive income.
If Dynex REIT fails to meet either the 75% income test or the 95% income test,
or both, in a taxable year, it might nonetheless continue to qualify as a REIT,
if its failure was due to reasonable cause and not willful neglect and the
nature and amounts of its items of gross income were properly disclosed to the
Internal Revenue Service. However, in such a case Dynex REIT would be required
to pay a tax equal to 100% of any excess non-qualifying income.
Nature and Diversification of Assets. At the end of each calendar quarter, three
asset tests must be met by Dynex REIT. Under the 75% asset test, at least 75% of
the value of Dynex REIT's total assets must represent cash or cash items
(including receivables), government securities or real estate assets. Under the
"10% asset test", Dynex REIT may not own more than 10% of the outstanding voting
securities of any single non-governmental issuer, if such securities do not
qualify under the 75% asset test. Under the "5% asset test," ownership of any
stocks or securities that do not qualify under the 75% asset test must be
limited, in respect of any single non-governmental issuer, to an amount not
greater than 5% of the value of the total assets of Dynex REIT.
If Dynex REIT inadvertently fails to satisfy one or more of the asset tests at
the end of a calendar quarter, such failure would not cause it to lose its REIT
status, provided that (i) it satisfied all of the asset tests at the close of a
preceding calendar quarter and (ii) the discrepancy between the values of Dynex
REIT's assets and the standards imposed by the asset tests either did not exist
immediately after the acquisition of any particular asset or was not wholly or
partially caused by such an acquisition. If the condition described in clause
(ii) of the preceding sentence was not satisfied, Dynex REIT still could avoid
disqualification by eliminating any discrepancy within 30 days after the close
of the calendar quarter in which it arose.
Distributions. With respect to each taxable year, in order to maintain its REIT
status, Dynex REIT generally must distribute to its shareholders an amount at
least equal to 95% of the sum of its "REIT taxable income" (determined without
regard to the deduction for dividends paid and by excluding any net capital
gain) and any after-tax net income from certain types of foreclosure property
minus any "excess noncash income." The Code provides that distributions relating
to a particular year may be made in the following year, in certain
circumstances. Dynex REIT will balance the benefit to the shareholders of making
these distributions and maintaining REIT status against their impact on the
liquidity of Dynex REIT. In an unlikely situation, it may benefit the
shareholders if Dynex REIT retained cash to preserve liquidity and thereby lose
REIT status.
Ownership. In order to maintain its REIT status, Dynex REIT must not be deemed
to be closely held and must have more than 100 shareholders. The closely held
prohibition requires that not more than 50% of the value of Dynex REIT's
outstanding shares be owned by five or fewer persons at anytime during the last
half of Dynex REIT's taxable year, The more than 100 shareholder rule requires
that Dynex REIT have at least 100 shareholders for 335 days of a twelve-month
taxable year. In the event that Dynex REIT failed to satisfy the ownership
requirements Dynex REIT would be subject to fines and required to take curative
action to meet the ownership requirements in order to maintain its REIT status.
For federal income tax purposes, Dynex REIT is required to recognize income on
an accrual basis and to make distributions to its shareholders when income is
recognized. Accordingly, it is possible that income could be recognized and
distributions required to be made in advance of the actual receipt of such funds
by Dynex REIT. The nature of Dynex REIT's investments is such that it expects to
have sufficient assets to meet any federal income tax distribution requirements.
Taxation of Distributions by Dynex REIT
Assuming that Dynex REIT maintains its status as a REIT, any distributions that
are properly designated as "capital gain dividends" will generally be taxed to
shareholders as long-term or mid-term capital gains, regardless of how long a
shareholder has owned his shares. Any other distributions out of Dynex REIT's
current or accumulated earnings and profits will be dividends taxable as
ordinary income. Distributions in excess of Dynex REIT's current or accumulated
earnings and profits will be treated as tax-free returns of capital, to the
extent of the shareholder's basis in his shares and, as gain from the
disposition of shares, to the extent they exceed such basis. Shareholders may
not include on their own tax returns any of Dynex REIT ordinary or capital
losses. Distributions to shareholders attributable to "excess inclusion income"'
of Dynex REIT will be characterized as excess inclusion income in the hands of
the shareholders. Excess inclusion income can arise from Dynex REIT's holdings
of residual interests in real estate mortgage investment conduits and in certain
other types of mortgage-backed security structures created after 1991. Excess
inclusion income constitutes unrelated business taxable income ("UBTI") for
tax-exempt entities (including employee benefit plans and individual retirement
accounts) and it may not be offset by current deductions or net operating loss
carryovers. In the unlikely event that Dynex REIT's excess inclusion income is
greater than its taxable income, Dynex REIT's distribution would be based on
Dynex REIT's excess inclusion income. Dividends paid by Dynex REIT to
organizations that generally are exempt from federal income tax under Section
501(a) of the Code should not be taxable to them as UBTI except to the extent
that (i) purchase of shares of Dynex REIT was financed by "acquisition
indebtedness" or (ii) such dividends constitute excess inclusion income. In
1998, Dynex REIT's excess inclusion income was de minimus.
Taxable Income
Dynex REIT uses the calendar year for both tax and financial reporting purposes.
However, there may be differences between taxable income and income computed in
accordance with GAAP. These differences primarily arise from timing differences
in the recognition of revenue and expense for tax and GAAP purposes. For the
year ended December 31, 1998, Dynex REIT's estimated taxable income was
approximately $44.2 million.
REGULATION
As an approved mortgage and consumer loan originator and servicer, the Company
is subject to various federal and state regulations. A violation of such
regulations may result in the Company losing its ability to originate mortgage
and consumer loans in the respective jurisdiction.
The rules and regulations applicable to the production operations, among other
things, prohibit discrimination and establish underwriting guidelines that
include provisions for inspections and appraisals, require credit reports on
prospective borrowers and fix maximum loan amounts. Certain of the Company's
funding activities are subject to, among other laws, the Equal Credit
Opportunity Act, Federal Truth-in-Lending Act and the Real Estate Settlement
Procedures Act and the regulations promulgated thereunder that prohibit
discrimination and require the disclosure of certain basic information to
mortgagors concerning credit terms and settlement costs. The Company's servicing
activities are also subject to, among other laws, the Fair Credit Reporting Act
and the Fair Debt Collections Practices Act.
Additionally, there are various state and local laws and regulations affecting
the production and servicing operations. The production operations are licensed
in those states requiring such a license. Production operations may also be
subject to applicable state usury statutes. The Company believes that it is in
material compliance with all material rules and regulations to which it is
subject.
COMPETITION
The Company competes with a number of institutions with greater financial
resources in originating and purchasing loans through their production
operations. In addition, in purchasing portfolio investments and in issuing
securities, the Company competes with investment banking firms, savings and loan
associations, commercial banks, mortgage bankers, insurance companies and
federal agencies and other entities purchasing mortgage assets, many of which
have greater financial resources than the Company. Additionally, securities
issued relative to its production operations will face competition from other
investment opportunities available to prospective purchasers.
EMPLOYEES
As of December 31, 1998, the Dynex REIT had 54 employees and DHI had 299
employees.
Item 2. PROPERTIES
The Company's executive and administrative offices and operations offices are
both located in Glen Allen, Virginia, on properties leased by the Company which
consist of approximately 32,000 square feet. The address is 10900 Nuckols Road,
3rd Floor, Glen Allen, Virginia 23060. The lease expires in 2003. DHI and
subsidiaries also occupy space located in Glen Allen, Virginia; Vancouver,
Washington; Cincinnati, Ohio; Houston, Texas; Atlanta, Georgia; Fort Worth,
Texas; Charlotte, North Carolina; Columbia, South Carolina; Troy, Michigan; and
Pittsburgh, Pennsylvania. These locations consist of approximately 66,000 square
feet, and the leases associated with these properties expire in 1999 through
2003.
Item 3. LEGAL PROCEEDINGS
On March 20, 1997, American Model Homes ("Plaintiff") filed a complaint against
the Company in Federal District Court in the Central District of California
alleging that the Company, among other things, misappropriated Plaintiff's trade
secrets and confidential information in connection with the Company's
establishment of its model home lending business. The case was transferred to
the US District Court for the Eastern District of Virginia, which dismissed this
complaint with prejudice on February 20, 1998. The plaintiffs had appealed the
Court's decision to the Fourth Circuit Court of Appeals. The Fourth Circuit
Court of Appeals denied this appeal on February 24, 1999.
On February 8, 1999, AutoBond, AutoBond Master Funding Corporation V
("Funding"), and its three principal common shareholders (collectively, the
"Plaintiffs") commenced an action in the District Court of Travis County, Texas
(250th Judicial District) against the Company and James Dolph (collectively, the
"Defendants") alleging that the Company breached the terms of the Credit
Agreement, dated June 9, 1998, by and among AutoBond, Funding and the Company.
The Plaintiffs also allege that the Company and Mr. Dolph conspired to
misrepresent and mischaracterize AutoBond's credit underwriting criteria and its
compliance with such criteria with the intention of interfering and causing
actual damage to AutoBond's business, prospective business and contracts. In
addition to actual, punitive and exemplary damages, the Plaintiffs also seek
injunctive relief compelling the Company to fund immediately all advances due
AutoBond under the Credit Agreement. The Company believes AutoBond's claims are
without merit and intends to defend against them vigorously. The Company filed a
complaint against the Plaintiffs in the United States District Court for the
Eastern District of Virginia (Richmond District) seeking declaratory relief and
damages.
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 3,950
holders of record as of February 28, 1998. 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, were as follows:
- - -------------------------------------------- -------------- ------------- ---------------
Cash
Dividends
High Low Declared
- - -------------------------------------------- -------------- ------------- ---------------
1998:
First quarter $ 13 5/8 $ 11 3/16 $0.30
Second quarter 12 1/2 9 1/2 0.30
Third quarter 11 1/2 7 5/8 0.25
Fourth quarter 8 5/16 4 1/16 -
1997:
First quarter $ 15 11/16 $ 12 3/4 $0.325
Second quarter 15 1/2 12 13/16 0.335
Third quarter 15 5/16 13 1/8 0.345
Fourth quarter 14 13/16 13 1/16 0.350
- - -------------------------------------------- -------------- ------------- ---------------
Item 6. SELECTED FINANCIAL DATA
(amounts in thousands except share data)
- - ----------------------------------------------------------------------------------------------------------------------------
Years ended December 31, 1998 1997 1996 1995 1994
- - ----------------------------------------------------------------------------------------------------------------------------
Net interest margin $ 66,538 $ 83,454 $ 73,750 $ 41,778 $ 40,225
Permanent impairment on AutoBond assets (17,632) - - - -
Equity in earnings (loss) of Dynex Holding, Inc. 2,456 (1,109) (4,309) 11,600 2,235
Gain on sale of single family mortgage operations - - 21,512 - -
(Loss) gain on sale of investments and trading (2,714) 11,584 (385) (7,060) 6,459
activities
Other income 2,852 1,716 606 294 131
General and administrative expenses (8,973) (9,531) (8,365) (5,036) (5,676)
Net administrative fees and expenses (to) from Dynex (22,379) (12,116) (9,761) (4,666) 8,883
Holding, Inc.
Extraordinary loss - loss on extinguishment of debt (571) - - - -
- - ----------------------------------------------------------------------------------------------------------------------------
Net income $ 19,577 $ 73,998 $ 73,048 $ 36,910 $ 52,257
- - ----------------------------------------------------------------------------------------------------------------------------
Total revenue $ 410,821 $ 346,859 $ 333,029 $ 250,830 $ 218,115
- - ----------------------------------------------------------------------------------------------------------------------------
Total expenses $ 391,244 $ 272,861 $ 259,981 $ 213,920 $ 165,858
- - ----------------------------------------------------------------------------------------------------------------------------
Income per common share before extraordinary item:
Basic(1) $ 0.16 $ 1.38 $ 1.54 $ 0.85 $ 1.32
Diluted (1) 0.16 1.37 1.49 0.85 1.32
Net income per common share after extraordinary item:
Basic(1) $ 0.14 $ 1.38 $ 1.54 $ 0.85 $ 1.32
Diluted (1) 0.14 1.37 1.49 0.85 1.32
Dividends declared per share:
Common (1) $ 0.85 $ 1.355 $ 1.133 $ 0.84 $ 1.38
Series A Preferred 2.37 2.710 2.375 1.17 -
Series B Preferred 2.37 2.710 2.375 0.42 -
Series C Preferred 2.92 2.920 0.600 - -
Return on average common shareholders' equity (2) 2.0% 17.9% 21.6% 12.5% 19.2%
Total fundings $2,520,237 $2,490,490 $1,508,780 $ 916,570 $2,861,443
- - ----------------------------------------------------------------------------------------------------------------------------
- - ----------------------------------------------------------------------------------------------------------------------------
Years ended December 31, 1998 1997 1996 1995 1994
- - ----------------------------------------------------------------------------------------------------------------------------
Investments (3) $4,956,665 $5,211,009 $3,918,989 $3,421,470 $3,282,188
Total assets 5,178,802 5,367,358 3,980,827 3,482,669 3,324,467
Non-recourse debt 3,665,316 3,632,079 2,149,068 843,856 351,406
Recourse debt 1,032,733 1,133,536 1,294,972 2,237,571 2,766,630
Total liabilities 4,725,998 4,806,449 3,477,210 3,127,846 3,134,434
Shareholders' equity 452,804 560,909 503,617 354,823 190,033
Number of common shares outstanding 46,027,426 45,146,242 20,653,593 20,198,654 20,078,013
Average number of common shares 45,746,394 43,031,381 20,444,790 20,122,772 19,829,609
Book value per common share (1) $ 6.94 $ 9.40 $ 8.65 $ 6.53 $ 4.73
- - ----------------------------------------------------------------------------------------------------------------------------
(1) Adjusted for two-for-one common stock split effective May 5, 1997.
