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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, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer I.D. No.)
10900 Nuckols Road, 3rd Floor, Glen Allen, Virginia 23060
(Address of principal executive offices) (Zip Code)
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 __ No XX
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
As of March 31, 2000, the aggregate market value of the voting stock held
by non-affiliates of the registrant was approximately $64,373,558 (11,444,188
shares at a closing price on The New York Stock Exchange of $5.625). Common
stock outstanding as of March 31, 2000 was 11,444,188 shares.
DOCUMENTS INCORPORATED BY REFERENCE Portions of the Definitive Proxy
Statement to be filed pursuant to Regulation 14A within 120 days from December
31, 1999, are incorporated by reference into Part III.
DYNEX CAPITAL, INC.
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
PART I
Item 1. BUSINESS.............................................. 3
Item 2. PROPERTIES........................................... 12
Item 3. LEGAL PROCEEDINGS.................................... 12
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS... 13
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS...................... 13
Item 6. SELECTED FINANCIAL DATA.............................. 14
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS........ 15
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK.......................................... 29
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......... 31
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE............... 31
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT... 31
Item 11. EXECUTIVE COMPENSATION............................... 32
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT................................ 32
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....... 32
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K.............................. 32
SIGNATURES ..................................................... 34
Item 1. BUSINESS
GENERAL
Dynex Capital, Inc. (the "Company") was incorporated in the Commonwealth of
Virginia in 1987. The Company is a financial services company which invests in a
portfolio of securities and investments backed principally by single family
mortgage loans, commercial mortgage loans and manufactured housing installment
loans. Such loans have been funded generally by the Company's loan production
operations or purchased in bulk in the market. The Company's primary loan
production operations have included commercial mortgage lending, single family
mortgage lending (which was sold in 1996) and manufactured housing lending
(which was sold in 1999). Through its specialty finance business, the Company
also has provided for the purchase and leaseback of single family model homes to
builders (which was sold in 1999) and the purchase and management of delinquent
property tax receivables. Loans funded through the Company's production
operations have generally been pooled and pledged (i.e. securitized) as
collateral for non-recourse bonds ("collateralized bonds"), which provides
long-term financing for such loans while limiting credit, interest rate and
liquidity risk.
The Company's principal source of earnings is net interest income from its
investment portfolio. The Company's investment portfolio consists primarily of
collateral for collateralized bonds, asset-backed securities and loans held for
sale or securitization. The Company funds its investment portfolio with both
borrowings and funds raised from the issuance of equity. For the portion of the
investment portfolio funded with borrowings, the Company generates net interest
income to the extent that there is a positive spread between the yield on the
interest-earning assets and the cost of borrowed funds. The cost of the
Company's borrowings may be increased or decreased by interest rate swap, cap or
floor agreements. For the other portion of the investment portfolio funded with
equity, net interest income is primarily a function of the yield generated from
the interest-earning asset.
References to "Dynex REIT" mean the parent company and its wholly-owned
subsidiaries, consolidated for financial reporting purposes, while references to
the "Company" mean the parent company, its wholly-owned subsidiaries and Dynex
Holding, Inc. ("DHI") and its subsidiaries, which are not consolidated for
financial reporting or tax purposes. All of the outstanding non-voting preferred
stock (which represents a 99% economic interest in DHI) is owned by Dynex REIT.
All of the outstanding voting common stock (which represents a 1% economic
interest in DHI) is owned by certain senior officers of Dynex REIT. In light of
these factors, DHI is accounted for under a method similar to the equity method.
Dynex REIT has elected to be treated as a real estate investment trust ("REIT")
for federal income tax purposes under the Internal Revenue Code of 1986, as
amended, and, as such, must distribute substantially all of its taxable income
to shareholders and will generally not be subject to federal income tax.
During 1999, as a result of the difficult market environment for specialty
finance companies such as the Company, the Company sold both its manufactured
housing lending operations and model home purchase/leaseback business.
Additionally, to conserve capital and to minimize its recourse borrowings, the
Company decided in the fourth quarter of 1999 not to extend approximately $255.6
million of forward commitments to fund commercial mortgage loans and to sell
versus securitize the commercial loans the Company held in inventory. This
difficult market environment was a result of the disruption in the fixed income
markets during the fourth quarter of 1998. As a result of such disruption,
investors in fixed income securities generally demanded higher yields in order
to purchase securities issued by such specialty finance companies. Additionally,
the Company believes the ratings agencies imposed higher credit enhancement
levels and other requirements on securitizations sponsered by specialty finance
companies. The net result of such changes in the market (which appear to be
permanent versus temporary at this time) reduced the Company's ability to
compete against larger finance companies, investment banks and depository
institutions, which generally have not been penalized by investors or ratings
agencies when issuing fixed income securities. In addition, interim lenders that
provided short-term funding to support the accumulation of loans for
securitization have generally reduced their credit lines to specialty finance
companies and otherwise tightened terms. As a result of the decision not to
extend the forward commitments on commercial mortgage loans and the related
decision to sell (versus securitize) many of the commercial mortgage loans in
inventory, the Company recorded a charge in the fourth quarter of 1999 of $54.6
million.
As more fully described in Note 1 in the accompanying consolidated
financial statements, the Company is currently subject to certain significant
risks and uncertainties, including violations of covenants in credit facilities,
litigation, and the lack of access to new sources of capital. Management's plans
concerning these risks and uncertainties are discussed in Note 1.
Business Focus and Strategy
The Company strives to create a diversified investment portfolio that in
the aggregate generates stable income for the Company in a variety of interest
rate environments and preserves the capital base of the Company. The Company
historically focused on markets where it believed that it could generate
investments for its portfolio at a lower cost than if these investments were
purchased in the secondary market. Over the past five years, the markets that
the Company has participated in have included single family mortgage lending,
commercial mortgage lending, manufactured housing lending, and various specialty
finance businesses, including purchase/leaseback of model homes and the purchase
and collection of delinquent property tax receivables. As previously indicated,
the Company sold its single family lending business in 1996, and its
manufactured housing lending operations and its purchase/leaseback model home
business in 1999. As a result of these sales and the decision not to extend the
forward commitments on commercial mortgage loans, the Company expects very
limited direct fundings in the foreseeable future.
The Company has sought to generate growth in earnings and dividends per
share in a variety of ways, including (i) adding investments to its portfolio
when opportunities in the market are favorable; (ii) developing production
capabilities to originate and acquire financial assets in order to create
attractively priced investments for its portfolio, as well as control the
underwriting and servicing of these assets; and (iii) increasing the efficiency
with which the Company utilizes its equity capital over time. To increase
potential returns to shareholders, the Company has employed leverage through the
use of secured borrowings and repurchase agreements to fund a portion of its
investment portfolio.
Prior Lending Operations
The Company generally has been a vertically integrated lender by performing
the sourcing, underwriting, funding and servicing of loans to maximize
efficiency and provide superior customer service. The Company generally has
focused on loan products that maximize the advantages of the REIT tax election
and has emphasized direct relationships with the borrower and minimized, to the
extent practical, the use of origination intermediaries. The Company has
historically utilized internally generated guidelines to underwrite loans for
all product types and maintained centralized loan pricing, and performed the
servicing function for loans on which the Company has credit exposure.
The following table summarizes the loan production activity for the three
years ended December 31, 1999, 1998 and 1997.
Loan Production Activity
($ in thousands)
------------------------------------------------ ------------------------------------------------------------
For the Years Ended December 31
------------------------------------------------------------
1999 1998 1997
------------------------------------