(2) Excludes unrealized gain/loss on investments available-for-sale.
(3) Investments classified as available-for-sale are shown at fair value as
of December 31, 1998, 1997, 1996, 1995 and 1994.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company is a financial services company that originates primarily mortgage
loans secured by multifamily and commercial properties and loans secured by
manufactured homes. The Company will generally securitize the loans funded as
collateral for collateralized bonds, thereby limiting its credit and liquidity
risk and providing long-term financing for its investment portfolio.
FINANCIAL CONDITION
- - ----------------------------------------------------------------------------------------------
December 31,
(amounts in thousands except per share data) 1998 1997
- - ----------------------------------------------------------------------------------------------
Investments:
Collateral for collateralized bonds $ 4,293,528 $ 4,375,561
Securities 217,612 515,501
Other investments 56,743 85,989
Loans held for securitization 388,782 233,958
Non-recourse debt 3,665,316 3,632,079
Recourse debt 1,032,733 1,133,536
Shareholders' equity 452,804 560,909
Book value per common share 6.94 9.40
- - ---------------------------------------------------------------------------------------------
Collateral for Collateralized Bond
Collateral for collateralized bonds consists primarily of securities backed
by adjustable-rate and fixed rate mortgage loans secured by first liens on
single family properties, fixed-rate loans secured by first liens on multifamily
and commercial properties, manufactured housing installment loans secured by
either a UCC filing or a motor vehicle title and property tax receivables. As of
December 31, 1998, Dynex REIT had 33 series of collateralized bonds outstanding.
The collateral for collateralized bonds decreased to $4.3 billion at December
31, 1998 compared to $4.4 billion at December 31, 1997. This decrease of $0.1
billion is principally the combined result of $2.1 billion in paydowns on
collateral and $0.1 billion decrease in unrealized gain on investments
available-for-sale. This decrease was primarily offset by the addition of $2.2
billion of collateral related to the issuance of two series of collateralized
bonds in 1998.
Securities
Securities consist primarily of fixed-rate "funding notes" secured by
automobile installment contracts and adjustable-rate and fixed-rate
mortgage-backed securities. Securities also include derivative and residual
securities. Derivative securities are classes of collateralized bonds, mortgage
pass-through certificates or mortgage certificates that pay to the holder
substantially all interest (i.e., an interest-only security), or substantially
all principal (i.e., a principal-only security). Residual interests represent
the right to receive the excess of (i) the cash flow from the collateral pledged
to secure related mortgage-backed securities, together with any reinvestment
income thereon, over (ii) the amount required for principal and interest
payments on the mortgage-backed securities or repurchase arrangements, together
with any related administrative expenses. Securities decreased to $217.6 million
at December 31, 1998 compared to $515.5 million at December 31, 1997. The
decrease was primarily the result of Dynex REIT pledging $710.1 million of
securities as part of the $1.7 billion collateral for collateralized bonds
issued during the second quarter of 1998. In addition, Dynex REIT sold $388.5
million of securities and received $122.7 million in paydowns during 1998. These
decreases were partially offset by new securities acquired during 1998 of $1.0
billion resulting from Dynex REIT's exercise of its call rights on $455.7
million of securities and purchasing $568.6 million of securities in the open
market during the same period.
Other Investments
Other investments consist primarily of corporate bonds, a note receivable
received in connection with the sale of the Company's single family mortgage
operations in May 1996 and property tax receivables. Other investments decreased
from $86.0 million at December 31, 1997 to $56.7 million at December 31, 1998.
This decrease of $29.3 million is primarily the result of the securitization of
$86.0 million of property tax receivables as collateral for collateralized bonds
during 1998 and the receipt of $19.0 million in principal payments on the note
receivable from the 1996 sale of the single family mortgage operations. These
decreases were partially offset by the purchase $25.0 million of corporate bonds
and $62.7 million of property tax receivables during 1998.
Loans Held for Securitization
Loans held for securitization increased from $234.0 million at December 31,
1997 to $388.8 million at December 31, 1998. This increase was due to new loan
fundings from the Company's production operations totaling $1.2 billion and bulk
purchases of single family loans totaling $562.0 million during 1998. These
increases were partially offset by the securitization of $1.4 billion of loans
held for securitization as collateral for collateralized bonds issued during
1998.
Non-recourse Debt
Collateralized bonds issued by Dynex REIT are recourse only to the assets
pledged as collateral, and are otherwise non-recourse to Dynex REIT.
Collateralized bonds increased to $3.7 billion at December 31, 1998 from $3.6
billion at December 31, 1997 primarily as a result of the issuance of $2.0
billion of collateralized bonds during the 1998, of which $0.2 million was
retained and financed through repurchase agreements. These increases were
partially offset by $2.1 billion of paydowns.
Recourse Debt
Recourse debt decreased to $1.0 billion at December 31, 1998 from $1.1
billion at December 31, 1997. This decrease was primarily due to the $182.1
million reduction in repurchase agreements due to the securitization during 1998
of $258.0 million of securities, which were previously financed by repurchase
agreements, as collateral for collateralized bonds. Also, Dynex REIT sold $342.6
million of previously retained collateralized bonds which had been financed by
$341.7 million of repurchase agreements. In addition, Dynex REIT pledged $433.7
million of commercial loans as collateral for collateralized bonds during 1998
which were previously financed by $384.9 million of notes payable. These
decreases were offset by the addition of $656.2 million of notes payable as a
result of additional loan fundings.
Shareholders' Equity
Shareholders' equity decreased to $452.8 million at December 31, 1998 from
$560.9 million at December 31, 1997. This decrease was primarily the result of a
$82.5 million reduction in the net unrealized gain on investments
available-for-sale from a positive $79.4 million at December 31, 1997 to a
negative $3.1 million at December 31, 1998. During 1998, the dividends declared
by the Dynex REIT exceeded its earnings (based on generally accepted accounting
principles) by $32.3 million, resulting in a decline in shareholders' equity of
such amount. Also, Dynex REIT repurchased 88,533 of its common shares at an
aggregate purchase price of $0.9 million during 1998. These decreases were
partially offset by $7.7 million of common stock proceeds received through the
dividend reinvestment plan during the same period.
RESULTS OF OPERATIONS
- - -----------------------------------------------------------------------------------------------------------------
For the Year Ended December 31,
(amounts in thousands except per share information) 1998 1997 1996
- - -----------------------------------------------------------------------------------------------------------------
Net interest margin $ 66,538 $ 83,454 $ 73,750
Impairment on AutoBond related assets (17,632) - -
Equity in earnings (losses) of DHI 2,456 (1,109) (4,309)
Gain on sale of single family mortgage operations - - 21,512
(Loss) gain on sale of investments and trading activities (2,714) 11,584 (385)
General and administrative expenses 8,973 9,531 8,365
Net administrative fees and expenses to DHI 22,379 12,116 9,761
Net income 19,577 73,998 73,048
Basic net income per common share(1) 0.14 1.38 1.54
Diluted net income per common share(1) 0.14 1.37 1.49
Dividends declared per share:
Common(1) 0.85 1.355 1.1325
Series A Preferred 2.37 2.710 2.3750
Series B Preferred 2.37 2.710 2.3750
Series C Preferred 2.92 2.920 0.6000
- - -----------------------------------------------------------------------------------------------------------------
(1 Adjusted for two-for-one common stock split effective May 5, 1997.
1998 Compared to 1997. The decrease in net income during 1998 as compared
to 1997 is primarily the result of (i) a decrease in net interest margin, (ii) a
decrease in the gain on sale of investments and trading activities, (iii) an
impairment charge on AutoBond related assets, and (iv) an increase in net
administrative fees and expenses to DHI. The decrease in net income per common
share during 1998 as compared to 1997 is the combined result of the decrease in
net income and an increase in the average number of common shares outstanding
due to the issuance of new common stock and the partial conversion of
outstanding preferred stock.
Net interest margin for the year ended December 31, 1998 decreased to $66.5
million, or 20.3%, over net interest margin of $83.5 million for the same period
in 1997. This decrease in net interest margin was primarily the result of a $9.1
million increase in premium amortization expense during the year ended December
31, 1998 compared to the year ended December 31, 1997. The increase in premium
amortization resulted from a higher rate of prepayments in the investment
portfolio during the year ended December 31, 1998 than during the same period in
1997. In addition, the net interest spread on the investment portfolio decreased
to 1.20% for the year ended December 31, 1998 from 1.42% for the same period in
1997. The decrease in the net interest spread is also primarily the result of
higher premium amortization as a result of the increase in principal prepayments
as well as the decrease in spreads between the indices on which the
interest-earning assets (primarily six-month LIBOR and the one-year Constant
Maturity Treasury) and interest-bearing liabilities (primarily one-month LIBOR)
are based.
The Company recorded charges to earnings totaling $17.6 million in regard
to AutoBond related assets. This charge included an impairment charge on the
funding notes of $14.0 million. It also included a $0.6 million charge to the
Company's investment in AutoBond common and preferred stock to its quoted market
value at December 31, 1998. The Company also fully reserved for the $3.0 million
senior convertible note it acquired from AutoBond.
The (loss) gain on sale of investments and trading activities for 1998
decreased to a $2.7 million loss, as compared to a $11.6 million gain for 1997.
This decrease is primarily the result of net losses recognized of $1.4 million
on trading positions entered into during the twelve months ended December 31,
1998. The gain on sale of assets during 1997 is primarily the result of premiums
received of $9.9 million on covered call options and put options written during
1997 and gains generated of $0.6 million on the sale of certain investments.
Net administrative fees and expenses to DHI increased $10.3 million, or
84.7%, to $22.4 million in 1998. This increase is primarily a result of the
continued growth in the Company's production operations, primarily in the
manufactured housing and commercial lending business.
1997 Compared to 1996. The increase in net income during 1997 as compared
to 1996 is primarily the result of an increase in both net interest margin and
gain on sale of investments and trading activities. These increases were offset
partially by an increase in both general and administrative expenses and net
administrative expenses and fees to DHI and no comparable gain to the gain on
sale of the single family mortgage operations in 1996. The decrease in net
income per common share during 1997 as compared to 1996 is primarily the result
of an increase in the average number of common shares outstanding due to the
issuance of new common stock and the partial conversion of outstanding preferred
stock during 1997.
Net interest margin for the year ended December 31, 1997 increased to $83.5
million, or 13.2%, over net interest margin of $73.8 million for the same period
in 1996. This increase in net interest margin was a result of an overall growth
in average interest-earning assets which increased to $4.5 billion during 1997
as compared to $4.1 billion for 1996. Additionally, the increase in net interest
margin was due to the additional common stock issued during 1997, the proceeds
from which was initially used to pay short-term borrowings.
The gain on the sale of the single family mortgage operations in 1996 was a
one-time gain related to the sale of the Company's single family correspondent,
wholesale and servicing business on May 13, 1996. The (loss) gain on sale of
investments and trading activities for 1997 increased to a $11.6 million gain,
as compared to a $0.4 million loss for 1996. This increase is primarily the
result of premiums received of $9.9 million on covered call options and put
options written during 1997 and gains generated of $0.6 million on the sale of
certain investments. During 1996, Dynex REIT sold certain investments in its
portfolio which resulted in a $2.0 million net gain. Dynex REIT also wrote down,
by $1.5 million, the carrying value of certain mortgage derivative securities as
anticipated future prepayment rates were expected to result in less cash
receipts than the remaining basis in those investments.
Net administrative fees and expenses to DHI increased $2.4 million, or
24.1%, to $12.1 million in 1997. This increase is primarily a result of the
growth in the Company's production operations offset partially by the expense
reductions resulting from the sale of the single family mortgage operations in
May 1996. In 1997, the Company opened one regional office and three district
offices to support its manufactured housing lending operations
The following table summarizes the average balances of interest-earning
assets and their average effective yields, along with the average
interest-bearing liabilities and the related average effective interest rates,
for each of the periods presented.
Average Balances and Effective Interest Rates
- - --------------------------------------------------------------------------------------------------------------------------
(amounts in thousands) Year ended December 31,
- - --------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate
- - --------------------------------------------------------------------------------------------------------------------------
Interest-earning assets (1):
Collateral for collateralized bonds $ 4,094,030 7.43% $ 2,775,494 7.53% $1,832,141 8.11%
(2) (3)
Securities 544,660 7.63 1,110,646 8.36 1,831,621 7.00
Other investments 217,724 8.08 136,189 8.27 62,692 8.19
Loans held for securitization 546,272 8.14 499,115 7.95 351,487 8.36
-------------- ------------ -------------- ----------- -------------- -----------
Total interest-earning assets $ 5,402,686 7.54% $ 4,521,444 7.80% $4,077,941 7.63%
============== ============ ============== =========== ============== ===========
Interest-bearing liabilities:
Non-recourse debt (3) $ 3,544,898 6.41% $ 2,226,894 6.67% $1,493,397 6.63%
Recourse debt - collateralized bonds 523,208 5.90 419,621 5.82 248,657 5.63
retained
-------------- ------------ -------------- ----------- -------------- -----------
4,068,106 6.34 2,646,515 6.53 1,742,054 6.49
Recourse debt secured by investments:
Securities 403,732 5.91 931,334 5.74 1,691,629 5.57
Other investments 126,793 6.71 24,611 7.05 764 10.33
Loans held for securitization 415,778 5.57 354,116 5.83 229,494 5.84
Recourse debt - unsecured 143,378 8.97 87,881 9.23 46,375 10.18
============== ============ ============== =========== ============== ===========
Total interest-bearing $ 5,157,788 6.34% $ 4,044,457 6.38% $3,710,316 6.12%
liabilities
============== ============ ============== =========== ============== ===========
Net interest spread on all investments (3) 1.20% 1.42% 1.51%
============ =========== ===========
Net yield on average interest-earning 1.49% 2.10% 2.07%
assets ============ =========== ===========
- - ---------------------------------------------------------------------------------------------------------- -----------
(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 $3,189, $2,481 and
$2,839 for the years ended December 31, 1998, 1997 and 1996, respectively.
(3) Effective rates are calculated excluding non-interest related
collateralized bond expenses and provision for credit losses.
1998 compared to 1997 The net interest spread decreased to 1.20% for the
year ended December 31, 1998 from 1.42% for the same period in 1997. This
decrease was due to the reduction in interest-earning asset yields from
increased premium amortization expense and the addition of lower yielding assets
to the investment portfolio. The overall yield on interest-earning assets
decreased to 7.54% for year ended December 31, 1998, from 7.80% for the same
period in 1997 while the cost of interest-bearing liabilities remained
relatively flat for the year ended December 31, 1998 compared to the same period
in 1997.
Individually, the net interest spread on collateralized bonds increased 9
basis points, from 100 basis points for the year ended December 31, 1997 to 109
basis points for the same period in 1998. This slight increase was primarily due
to the securitization of collateral which has a lower premium as a percentage of
principal, during the second quarter of 1998. In addition, one-month LIBOR
decreased 27 basis points during the fourth quarter of 1998 which increased the
net interest spread on collateralized bonds since the ARM loans underlying the
collateralized bonds take on average three to six months to adjust to lower
interest rates. The net interest spread on securities decreased 90 basis points,
from 262 basis points for the year ended December 31, 1997 to 172 basis points
for the year ended December 31, 1998. This decrease was primarily the result of
the sale of certain higher coupon collateral during the third quarter of 1998
along with the purchase of lower coupon fixed-rate mortgage securities during
the first quarter of 1998. In addition, certain assets were placed on
non-accrual status during 1998. The net interest spread on other investments
increased 15 basis points, from 122 basis points for the year ended December 31,
1997, to 137 basis points for the year ended December 31, 1998, due primarily to
lower borrowing costs associated with the Company's single family model home
purchase and leaseback business during 1998. The net interest spread on loans
held for securitization increased 45 basis points, from 212 basis points from
the year ended December 31, 1997, to 257 basis points for the same period in
1998. This increase is primarily attributable to lower borrowing costs as a
result of higher level of compensating cash balances during the year ended
December 31, 1998 compared to the same period in 1997. Credits earned from these
compensating cash balances are used by the Company to offset interest expense.
1997 compared to 1996 The net interest spread decreased to 1.42% for the
year ended December 31, 1997 from 1.51% for the same period in 1996. This
decrease was primarily the result of the decline in the spread on the
collateralized bonds, which for 1997 constituted the largest portion of the
investment portfolio on a weighted-average basis. In addition, short-term
interest rates increased 0.25% during March 1997, which raised the Company's
weighted-average borrowing costs to 6.38% for the year ended December 31, 1997,
from 6.12% for the year ended December 31, 1996. The overall yield on
interest-earning assets increased to 7.80% for year ended December 31, 1997,
from 7.63% for the same period in 1996. This increase is primarily due to the
ARM assets in the portfolio resetting upwards during 1997 and the purchase of
higher yielding ARM residual trusts during the latter part of 1996 and during
the first three quarters of 1997.
Individually, the net interest spread on collateralized bonds decreased 62
basis points, from 162 basis points for the year ended December 31, 1996 to 100
basis points for the same period in 1997. This decline was primarily due to the
securitization of lower coupon collateral, principally A+ quality single family
ARM loans during 1997 coupled with the prepayments of seasoned, higher coupon
single family collateral during 1997. In addition, the spread on the net
investment in collateralized bonds decreased due to higher premium amortization
caused by increased prepayments during the latter part of 1997. The net interest
spread on securities increased 119 basis points, from 143 basis points for the
year ended December 31, 1996 to 262 basis points for the year ended December 31,
1997. This increase is primarily attributed to the ARM securities in the
portfolio during 1997 having a higher margin than those ARM securities in the
portfolio in 1996. In addition, Dynex REIT purchased higher yielding ARM
residual trusts during the latter part of 1996 and during the first three
quarters of 1997. The net interest spread on other investments increased 336
basis points, from a negative 214 basis points for the year ended December 31,
1996, to a positive 122 basis points for the year ended December 31, 1997, due
primarily to lower borrowing costs associated with the Company's single family
model home purchase and leaseback business during 1997. The net interest spread
on loans held for securitization decreased 40 basis points, from 252 basis
points from the year ended December 31, 1996, to 212 basis points for the same
period in 1997. This decrease is primarily attributable to the purchase of lower
coupon loans, principally A+ quality single family ARM loans during 1997.
The following tables summarize the amount of change in interest income and
interest expense due to changes in interest rates versus changes in volume:
- - --------------------------------------------------------------------------------------------------------------------
1998 to 1997 1997 to 1996
- - --------------------------------------------------------------------------------------------------------------------
Rate Volume Total Rate Volume Total
- - --------------------------------------------------------------------------------------------------------------------
Collateral for collateralized bonds $ (2,895) $ 97,943 $ 95,048 $(11,428) $ 71,699 $ 60,271
Securities (7,437) (43,797) (51,234) 21,668 (57,006) (35,338)
Other investments (268) 6,592 6,324 52 6,077 6,129
Loans held for securitization 933 3,820 4,753 (1,494) 11,804 10,310
- - --------------------------------------------------------------------------------------------------------------------
Total interest income (9,667) 64,558 54,891 8,798 32,574 41,372
- - --------------------------------------------------------------------------------------------------------------------
Non-recourse debt (5,991) 84,638 78,647 472 48,887 49,359
Recourse debt - collateralized bonds 342 6,106 6,448 470 9,932 10,402
retained
- - --------------------------------------------------------------------------------------------------------------------
Total collateralized bonds (5,649) 90,744 85,095 942 58,819 59,761
Recourse debt secured by investments:
Securities 1,581 (31,577) (29,996) 2,845 (44,158) (41,313)
Other investments (88) 6,952 6,864 (33) 1,711 1,678
Loans held for securitization (990) 3,514 2,524 (16) 7,368 7,352
Recourse debt - unsecured (235) 4,986 4,751 (476) 3,870 3,394
- - --------------------------------------------------------------------------------------------------------------------
Total interest expense (5,381) 74,619 69,238 3,262 27,610 30,872
- - --------------------------------------------------------------------------------------------------------------------
Net margin on portfolio $ (4,286) $ (10,061) $ (14,347) $ 5,536 $ 4,964 $ 10,500
- - --------------------------------------------------------------------------------------------------------------------
Note: The change in interest income and interest expense due to changes in
both volume and rate, which cannot be segregated, has been allocated
proportionately to the change due to volume and the change due to rate. This
table excludes net interest income on advances to DHI, other interest expense
and provision for credit losses.
Interest Income and Interest-Earning Assets
Average interest-earning assets grew to $5.4 billion during 1998, an
increase of 19% from $4.5 billion of average interest-earning assets during
1997. This increase in average interest-earnings assets was primarily the result
of loan originations of $1.2 billion and loan purchases of $562.0 million for
the year ended December 31, 1998. In addition, Dynex REIT purchased $568.6
million of securities and $62.1 million of other investments during the year
ended December 31, 1998. Dynex REIT also exercised call rights on $455.7 million
of securities during the same period. These increases were partially offset by
$2.3 billion of paydowns on investments and $388.5 million of securities sold
during the year ended December 31, 1998. Average interest-earning assets
increased to $4.5 billion during 1997, from $4.1 billion during 1996. This
increase in average interest-earning assets was primarily the result of the
addition of $2.7 billion of collateral for collateralized bonds during 1997. Of
this amount, $0.3 billion resulted from the pledge of ARM securities already
owned by Dynex REIT as collateral for collateralized bonds. This was offset by
$1.1 billion of principal paydowns on investments during 1997. Total interest
income rose 16% during 1998, from $352.7 million for the year ended December 31,
1997, to $407.6 million for the same period of 1998. This increase in total
interest income was due to the growth in average interest-earning assets during
1998. Total interest income also rose 13% during 1997 from $311.3 million for
the year ended December 31, 1996 to $352.7 million for the same period in 1997,
due to the increase in average interest-earning assets. Overall, the yield on
average interest-earning assets fell to 7.54% for the year ended December 31,
1998, from 7.80% and 7.63% for the years ended December 31, 1997 and 1996,
respectively. These decreases resulted from increased premium amortization
expense due to an increase in principal prepayments on investments and an
overall decrease in interest rates during 1998. Premium amortization expense
reduced the average interest-earning assets yield 0.51% for the year ended
December 31, 1998 versus 0.41% and 0.34% for the year ended December 31, 1997
and 1996, respectively.
Earning Asset Yield
($ in millions)
- - ------------------- ------------------------ ----------------------- ------------------------
Average Interest
Earning Assets Interest Income (1) Average Asset Yield
- - ------------------- ------------------------ ----------------------- ------------------------
1996 $ 4,077.9 $ 311.3 7.63%
1997 4,521.4 352.7 7.80%
1998 5,402.7 407.6 7.54%
- - ------------------- ------------------------ ----------------------- ------------------------
(1) Interest income includes amounts related to the gross interest
income on certain securities which are accounted for net of the related
interest expense. Interest income excludes amounts related to the net
interest income on advances to DHI.
Approximately $2.8 billion of the investment portfolio as of December 31,
1998 is comprised of loans or securities that have coupon rates which adjust
over time (subject to certain periodic and lifetime limitations) in conjunction
with changes in short-term interest rates. Approximately 60% of the ARM loans
underlying the ARM securities and collateral for collateralized bonds are
indexed to and reset based upon the level of six-month LIBOR; approximately 28%
are indexed to and reset based upon the level of the one-year Constant Maturity
Treasury (CMT) index.
Investment Portfolio Composition (1)
($ in millions)
- - ------------------------------- ------------------ ------------------- --------------------- --------------- ---------------
Other Indices Based
LIBOR Based ARM CMT Based ARM ARM Loans Fixed-Rate
December 31, Loans Loans Loans Total
- - ------------------------------- ------------------ ------------------- --------------------- --------------- ---------------
1998 $ 1,644.0 $ 720.4 $ 195.4 $ 1,704.0 $ 4,263.8
- - ------------------------------- ------------------ ------------------- --------------------- --------------- ---------------
(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. By creating its investments through its
production operations, the Company believes that premium amounts are less than
if the investments were acquired in the market. As indicated in the table below,
premiums on the collateral for collateralized bonds, ARM securities and
fixed-rate securities at December 31, 1998 were $77.8 million, or approximately
1.83% of the aggregate balance of collateral for collateralized bonds, ARM
securities and fixed-rate securities. Of this $77.8 million, $38.5 million
relates to the premium on multifamily and commercial mortgage loans that have
prepayment lockouts or yield maintenance for at least seven years. Amortization
expense as a percentage of principal paydowns has declined to 1.24% for the year
ended December 31, 1998 from 1.85% and 1.84% for the same periods in 1997 and
1996 as the investment portfolio mix changed to assets funded primarily at par
or at a discount. The principal repayment rate (indicated in the table below as
"CPR Annualized Rate") was 41% for the year ended December 31, 1998. CPR or
"constant prepayment rate" is a measure of the annual prepayment rate on a pool
of loans. Excluded from this table are loans held for securitization, which are
carried at a net discount of $11.6 million at December 31, 1998.
Premium Basis and Amortization
($ in millions)
- - -----------------------------------------------------------------------------------------------------
Amortization
CPR Annualized Expense as a %
Net Premium Amortization Rate Principal of Principal
Expense Paydowns Paydowns
- - -----------------------------------------------------------------------------------------------------
1996 $ 54.1 $ 13.8 24% $ 752.5 1.84%
1997 56.9 18.4 37% 993.2 1.85%
1998 77.8 27.5 41% 2,215.2 1.24%
- - -----------------------------------------------------------------------------------------------------
Interest Expense and Cost of Funds
Dynex REIT's largest expense is the interest cost on borrowed funds. Funds
to finance the investment portfolio are borrowed primarily in the form of
non-recourse collateralized bonds or repurchase agreements. The interest rates
paid on collateralized bonds are either fixed or floating rates; the interest
rates on the repurchase agreements are floating rates. Dynex REIT may use
interest rate swaps, caps and financial futures to manage its interest rate
risk. The net cost of these instruments is included in the cost of funds table
below as a component of interest expense for the period to which they relates.
Average borrowed funds increased from $4.0 billion during 1997 to $5.2 billion
during 1998. The increase resulted primarily from the issuance of $2.0 billion
of collateralized bonds during 1998 and the addition of $271.3 million of notes
payable as a result of additional assets. This increase was partially offset by
paydowns on the collateralized bonds of $2.1 billion. For the year ended
December 31, 1998, interest expense also increased to $327.1 million from $257.8
million for the year ended 1997, while the average cost of funds decreased to
6.34% for 1998 compared to 6.38% for 1997. The decrease in the cost of funds was
a result of a decrease in the one-month LIBOR rates during the fourth quarter of
1998. The cost of funds for the year ended December 31, 1997, compared to
December 31, 1996, increased to 6.38% from 6.12 %, respectively as a result of
the increase of the one-month LIBOR rate during the first quarter of 1997.
Cost of Funds
($ in millions)
- - --------------------------------------------------------------------------------------
Average Borrowed Interest Expense Cost of
Funds (1)(2) Funds
- - --------------------------------------------------------------------------------------
1996 $ 3,710.3 $ 227.0 6.12%
1997 4,044.5 257.8 6.38%
1998 5,157.8 327.1 6.34%
- - --------------------------------------------------------------------------------------
(1) Excludes non-interest collateralized bond-related expenses.
(2) Includes the net amortization expense of bond discounts and bond premiums.
Interest Rate Agreements
As part of the asset/liability management process for its investment
portfolio, Dynex REIT may enter into interest rate agreements such as interest
rate caps, swaps and financial futures contracts. These agreements are used to
reduce interest rate risk which arises from the lifetime yield caps on the ARM
securities, the mismatched repricing of portfolio investments versus borrowed
funds, the funding of fixed interest rates on certain portfolio investments with
floating rate borrowings and finally, assets repricing on indices such as the
prime rate which differ from the related borrowing indices. The agreements are
designed to protect the portfolio's cash flow and to provide income and capital
appreciation to Dynex REIT in the event that short-term interest rates rise
quickly.
The following table includes all interest rate agreements in effect as of
each year end for asset/liability management of the investment portfolio. This
table excludes all interest rate agreements in effect for the loan production
operations as generally these agreements are used to hedge interest rate risk
relating to forward commitments to fund loans. Generally, interest rate swaps
and caps are used to manage the interest rate risk associated with assets that
have periodic and annual interest rate reset limitations financed with
borrowings that have no such limitations. Amounts presented are aggregate
notional amounts. To the extent any of these agreements are terminated, gains
and losses are generally amortized over the remaining period of the original
agreement.
Instruments Used for Interest Rate Risk Management Purposes(1)
(Notional amounts in millions)
- - ----------------------------------------------------------
Interest Rate Interest Rate
December 31 Caps Swaps
- - ----------------------------------------------------------
1996 $ 1,599 $ 1,453
1997 1,599 1,354
1998 1,599 1,140
- - ----------------------------------------------------------
(1) Excludes all interest rate agreements in effect for the Company's
loan production operations.
Net Interest Rate Agreement Expense
The net interest rate agreement expense, or hedging expense, equals the
cost of the agreements presented in the previous table, net of any benefits
received from these agreements. For the year ended December 31, 1998, net
hedging expense amounted to $6.70 million versus $6.61 million and $6.62 million
for the years ended December 31, 1997 and 1996, respectively. Such amounts
exclude the hedging costs and benefits associated with the Company's production
activities as these amounts are deferred as additional premium or discount on
the loans funded and amortized over the life of the loans as an adjustment to
their yield. The net interest rate agreement expense increased for the year
ended December 31, 1998 compared to the same period in 1997, primarily due to
the Company entering into $1.1 billion of new interest rate agreements during
1998. Due to a decline in Treasury yields during the fourth quarter of 1998, the
Company terminated $1.2 billion of interest rate agreements for a total loss of
$10.1 million. This loss is being amortized into income or expense of the
corresponding hedged instrument over the remaining period of the original hedge
or hedged instrument as a yield adjustment. The net interest rate agreement
expense was essentially unchanged for the year ended December 31, 1997 compared
to the same period in 1996.
Net Interest Rate Agreement Expense
($ in millions)
- - -------------------------------------------------------------------------------------------
Net Expense as Net Expense as
Net Interest Percentage of Average Percentage of Average
Rate Agreement Expense Assets (annualized) Borrowings
(annualized)
- - -------------------------------------------------------------------------------------------
1996 $ 6.62 0.16% 0.18%
1997 6.61 0.15% 0.16%
1998 6.70 0.12% 0.13%
- - -------------------------------------------------------------------------------------------
Fair value
The fair value of the available-for-sale portion of the investment
portfolio as of December 31, 1998, as measured by the net unrealized gain on
investments available-for-sale, was $3.1 million below its amortized cost basis,
which represents a $82.5 million decrease from December 31, 1997. At December
31, 1997, the fair value of the investment portfolio was $79.4 million above its
amortized cost basis. This decrease in the portfolio's value is primarily
attributable to the accelerated prepayment activity on in the investment
portfolio during 1998 and the securitization of $433.7 million of commercial
loans during the fourth quarter of 1998.
Credit Exposures
The following table summarizes single family mortgage loan, manufactured
housing loan and commercial mortgage loan delinquencies as a percentage of the
outstanding collateral balance for those securities in which Dynex REIT has
retained a portion of the direct credit risk. The decrease in delinquencies as a
percentage of the outstanding collateral balance from 3.30% at December 31, 1997
to 1.61% at December 31, 1998 is primarily related to the fact that the single
family loans related to the Company's single family operations that were sold in
1996 are a smaller portion of such securities, and that the aggregate
delinquency rate on the other single family loans, the manufactured housing
loans and the commercial mortgage loans are 1.2%. 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, 1998, management believes the credit reserves are
sufficient to cover any losses which may occur as a result of current
delinquencies presented in the table below.
Delinquency Statistics (1)
- - -----------------------------------------------------------------------------------------------------
60 to 89 days delinquent 90 days and over
December 31, delinquent (2) Total
- - -----------------------------------------------------------------------------------------------------
1996 0.88% 3.40% 4.28%
1997 0.52% 2.78% 3.30%
1998 0.18% 1.43% 1.61%
- - -----------------------------------------------------------------------------------------------------
(1) Excludes funding notes.
(2) Includes foreclosures, repossessions and REO.
The following table summarizes the credit rating for collateral for
collateralized bonds, securities and certain other investments held in the
investment portfolio. This table excludes $18.9 million other derivative and
residual securities (as the risk on such securities is primarily
prepayment-related, not credit-related), $30.4 million of certain other
investments which are not debt securities and $388.8 million of loans held for
securitization. The table also excludes the funding notes, aggregating $122.0
million which are not rated. The balance of the investments rated below A are
net of credit reserves and discounts. All balances exclude the related
mark-to-market adjustment on such assets. At December 31, 1998, securities with
a credit rating of AA or better were $3.8 billion, or 92.3% of the total. At the
end of 1998, $27.2 million of investments were AA-rated by one rating agency and
lower rated by another rating agency. For purposes of this table, split-rated
investments were classified based on the higher credit rating.
Investments by Credit Rating (1)
($ in millions)
- - ----------------- ------------- ------------- ------------- ------------- -------------- ------------- ------------- -------------
Below BBB
AAA/AA BBB Carrying AAA/AA BBB Percent Below BBB
Carrying A Carrying Carrying Value Percent of A Percent of Total Percent of
December 31, Value Value Value Total of Total Total
- - ----------------- ------------- ------------- ------------- ------------- -------------- ------------- ------------- -------------
1998 $ 3,815.6 $ 206.2 $ 97.6 $ 14.4 92.3% 5.0% 2.4% 0.3%
- - ----------------- ------------- ------------- ------------- ------------- -------------- ------------- ------------- -------------
(1) Carrying value does not include funding notes, derivative and residual
securities, certain other investments which are not debt securities and
loans held for securitization. Balances also exclude the mark-to-market
adjustment. Carrying value also excludes $206.8 million of
overcollateralization, net of $54.5 million of reserves.
General and Administrative Expenses
General and administrative expenses and net administrative fees and
expenses to DHI (collectively, "G&A expense") consist of expenses incurred in
conducting the production activities and managing the investment portfolio, as
well as various corporate expenses. G&A expense increased for 1998 as compared
to 1997, primarily as a result of continued costs in connection with the
building of the production infrastructure for the manufacturing housing,
commercial lending and specialty finance businesses. The Company expects overall
1999 G&A expense levels to be consistent with 1998.
The following table summarizes the ratio of G&A expense to average
interest-earning assets, and the ratio of G&A expense to average total equity.
Operating Expense Ratios
- - -------------------------------------------------------------------------------------
G&A Expense/Average G&A Expense/Average
Interest-earning Total Equity (1)
Assets
- - -------------------------------------------------------------------------------------
1996 0.44% 4.61%
1997 0.48% 4.66%
1998 0.58% 6.54%
- - -------------------------------------------------------------------------------------
(1) Average total equity excludes net unrealized gain (loss) on investments
available-for-sale.
Net Income and Return on Equity
Net income decreased from $74.0 million for the year ended December 31,
1997 to $19.6 million for the same period in 1998. Net income available to
common shareholders decreased from $59.2 million to $6.6 million for the same
periods, respectively. Return on common equity (equity excludes net unrealized
gain on investments available-for-sale) decreased from 17.9% for 1997 to 2.0%
1998. The decrease in the return on common equity is a result of the decline in
net income available to common shareholders from 1997 to 1998 and the issuance
of new common shares.
Components of Return on Common Equity
- - ---------------------------------------------------------------------------------------------------------------------------
Net Equity in
Interest Provision Permanent Earnings, Gains G&A Preferred
Margin/Average for Losses Impairment and Other Expense/ Dividend/ Return on Net Income
Common /Average on AutoBond Income Average Average Average Available to
Equity Common Assets /Average Common Common Common Common Common
Equity Equity Equity Equity Equity Shareholders
- - ---------------------------------------------------------------------------------------------------------------------------
1996 26.3% 1.0% - 5.9% 6.2% 3.4% 21.6% 63,039
1997 26.8% 1.5% - 3.7% 6.6% 4.5% 17.9% 59,178
1998 20.8% 1.8% 5.0% 0.6% 8.9% 3.7% 2.0% 6,558
- - ---------------------------------------------------------------------------------------------------------------------------
Dividends and Taxable Income
Dynex REIT has elected to be treated as a real estate investment trust for
federal income tax purposes. The REIT provisions of the Internal Revenue Code
require Dynex REIT to distribute to shareholders substantially all of its
taxable income, thereby restricting its ability to retain earnings. The Dynex
REIT may issue additional common stock, preferred stock or other securities in
the future in order to fund growth in its operations, growth in its investment
portfolio or for other purposes.
Dynex REIT intends to declare and pay out as dividends 100% of its taxable
income over time. Dynex REIT's current practice is to declare quarterly
dividends. Generally, Dynex REIT strives to declare a quarterly dividend which
will result in the distribution of most or all of the taxable income earned
during the applicable year. At the time of the dividend announcement, however,
the total level of taxable income for the quarter is unknown. Additionally,
Dynex REIT has considerations other than the desire to pay out most of the
taxable earnings for the year, which may take precedence when determining the
level of dividends.
Dividend Summary
($ in thousands, except per share amounts)
- - ------------------------------------------------------------------------------------------------------
Taxable Net
Income Taxable Net Dividend Cumulative
Available to Income Per Declared Per Dividend Undistributed
Common Common Share Common Share Pay-out Taxable Income
Shareholders Ratio (Loss)
- - ------------------------------------------------------------------------------------------------------
1996 $ 51,419 $ 1.260 $ 1.1325 90% $ 8,210
1997 56,528 1.331 1.3550 102% 3,949
1998 44,243 (1) 0.753 (1) 0.8500 113% (1) (653) (1)
- - ------------------------------------------------------------------------------------------------------
(1) Estimated.
Taxable income for 1998 is estimated as Dynex REIT has not filed its 1998
federal income tax returns. Taxable income differs from the financial statement
net income, which is determined in accordance with generally accepted accounting
principles (GAAP). For the year ended December 31, 1998, taxable net income per
common share exceeded GAAP income per common share principally due to the
permanent impairment on AutoBond related assets and the installment sale gain
relating to the sale of the single family mortgage operations during 1996. These
were partially offset by a loss for tax purposes on the securitization of $433.7
million in commercial mortgage loans. Cumulative undistributed taxable income
represents timing differences in the amounts earned for tax purposes versus the
amounts distributed. Such amounts can be distributed for tax purposes in the
subsequent year as a portion of the normal quarterly dividend.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS No. 133"). FAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. FAS No. 133 is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. The
impact of adopting FAS No. 133 has not yet been determined.
In October 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise" ("FAS No. 134"). FAS No. 134 requires that after
the securitization of mortgage loans held for sale that meets all of the
criteria of FAS No. 125 and is accounted for as a sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interests based on its ability and intent to sell or hold those
investments. FAS No. 134 is effective for fiscal quarters beginning after
December 15, 1998. The Company does not expect FAS No. 134 to have a material
impact on the financial statements as the Company typically accounts for
securitization of assets as secured financing transactions.
Year 2000
The Company is dependent upon purchased, leased, and internally-developed
software to conduct certain operations. In addition, the Company relies upon
certain counterparties such as banks and loan servicers who are also highly
dependent upon computer systems. The Company recognizes that some computer
software may incorrectly recognize dates beyond December 31, 1999. The ability
of the Company and its counterparties to correctly operate computer software in
the Year 2000 is critical to the Company;s operations.
The Company uses several major and minor computer systems to conduct its
business operations. The computer systems deemed most important to the Company's
ability to continue operations are as follows:
The internally-developed loan origination system for manufactured
housing operations
The internally-developed loan origination and asset management
system for commercial loans
The internally-developed investment portfolio analytics,
securitization, and securities administration software
The purchased servicing system for commercial loans
The purchased servicing system for single family and manufactured
housing loans
The purchased general ledger accounting system
In addition, the Company is involved in data interchange with a number of
counterparties in the normal course of business. Each system or interface that
the Company relies on is being tested and evaluated for Year 2000 compliance.
The Company has contacted all of its key software vendors to determine
their Year 2000 readiness. The Company has received documentation from each of
the vendors providing assurances of Year 2000 compliance:
Baan/CODA, vendor of the general ledger accounting system, has
provided confirmation that their current software release is fully
Year 2000 compliant. The Company plans to apply this release in the
first half of 1999.
Synergy Software, vendor of the commercial loan servicing system,
has provided confirmation that the current release of their software
is fully Year 2000 compliant. The Company has installed and
performed initial testing on this version with no issues discovered.
Interlinq Software, vendor of the single-family and manufactured
housing loan servicing software, has provided assurance that their
software is Year 2000 compliant.
All software developed internally by the Company was designed to be Year
2000 compliant. Nevertheless, the Company has established a Year 2000 test-bed
to ensure that there were no design or development oversights that could lead to
a Year 2000 problem. Initial testing of all key applications was completed in
January of 1999, with only minor issues discovered and subsequently remedied.
Continued testing of certain applications will continue through June of 1999.
The Company has reviewed or is reviewing the Year 2000 progress of its
primary financial counterparties. Based on initial reviews, these counterparties
are expected to be in compliance. The Company, as master servicer of certain
securities, is in the process of assessing the Year 2000 readiness of its
external servicers, to ensure that these parties will be able to correctly remit
loan information and payments after December 31, 1999.
The Company believes that, other than its exposure to financial
counterparties, its most significant risk with respect to internal or purchased
software is the software systems used to service manufactured housing loans. The
Company will not be able to service these loans without the automated system.
Should these loans go unattended for a period greater than three months, the
result could have a material adverse impact on the Company.
The Company is also at significant risk if the systems of the financial
institutions that provide the Company financing and software for cash management
services should fail. In a worst case scenario, the Company would be unable to
fund its operations or pay on its obligations for an unknown period of failure.
This would have material adverse impact on the Company.
The Company is also at significant risk if the voice and data
communications network supplied by its provider should fail. In such an instance
the Company would be unable to originate or efficiently service its manufactured
housing loans until the problem is remedied. The Company is closely monitoring
the Year 2000 efforts of its telecommunications provider and is developing
contingency plans in the event that the provider does not give sufficient
assurance of compliance by June 30, 1999.
The Company is also at significant risk should the electric utility company
for the Company's offices in Glen Allen, Virginia, fail to provide power for
several business days. In such an instance, the Company would be unable (i) to
communicate over its telecommunication systems, (ii) would be unable to process
data, and (iii) would be unable to originate or service loans until the problem
is remedied. Dynex continues to monitor the Year 2000 status of its utility
provider, whose plan is scheduled to be completed in the fall of 1999.
The Company uses many other systems (including systems that are not
information technology oriented), both purchased and developed internally, that
could fail to perform accurately after December 31, 1999. Management believes
that the functions performed by these systems are either non-critical or could
be performed manually in the event of failure.
The Company will complete its Year 2000 test plan and remediation efforts
in the second quarter of 1999. Management believes that there is little
possibility of a significant disruption in business. The major risks are those
related to the ability of vendors and business partners to complete Year 2000
plans. The Company expects that those vendors and counterparties will complete
their Year 2000 compliance programs before January 1, 2000.
The Company has incurred less than $50,000 in costs to date in carrying out
its Year 2000 compliance program. The Company estimates that it will spend less
than $100,000 to complete the plan. Costs could increase in the event that the
Company determines that a counterparty will not be Year 2000 compliant.
The Company is still developing contingency plans in the event that a
system or counterparty is not Year 2000 compliant. These plans will be developed
prior to June 30, 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company finances its operations from a variety of sources. These
sources include cash flow generated from the investment portfolio, including net
interest income and principal payments and prepayments, common stock offerings
through the dividend reinvestment plan, short-term warehouse lines of credit
with commercial and investment banks, repurchase agreements and the capital
markets via the asset-backed securities market (which provides long-term
non-recourse funding of the investment portfolio via the issuance of
collateralized bonds). Historically, cash flow generated from the investment
portfolio has satisfied its working capital needs, and the Company has had
sufficient access to capital to fund its loan production operations, on both a
short-term (prior to securitization) and long-term (after securitization) basis.
However, if a significant decline in the market value of the investment
portfolio that is funded with recourse debt should occur, the available
liquidity from these other borrowings may be reduced. As a result of such a
reduction in liquidity, the Company may be forced to sell certain investments in
order to maintain liquidity. If required, these sales could be made at prices
lower than the carrying value of such assets, which could result in losses.
In order to grow its equity base, Dynex REIT may issue additional capital
stock. Management strives to issue such additional shares when it believes
existing shareholders are likely to benefit from such offerings through higher
earnings and dividends per share than as compared to the level of earnings and
dividends Dynex REIT would likely generate without such offerings. During 1998,
Dynex REIT issued 622,768 shares of its common stock during 1998 pursuant to its
dividend reinvestment program for net proceeds of $7.7 million.
Certain aspects of Dynex REIT's funding strategies subject it to liquidity
risk. Liquidity risk stems from Dynex REIT's use of repurchase agreements, its
use of committed lines of credit with mark-to-market provisions and the reliance
on the asset-backed securitization markets for its long-term funding needs.
Liquidity risk also stems from hedge positions the Company may take to hedge its
commercial and manufactured housing loan production. Repurchase agreements are
generally provided by investment banks, and subject Dynex REIT to margin call
risk if the market value of assets pledged as collateral for the repurchase
agreements declines. Dynex REIT has established 'target equity' requirements
for each type of investment pledged as collateral, taking into account the price
volatility and liquidity of each such investment. Dynex REIT strives to maintain
enough liquidity to meet anticipated margin calls if short-term interest rates
increased 300 basis points in a twelve-month period. Due to dislocations in the
fixed-income markets in the third and fourth quarters of 1998, Dynex REIT
experienced declines in the market value of collateral pledged to repurchase
agreements and its loan hedge positions and experienced margin calls, even
though interest rates were generally decreasing. Dynex REIT was able to meet
these margin calls from its available liquidity, but sold assets in October and
November 1998 in order to increase its liquidity. The total book value for all
the assets sold during the fourth quarter of 1998 was $42.3 million and resulted
in losses totaling $8.4 million.
Dynex REIT has committed lines of credit and uncommitted repurchase
facilities to finance the accumulation of assets for securitization. Dynex REIT
borrows on these lines of credit on a short-term basis to support the
accumulation of assets prior to the issuance of collateralized bonds. These
borrowings may bear fixed or variable interest rates, may require additional
collateral in the event that the value of the existing collateral declines, and
may be due on demand or upon the occurrence of certain events. If borrowing
costs are higher than the yields on the assets financed with such funds, Dynex
REIT's ability to acquire or fund additional assets may be substantially reduced
and it may experience losses. Dynex REIT currently has a total of $925 million
of committed lines of credit and $700 million of uncommitted repurchase
facilities to finance loans held for securitization and other investments. These
borrowings are paid down as Dynex REIT securitizes or sells assets. Generally
these borrowings allow for the warehousing of assets for a period of 180-365
days. Dynex REIT generally intends to securitize assets by product type every
120-365 days. If there exists a dislocation or disruption in the asset-backed
market, Dynex REIT may be unable to securitize the assets, or may only be able
to securitize the assets on unfavorable terms. In such a case, Dynex REIT would
be required to repay the lines of credit with either available liquidity or
would be required to liquidate the assets or other assets to generate liquidity.
In addition, lines of credit with commercial and investment banks may include
provisions by such banks to mark the collateral to market on a daily basis. To
the extent the market value of the associated asset has declined due to market
conditions, Dynex REIT may be required to provide additional collateral or sell
the associated asset which may result in losses.
As a part of its strategy to hedge exposure to changes in interest rates on
commercial mortgage loans funded and commitments to fund commercial mortgage
loans, Dynex REIT may enter into forward sales of Treasury futures. Such sales
are executed through third parties, which require cash collateral in the event
that movements in interest rates adversely impact the value of the futures
position. The value of the related loans or loan commitments will generally
increase in value as the futures position decreases; however, such value is
generally not recognized until the loans are securitized. In order to maintain
its hedge positions, Dynex REIT may therefore be exposed to additional cash
collateral requirements in adverse interest rate environments.
A substantial portion of the assets are pledged to secure indebtedness
incurred by Dynex REIT. Accordingly, those assets would not be available for
distribution to any general creditors or the stockholders of Dynex REIT in the
event of the liquidation, except to the extent that the value of such assets
exceeds the amount of the indebtedness they secure.
Non-recourse Debt
Dynex REIT, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds to fund the majority of
its investment portfolio. The obligations under the collateralized bonds are
payable solely from the collateral for collateralized bonds and are otherwise
non-recourse to Dynex REIT. Collateral for collateralized bonds are not subject
to margin calls. The maturity of each class of collateralized bonds is directly
affected by the rate of principal prepayments on the related collateral. Each
series is also subject to redemption according to specific terms of the
respective indentures, generally when the remaining balance of the bonds equals
35% or less of the original principal balance of the bonds. At December 31,
1998, Dynex REIT had $3.7 billion of collateralized bonds outstanding as
compared to $3.6 billion at December 31, 1997.
Recourse Debt
Secured. At December 31, 1998, Dynex REIT had four committed credit
facilities aggregating $925 million, comprised of (i) a $250 million credit
line, expiring in April 2000, from a consortium of commercial banks primarily
for the warehousing of multifamily construction and permanent loans (including
providing the letters of credit for tax-exempt bonds) and manufactured housing
loans, (ii) a $400 million credit line, expiring in November 1999, from an
investment bank primarily for the warehousing of permanent loans on multifamily
and commercial properties, (iii) a $175 million credit line, expiring in April
1999, from a consortium of commercial banks and finance companies to fund the
purchase of model homes, and (iv) a $100 million credit line, expiring in
September 1999, from an investment bank for the warehousing of the funding
notes. Dynex REIT expects these credit facilities will be renewed or replaced,
if necessary, at their respective expiration dates, although there can be no
assurance of such renewal or replacement. The lines of credit contain certain
financial covenants which Dynex REIT met as of December 31, 1998. However,
changes in asset levels or results of operations could result in the violation
of one or more covenants in the future. At December 31, 1998, Dynex REIT had
$374.6 million outstanding under its committed credit facilities.
Dynex REIT also uses repurchase agreements to finance a portion of its
investments, which generally have thirty day maturities. Repurchase agreements
allow Dynex REIT to sell investments for cash together with a simultaneous
agreement to repurchase the same investments on a specified date for a price
which is equal to the original sales price plus an interest component. Dynex
REIT has two uncommitted master repurchase facilities aggregating $700 million
for the accumulation of assets for securitization. These agreements expire in
1999. Dynex REIT expects these repurchase facilities will be renewed, if
necessary, at their expiration dates, although there can be no assurance of such
renewal. At December 31, 1998, outstanding obligations under all repurchase
agreements totaled $528.3 million compared to $889.0 million at December 31,
1997. The following table summarizes the outstanding balances of repurchase
agreements by credit rating of the related assets pledged as collateral to
support such repurchase agreements as of December 31, 1998. The table excludes
repurchase agreements used to finance loans held for securitization, which
totaled $137.6 million at December 31, 1998.
Repurchase Agreements by Rating of Investments Financed
($ in millions)
- - --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
December 31, AAA AA A BBB Below BBB Total
- - --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
1998 $ 124.5 $ 109.5 $ 91.4 $ 65.6 $ - $ 391.0
- - --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
Increases in short-term interest rates, long-term interest rates or market
risk could negatively impact the valuation of securities and may limit Dynex
REIT's borrowing ability or cause various lenders to initiate margin calls for
securities financed using repurchase agreements. Additionally, certain
investments are classes of securities rated AA, A or BBB that are subordinated
to other classes from the same series of securities. Such subordinated classes
may have less liquidity than securities that are not subordinated and the value
of such classes is more dependent on the credit rating of the related insurer or
the credit performance of the underlying loans. In instances of a downgrade of
an insurer or the deterioration of the credit quality of the underlying
collateral, Dynex REIT may be required to sell certain investments in order to
maintain liquidity. If required, these sales could be made at prices lower than
the carrying value of the assets, which could result in losses.
To reduce exposure to changes in short-term interest rates on its
repurchase agreements, Dynex REIT may lengthen the duration of its repurchase
agreements secured by investments by entering into certain interest rate futures
and/or option contracts. As of December 31, 1998, no such financial futures or
option contracts were outstanding.
Unsecured. Since 1994, Dynex REIT has issued three series of unsecured
notes payable totaling $150 million. The proceeds from these issuances have been
used to reduce short-term debt related to financing loans held for
securitization during the accumulation period as well as for general corporate
purposes. These notes payable have an outstanding balance at December 31, 1998
of $129.3 million. The above note agreements contain certain financial covenants
which Dynex REIT met as of December 31, 1998. However, changes in asset levels
or results of operations could result in the violation of one or more covenants
in the future.
Total recourse debt decreased from $1.1 billion for December 31, 1997 to
$1.0 billion for December 31, 1998. This decrease is primarily due to the $182.1
million reduction in repurchase agreements due to the securitization of $258.0
million securities as collateral for collateralized bonds during 1998 which were
previously financed by repurchase agreements. Also, Dynex REIT sold $342.6
million of retained collateralized bonds, which were previously financed by
$341.7 million of repurchase agreements. In addition, Dynex REIT pledged $433.7
million of commercial loans as collateral for collateralized bonds during 1998
which were previously financed by $384.9 million of notes payable. These
decreases were offset by the addition of $656.2 million of notes payable as a
result of the purchase or origination of additional assets. Total recourse debt
should continue to decline during 1999 as Dynex REIT continues to finance on a
long-term basis the loans held for securitization and securities through the
issuance of collateralized bonds.
Total Recourse Debt
($ in millions)
- - ----------------------------------------------------------------------------------------------------------
Total Recourse Debt to Recourse Interest
December 31, Total Recourse Debt Equity Coverage Ratio
- - ----------------------------------------------------------------------------------------------------------
1996 $ 1,295.4 3.03% 1.57%
1997 1,133.5 2.12% 1.82%
1998 1,032.7 1.94% 1.20%
- - -----------------------------------------------------------------------------------------------------------
Table 1
Components of Collateral for Collateralized Bonds
As of December 31, 1998
- - ---------------------------------------------------------------- --------------------
Collateral for collateralized bonds $ 4,177,592
Allowance for loan losses (16,593)
Funds held by trustees 1,104
Accrued interest receivable 27,834
Unamortized premiums and discounts, net 81,990
Unrealized gain, net 21,601
- - ---------------------------------------------------------------- --------------------
Total $ 4,293,528
- - ---------------------------------------------------------------- --------------------
Table 2
Collateral for Collateralized Bonds by Loan Product
As of December 31, 1998
- - ---------------------------------------------------------------- --------------------
Single-Family Loans:
ARMs:
1 month LIBOR $ 9,905
3 month LIBOR 86,644
6 month LIBOR 1,505,538
Prime 119,833
6 month CD 63,649
6 month CMT 892
1 year CMT 625,397
5 year CMT 192
- - ---------------------------------------------------------------- --------------------
Total ARMs 2,512,050
Fixed 310,827
- - ---------------------------------------------------------------- --------------------
Total single family 2,822,877
Manufactured housing:
ARM 13,288
Fixed 500,677
- - ---------------------------------------------------------------- --------------------
Total manufactured housing 513,965
Commercial loans 840,750
- - ---------------------------------------------------------------- --------------------
Total $ 4,177,592
- - ---------------------------------------------------------------- --------------------
Table 3
Collateral for Collateralized Bonds by Property Type
As of December 31, 1998
- - ---------------------------------------------------------------- --------------------
Single-family loans:
Single-family detached $ 2,194,304
Condominium 175,458
Single family attached 198,089
Planned unit development 143,293
Cooperative 41,633
Other 70,100
- - ---------------------------------------------------------------- --------------------
Total single family 2,822,877
Manufactured housing:
Single wide 157,787
Multi-sectional 356,177
- - ---------------------------------------------------------------- --------------------
Total manufactured housing 513,964
Commercial loans:
Multifamily (LIHTC) 531,233
Office 136,531
Hotel/motel 59,414
Industrial 34,217
Healthcare 30,342
Mixed use 28,600
Retail 16,744
Other 3,669
- - ---------------------------------------------------------------- --------------------
Total commercial 840,750
- - ---------------------------------------------------------------- --------------------
Total $ 4,177,592
- - ---------------------------------------------------------------- --------------------
Table 4
Repricing Periods for Adjustable-Rate Single Family and
Manufactured Housing Collateral
As of December 31, 1998
- - ----------------------------------------------------- ------------------ ------------------ -------------------
Single Manufactured
Family Housing Total
- - ----------------------------------------------------- ------------------ ------------------ -------------------
1st Quarter 1999 $ 896,908 $ - $ 896,908
2nd Quarter 1999 956,751 95 956,846
3rd Quarter 1999 86,113 510 86,623
4th Quarter 1999 84,674 1,032 85,706
1st Quarter 2000 and beyond 487,606 11,651 499,256
- - ----------------------------------------------------- ------------------ ------------------ -------------------
$ 2,512,052 $ 13,288 $ 2,525,339
- - ----------------------------------------------------- ------------------ ------------------ -------------------
Table 5
Commercial Loan Prepayment Protection Period (1)
As of December 31, 1998
- - ----------------------------------------------------- ---------------- -----------------
Number of Loans Principal
Balance
- - ----------------------------------------------------- ---------------- -----------------
0 - 4 years 1 $ 12,797
5 - 10 years 27 113,050
11 - 16 years 200 660,823
Over 16 years 9 54,080
- - ----------------------------------------------------- ---------------- -----------------
237 $ 840,750
- - ----------------------------------------------------- ---------------- -----------------
(1) The greater of prepayment lockout or the yield maintenance period
Table 6
Margin of Single Family Loans over Indices
As of December 31, 1998
- - ---------------------------------------------------------------- --------------------
Single-family loans:
ARM:
1 month LIBOR 3.24%
3 month LIBOR 2.87
6 month LIBOR 3.06
Prime (1) 2.48
6 month CD 2.50
6 month CMT 2.88
1 year CMT 2.85
5 year CMT 2.88
- - ---------------------------------------------------------------- --------------------
Total ARM 2.82
Manufactured housing (6 month LIBOR) 5.80
- - ---------------------------------------------------------------- --------------------
Weighted average margin 2.83%
- - ---------------------------------------------------------------- --------------------
(1) Relative to 1-month LIBOR, after giving effect to the Prime/LIBOR swap
owned by the Company.
Table 7
Weighted Average Coupon for Collateral
As of December 31, 1998
- - ---------------------------------------------------------------- --------------------
Single-family loans:
ARM loans 8.38%
Fixed 9.82
- - ---------------------------------------------------------------- --------------------
Total 8.54
Manufactured housing loans:
ARM loans 9.48
Fixed 9.07
- - ---------------------------------------------------------------- --------------------
Total 9.08
Commercial loans 8.01
- - ---------------------------------------------------------------- --------------------
Aggregate weighted average coupon 8.50%
- - ---------------------------------------------------------------- --------------------
FOURTH QUARTER REVIEW
The Company reported a net loss of $16.9 million for the fourth quarter of
1998 and earnings per common share of a negative $0.44. These results were a
decrease from the fourth quarter of 1997 net income of $17.8 million and
earnings per common share of $0.32. The decrease in the fourth quarter of 1998
compared to the same period in 1997 is primarily due to a decrease in net
interest margin, a loss in the sale of investments and trading activities and an
impairment charge related to certain assets of the Company.
Net interest margin for the fourth quarter of 1998 totaled $17.6 million
compared with $21.5 million for the fourth quarter of 1997. The decrease in the
net interest margin for the fourth quarter of 1998 was primarily due an increase
in the average interest-bearing liabilities the fourth quarter of 1998 compared
to the same period in 1997 and no corresponding increase in average
interest-bearing assets.
The average interest-earning assets were $5.1 billion for both the fourth
quarter of 1998 and 1997. However, the average asset yield for the quarter ended
December 31, 1998 decreased to 7.46% compared to 7.72% for the fourth quarter of
1997. The decrease in the yield during the fourth quarter was primarily due to
the prepayment of higher-yielding assets during 1998 being replaced with
lower-yielding assets. Additionally, the average interest-bearing liabilities
increased $0.3 billion to $4.9 billion for the fourth quarter of 1998 compared
to $4.6 billion for the fourth quarter of 1997. The average cost of funds
decreased from 6.49% for the fourth quarter of 1997 to 6.13% for the fourth
quarter of 1998. The decrease in the average cost of funds was due primarily to
a decrease in the average one-month LIBOR for the fourth quarter of 1998
compared to the fourth quarter of 1997.
For the fourth quarter of 1998, the Company recognized a $9.0 million net
loss on the sale of investments and trading activities compared to a gain of
$3.2 million in the fourth quarter of 1997. The loss in the fourth quarter of
1998 was primarily due to $8.6 million of net losses on $113.9 million of
securities sold during the fourth quarter of 1998, while the gain of $3.2
million in the fourth quarter of 1997 was the primarily the result of $1.9
million of net gains on trading position entered into during 1997.
Production from all sources for the fourth quarter of 1998 decreased to
$371.1 million from $465.3 million for the fourth quarter of 1997 primarily due
to a purchase in the fourth quarter of 1997 of $176.2 million of A+ quality
single family loans. This was offset by an increase in both commercial and
manufactured home loan fundings during the fourth quarter of 1998 as well as the
purchase of $48.9 million of funding notes secured by automobile installment
contracts.
In June 1998, the Company entered into a series of agreements with AutoBond
relating to the purchase on a flow basis of funding notes secured by automobile
contracts. In January 1999, the Company, in conjunction with third-party
specialists experienced in subprime auto lending, performed certain compliance
procedures in regard to AutoBond's compliance with the underwriting criteria as
set forth under the agreements. The results from the underwriting compliance
tests indicated that a significant number of loans contained material deviations
from the underwriting criteria. The specialists also performed various tests and
procedures related to AutoBond's compliance with the agreed upon servicing
procedures and guidelines. The results of those tests highlighted certain
irregularities which resulted in the Company's determination that the
delinquency ratio previously reported by AutoBond was understated. Based on the
findings from the compliance testing and subsequent analysis performed by the
Company as a result of these findings, the Company has determined that the
automobile contracts which secure the Company's funding notes are of a lower
credit quality than previously represented to the Company. As such, the Company
recorded a charge to earnings as of December 31, 1998 totaling $17.6 million.
This charge included an impairment charge on the funding notes of $14.0 million.
It also included a $0.6 million charge to the Company's investment in AutoBond
common and preferred stock to its quoted market value at December 31, 1998. The
Company also fully reserved for the $3.0 million unsecured senior convertible
note it acquired from AutoBond.
In March 1999, Dynex issued approximately $1.4 billion of collateralized
bonds secured by single family loans, ARM securities and manufactured housing
loans. Of the total, $323.3 million was issued through a public transaction and
$1.0 billion was issued through a private (144-A) transaction.
Summary of Selected Quarterly Results (unaudited)
(amounts in thousands except share data)
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
First Second Third Quarter Fourth Quarter
Year ended December 31, 1998 Quarter Quarter
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Operating results:
Total revenues $ 97,842 $ 111,813 $ 104,434 $ 96,732
Net interest margin 17,146 17,187 14,639 17,566
Net income (loss) 14,432 15,599 6,485 (16,939)
Basic net income per common share 0.25 0.27 0.07 (0.44)
Diluted net income per common share 0.25 0.27 0.07 (0.44)
Cash dividends declared per common share 0.30 0.30 0.25 -
Annualized return on common shareholders'
equity 12.50% 13.77% 3.68% (23.79%)
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Average interest-earning assets 5,120,191 5,780,504 5,571,742 5,138,306
Average borrowed funds 4,791,147 5,520,722 5,377,659 4,941,623
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Net interest spread on interest-earning assets 1.19% 1.17% 1.11% 1.33%
Average asset yield 7.59% 7.61% 7.50% 7.46%
Net yield on average interest-earning assets (1) 1.60% 1.47% 1.33% 1.57%
Cost of funds 6.40% 6.44% 6.39% 6.13%
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Loans funded 1,171,665 542,176 435,270 371,126
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
First Second Third Quarter Fourth Quarter
Year ended December 31, 1997 Quarter Quarter
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Operating results:
Total revenues $ 79,249 $ 82,521 $ 91,417 $ 93,673
Net interest margin 20,290 21,099 20,600 21,465
Net income 18,310 18,384 19,512 17,792
Basic net income per common share 0.35 0.36 0.32
0.35
Diluted net income per common share 0.35 0.36 0.32
0.34
Cash dividends declared per common share 0.35
0.325 0.335 0.345
Annualized return on common shareholders'
equity 18.83% 18.23% 18.83% 15.96%
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Average interest-earning assets 3,820,511 4,321,111 4,801,190 5,142,960
Average borrowed funds 3,379,959 3,869,713 4,357,869 4,570,289
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Net interest spread on interest-earning assets 1.69% 1.52% 1.34% 1.23%
Average asset yield 8.04% 7.86% 7.65% 7.72%
Net yield on average interest-earning assets (1) 2.42% 2.19% 1.92% 1.95%
Cost of funds 6.35% 6.34% 6.31% 6.49%
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
Loans funded 182,976 873,637 528,244 905,633
- - ----------------------------------------------------- ---------------- --------------- ---------------- ----------------
(1) Computed as net interest margin excluding non-interest collateralized bond expenses.
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-K made by the Company, that are
not historical fact constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such forward-looking statements may
involve factors that could cause the actual results of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. The Company cautions the public not to place
undue reliance on forward-looking statements, which may be based on assumptions
and anticipated events that do not materialize. The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.
Factors that may cause actual results to differ from historical results or
from any results expressed or implied by forward-looking statements include the
following:
Economic Conditions. The Company is affected by consumer demand for
manufactured housing, multifamily housing and other products which it finances.
A material decline in demand for these products and services would result in a
reduction in the volume of loans originated by the Company. The risk of defaults
and credit losses could increase during an economic slowdown or recession. This
could have an adverse effect on the Company's financial performance and the
performance on the Company's securitized loan pools.
Capital Resources. The Company relies on various credit facilities and
repurchase agreements with certain commercial and investment banking firms to
help meet the Company's short-term funding needs. The Company believes that as
these agreements expire, they will continue to be available or will be able to
be replaced; however no assurance can be given as to such availability or the
prospective terms and conditions of such agreements or replacements.
Capital Markets. The Company relies on the capital markets for the sale
upon securitization of its collateralized bonds or other types of securities.
While the Company has historically been able to sell such collateralized bonds
and securities into the capital markets, there can be no assurances that
circumstances relating either to the Company or the capital markets may limit or
preclude the ability of the Company to sell such collateralized bonds or
securities in the future.
Interest Rate Fluctuations. The Company's income depends on its ability to
earn greater interest on its investments than the interest cost to finance these
investments. Interest rates in the markets served by the Company generally rise
or fall with interest rates as a whole. A majority of the loans currently
originated by the Company are fixed-rate. The profitability of a particular
securitization may be reduced if interest rates increase substantially before
these loans are securitized. In addition, the majority of the investments held
by the Company are variable rate collateral for collateralized bonds and
adjustable-rate investments. These investments are financed through non-recourse
long-term collateralized bonds and recourse short-term repurchase agreements.
The net interest spread for these investments could decrease during a period of
rapidly rising short-term interest rates, since the investments generally have
periodic interest rate caps and the related borrowing have no such interest rate
caps.
Defaults. Defaults by borrowers on loans retained by the Company may have
an adverse impact on the Company's financial performance, if actual credit
losses differ materially from estimates made by the Company at the time of
securitization. The allowance for losses is calculated on the basis of
historical experience and management's best estimates. Actual defaults may
differ from the Company's estimate as a result of economic conditions. Actual
defaults on ARM loans may increase during a rising interest rate environment.
The Company believes that its reserves are adequate for such risks.
Prepayments. Prepayments by borrowers on loans securitized by the Company
may have an adverse impact on the Company's financial performance. Prepayments
are expected to increase during a declining interest rate or flat yield curve
environment. The Company's exposure to rapid prepayments is primarily (i) the
faster amortization of premium on the investments and, to the extent applicable,
amortization of bond discount, and (ii) the replacement of investments in its
portfolio with lower yield securities. At December 31, 1998, the yield curve was
considered flat relative to its normal shape, and as a result, the Company
expects a continuation of relatively high prepayment rates during the first six
months in 1999.
Competition. The financial services industry is a highly competitive
market. Increased competition in the market could adversely affect the Company's
market share within the industry and hamper the Company's efforts to expand its
production sources.
Regulatory Changes. The Company's business is subject to federal and state
regulation which, among other things require the Company to maintain various
licenses and qualifications and require specific disclosures to borrowers.
Changes in existing laws and regulations or in the interpretation thereof, or
the introduction of new laws and regulations, could adversely affect the
Company's operation and the performance of the Company's securitized loan pools.
New Production Sources. The Company has expanded both its manufactured
housing and commercial lending businesses. The Company is incurring or will
incur expenditures related to the start-up of these businesses, with no
guarantee that production targets set by the Company will be met or that these
businesses will be profitable. Various factors such as economic conditions,
interest rates, competition and the lack of the Company's prior experience in
these businesses could all impact these new production sources.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument due to fluctuations in
interest and foreign exchange rates and in equity and commodity prices. Market
risk is inherent to both derivative and non-derivative financial instruments,
and accordingly, the scope of the Company's market risk management extends
beyond derivatives to include all market risk sensitive financial instruments.
As a financial services company, net interest income comprises the primary
component of the Company's earnings. As a result, the Company is subject to risk
resulting from interest rate fluctuations to the extent that there is a gap
between the amount of the Company's interest-earning assets and the amount of
interest-bearing liabilities that are prepaid, mature or reprice within
specified periods. The Company's strategy is to mitigate interest rate risk
through the creation of a diversified investment portfolio of high quality
assets that, in the aggregate, preserves the Company's capital base while
generating stable income in a variety of interest rate and prepayment
environments. In many instances, the investment strategy involves not only the
creation of the asset, but also structuring the related securitization or
borrowing to create a stable yield profile and reduce interest rate risk.
The Company continuously monitors the aggregate cash flow, projected net
yield and market value of its investment portfolio under various interest rate
and prepayment assumptions. While certain investments may perform poorly in an
increasing or decreasing interest rate environment, other investments may
perform well, and others may not be impacted at all. Generally, the Company adds
investments to its portfolio that are designed to increase the diversification
and reduce the variability of the yield produced by the portfolio in different
interest rate environments.
The Company's Portfolio Executive Committee ("PEC"), which includes
executive management representatives, monitors and manages the interest rate
sensitivity and repricing characteristics of the balance sheet components
consistent with maintaining acceptable levels of change in both the net
portfolio value and net interest income. The Company's exposure to interest rate
risk is reviewed on a monthly basis by the PEC and quarterly by the Board of
Directors.
The Company utilizes several tools and risk management strategies to
monitor and address interest rate risk, including (i) a quarterly sensitivity
analysis using option-adjusted spread ("OAS") methodology to calculate the
expected change in net interest margin as well as the change in the market value
of various assets within the portfolio under various extreme scenarios; and (ii)
a monthly static cash flow and yield projection under 49 different scenarios.
Such tools allow the Company to continually monitor and evaluate its exposure to
these risks and to manage the risk profile of the investment portfolio in
response to changes in the market risk. While the Company may use such tools,
there can be no assurance the Company will accomplish the goal of adequately
managing the risk profile of the investment portfolio.
The Company measures the sensitivity of its net interest income to changes
in interest rates. Changes in interest rates are defined as instantaneous,
parallel, and sustained interest rate movements in 100 basis point increments.
The Company estimates its interest income for the next twelve months assuming no
changes in interest rates from those at period end. Once the base case has been
estimated, cash flows are projected for each of the defined interest rate
scenarios. Those scenario results are then compared against the base case to
determine the estimated change to net interest income.
The following table summarizes the Company's net interest margin
sensitivity analysis as of December 31, 1998. This analysis represents
management's estimate of the percentage change in net interest margin given a
parallel shift in interest rates. The "Base" case represents the interest rate
environment as it existed as of December 31, 1998. The analysis is heavily
dependent upon the assumptions used in the model. The effect of changes in
future interest rates , the shape of the yield curve or the mix of assets and
liabilities may cause actual results to differ from the modeled results. In
addition, certain financial instruments provide a degree of "optionality." The
model considers the effects of these embedded options when projecting cash flows
and earnings. The most significant option affecting the Company's portfolio is
the borrowers' option to prepay the loans. The model uses a dynamic prepayment
model that applies a Constant Prepayment Rate ranging from 5.5% to 70.1% based
on the projected incentive to refinance for each loan type in any given period.
While the Company's model considers these factors, the extent to which borrowers
utilize the ability to exercise their option may cause actual results to
significantly differ from the analysis. Furthermore, its projected results
assume no additions or subtractions to the Company's portfolio, and no change to
the Company's liability structure. Historically, the Company has made
significant changes to its assets and liabilities, and is likely to do so in the
future.
Basis Point % Change in Net
Increase (Decrease) Interest Margin from
in Interest Rates Base Case
----------------------- -----------------------
+200 (11.69)%
+100 (9.30)%
Base -
-100 9.65%
-200 21.29%
The Company's investment policy sets forth guidelines for assuming interest
rate risk. The investment policy stipulates that given a 200 basis point
increase or decrease in interest rates over a twelve month period, the estimated
net interest margin may not change by more than 25% of current net interest
margin during the subsequent one year period. Based on the projections above,
the Company is in compliance with its stated policy regarding the interest rate
sensitivity of net interest margin.
Approximately $2.8 billion of the Company's investment portfolio as of
December 31, 1998 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 60% and 28%
of the ARM loans underlying the Company's ARM securities and collateral for
collateralized bonds are indexed to and reset based upon the level of six-month
LIBOR and one-year CMT, respectively.
Generally, during a period of rising short-term interest rates, the
Company's net interest spread earned on its investment portfolio will decrease.
The decrease of the net interest spread results from (i) the lag in resets of
the ARM loans underlying the ARM securities and collateral for collateralized
bonds relative to the rate resets on the associated borrowings and (ii) rate
resets on the ARM loans which are generally limited to 1% every six months or 2%
every twelve months and subject to lifetime caps, while the associated
borrowings have no such limitation. As short-term interest rates stabilize and
the ARM loans reset, the net interest margin may be restored to its former level
as the yields on the ARM loans adjust to market conditions. Conversely, net
interest margin may increase following a fall in short-term interest rates. This
increase may be temporary as the yields on the ARM loans adjust to the new
market conditions after a lag period. In each case, however, the Company expects
that the increase or decrease in the net interest spread due to changes in the
short-term interest rates to be temporary. The net interest spread may also be
increased or decreased by the proceeds or costs of interest rate swap, cap or
floor agreements.
Because of the 1% or 2% periodic cap nature of the ARM loans underlying the
ARM securities, these securities may decline in market value in a rising
interest rate environment. In a rapidly increasing rate environment, as was
experienced in 1994, a decline in value may be significant enough to impact the
amount of funds available under repurchase agreements to borrow against these
securities. In order to maintain liquidity, the Company may be required to sell
certain securities. To mitigate this potential liquidity risk, the Company
strives to maintain excess liquidity to cover any additional margin required in
a rapidly increasing interest rate environment, defined as a 3% increase in
short-term interest rates over a twelve-month time period. Liquidity risk also
exists with all other investments pledged as collateral for repurchase
agreements, but to a lesser extent.
As part of its asset/liability management process, the Company enters into
interest rate agreements such as interest rate caps and swaps and financial
futures contracts ("hedges"). These interest rate agreements are used by the
Company to help mitigate the risk to the investment portfolio of fluctuations in
interest rates that would ultimately impact net interest income. To help protect
the Company's net interest income in a rising interest rate environment, the
Company has purchased interest rate caps with a notional amount of $1.6 billion,
which help reduce the Company's exposure to interest rate risk rising above the
lifetime interest rate caps on ARM securities and loans. These interest rate
caps provide the Company with additional cash flow should the related index
increase above the contracted rates. The contracted rates on these interest rate
caps are based on one-month LIBOR, six-month LIBOR or one-year CMT. The Company
will also utilize interest rate swaps to manage its exposure to changes in
financing rates of assets and to convert floating rate borrowings to fixed rate
where the associated asset financed is fixed rate. Interest rate caps and
interest rate swaps that the Company uses to manage certain interest rate risks
represent protection for the earnings and cash flow of the investment portfolio
in adverse markets. To date, short term interest rates have not risen at the
speed or to the extent such that the protective cashflows provided by the caps
and swaps have been realized.
The Company may also utilizes futures and options on futures to moderate
the risks inherent in the financing of a portion of its investment portfolio
with floating-rate repurchase agreements. The Company uses these instruments to
synthetically lengthen the terms of repurchase agreement financing, generally
from one to three or six months. Interest rate futures and option agreements
have historically provided the Company a means of essentially locking-in
borrowing costs at specified rates for specified period of time. Under these
contracts, the Company will receive additional cash flow if the underlying index
increases above contracted rates, mitigating the net interest income loss that
results from the higher repurchase agreement rates The Company will pay
additional cash flow if the underlying index decreases below contracted rates.
The Company has not utilized futures or options on futures since 1997, as they
primarily benefit the Company when expected rates as measured by the forward
yield-curve are less than current cash market rates.
Interest rate caps and interest rate swaps that the Company utilizes to
manage certain interest rate risks represent protection for the earnings and
cashflow of the investment portfolio in adverse markets. To date, market
conditions have not been adverse such that the caps and swaps have been
utilized.
The remaining portion of the Company's investments portfolio as of December
31, 1998, approximately $2.1 billion, is comprised of loans or securities that
have coupon rates that are either fixed or do not reset within the next 15
months. The Company has limited its interest rate risk on such investments
through (i) the issuance of fixed-rate collateralized bonds and notes payable,
and (ii) equity, which in the aggregate totals approximately $1.3 billion as of
the same date. Overall, the Company's interest rate risk is primarily related to
the rate of change in short term interest rates, not the level of short term
interest rates.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements and Supplemental Data and Exhibits 23.1 and 23.2 of
this Form 10-K have been omitted and the Company will be filing such items by
amendment pursuant to SEC Rule 12b-25 within the required 15 days.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 21, 1998, the Audit Committee of Dynex Capital, Inc. approved the
appointment of the accounting firm of Deloitte & Touche LLP ("D&T") as the
independent auditors for the year ending December 31, 1998 to replace KPMG Peat
Marwick LLP ("KPMG"), who were dismissed as the independent accountants
effective with such appointment.
The reports of KPMG on the Company's consolidated financial statements for
each of the two years ended December 31, 1997 and 1996 did not contain an
adverse opinion or a disclaimer of opinion and were not qualified or modified as
to uncertainty, audit scope or accounting principles.
In connection with the audits of the Company's consolidated financial
statements for the two years ended December 31, 1997 and 1996, and through July
21, 1998, there have been no disagreements between the Company and KPMG on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope and procedures which, if not resolved to the satisfaction of
KPMG, would have caused them to make reference thereto in their report on the
financial statements for such years.
During the two fiscal years ended December 31, 1997 and 1996, and through
July 21, 1998, the Company has not consulted with D&T regarding either (i) the
application of accounting principles to a specified transaction, either
completed or proposed; or the type of audit opinion that might be rendered on
the Company's financial statements, and either a written report was provided to
the Company or oral advice was provided that D&T concluded was an important
factor considered by the Company in reaching a decision as to the accounting,
auditing or financial reporting issue; or (ii) any matter that was either the
subject of a disagreement, as that term is defined in Item 304 (a) (1) (iv) of
Regulation S-K and the related instructions to Item 304 of Regulation S-K, or a
reportable event, as that term is defined in Item 304 (a) (1) (v) of Regulation
S-K.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to directors and executive officers
of the Company is included in the Company's proxy statement for its 1998 Annual
Meeting of Stockholders (the 1998 Proxy Statement) in the Election of Directors
and Management of the Company sections and is incorporated herein by reference.
Item 11. EXECUTIVE COMPENSATION
The information required by Item 11 is included in the 1998 Proxy Statement
in the Management of the Company section on 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 1998 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 1998 Proxy Statement
in the Compensation Committee Interlocks and Insider Participation section and
is incorporated herein by reference.
Part IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. and 2. Financial Statements and Financial Statement Schedule
The information required by this section of Item 14 is set forth in the
Consolidated Financial Statements and Independent Auditors' Report beginning at
page F-1 of this Form 10-K. The index to the Financial Statements and Schedule
is set forth at page F-2 of this Form 10-K.
3. Exhibits
Exhibit
Number Exhibit
3.1 Articles of Incorporation of the Registrant, as amended, effective as
of February 4, 1988. (Incorporated herein by reference to the
Company's Amendment No. 1 to the Registration Statement on Form S-3
(No. 333-10783)filed March 21, 1997.)
3.2 Amended Bylaws of the Registrant (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31,
1992, as amended.)
3.3 Amendment to the Articles of Incorporation, effective December
29, 1989 (Incorporated herein by reference to the Company's
Amendment No. 1 to the Registration Statement on Form S-3 (No.
333-10783) filed March 21, 1997.)
3.4 Amendment to Articles of Incorporation, effective June 27, 1995
(Incorporated herein by reference to the Company's Current Report on
Form 8-K (File No. 1-9819), dated June 26, 1995.)
3.5 Amendment to Articles of Incorporation, effective October 23, 1995
(Incorporated herein by reference to the Company's Current Report on
Form 8-K (File No. 1-9819), dated October 19, 1995.)
3.6 Amendment to the Articles of Incorporation, effective October 9, 1996
(Incorporated herein by reference to the Registrant's Current Report
on Form 8-K, filed October 15, 1996.)
3.7 Amendment to the Articles of Incorporation, effective October 10, 1996
(Incorporated herein by reference to the Registrant's Current Report
on Form 8-K, filed October 15, 1996.)
3.8 Amendment to the Articles of Incorporation, effective October 19,
1992. (Incorporated herein by reference to the Company's Amendment
No. 1 to the Registration Statement on Form S-3 (No. 333-10783)filed
March 21, 1997.)
3.9 Amendment to the Articles of Incorporation, effective August 17, 1992.
(Incorporated herein by reference to the Company's Amendment No. 1
to the Registration Statement on Form S-3 (No. 333-10783) filed March
21, 1997.)
3.10 Amendment to Articles of Incorporation, effective April 25, 1997.
(Incorporated herein by reference to the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 1997.)
3.11 Amendment to Articles of Incorporation, effective May 5, 1997. (
Incorporated herein by reference to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1997.)
10.1 Dividend Reinvestment and Stock Purchase Plan (Incorporated herein by
reference to the Company's Registration Statement on Form S-3
(No. 333-35769).)
10.2 Executive Deferred Compensation Plan (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31,
1993 (File No. 1-9819) dated March 21, 1994.)
10.3 Employment Agreement: Thomas H. Potts (Incorporated by reference to
Exhibits to the Company's Annual Report filed on Form 10-K for the
year ended December 31, 1994 (File No. 1-9819) dated March 31, 1995.)
10.4 Promissory Note, dated as of May 13, 1996, between the Registrant
(as Lender) and Dominion Mortgage Services, Inc.(as Borrower)
(Incorporated herein by reference to Exhibits to the Company's
Form 10-Q for the quarter ended June 30, 1996 (File No. 1-9819)
dated August 14, 1996.)
10.5 The Registrant's Bonus Plan (Incorporated by reference to Exhibits
to the Company's Annual Report filed on Form 10-K for the year ended
December 31, 1996 (File No. 1-9819) dated March 31, 1997.)
10.6 The Directors Stock Appreciation Rights Plan (Incorporated herein by
reference to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997.)
10.7 1992 Stock Incentive Plan as amended (Incorporated herein by
reference to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997.)
21.1 List of consolidated entities of the Company (filed herewith)
23.1 Consent of Deloitte & Touche LLP (filed herewith)
23.2 Consent of KPMG LLP (filed herewith)
(b) Reports on Form 8-K
Current Report on Form 8-K as filed with the Commission on February 26,
1999, relating to certain recent developments.
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, 1999 /s/ Thomas H. Potts
Thomas H. Potts
President
(Principal Executive Officer)
March 31, 1999 /s/ Lynn K. Geurin
Lynn K. Geurin
Executive Vice President and
Chief Financial Officer
(Principal Accounting and Financial Officer)
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Capacity Date
/s/ Thomas H. Potts Director March 31, 1999
Thomas H. Potts
/s/ J. Sidney Davenport, IV Director March 31, 1999
J. Sidney Davenport, IV
/s/ Richard C. Leone Director March 31, 1999
Richard C. Leone
/s/ Barry Shein Director March 31, 1999
Barry Shein
/s/ Donald B. Vaden Director March 31, 1999
Donald B. Vaden
EXHIBIT INDEX
Sequentially
Exhibit Numbered Page
21.1 List of consolidated entities I
23.1 Consent of Deloitte & Touche LLP (the Company will be
filing such item by amendment pursuant to SEC Rule 12b-25
within the required 15 days) II
23.2 Consent of KPMG LLP (the Company will be filing such item
by amendment pursuant to SEC Rule 12b-25 within the required
15 days) III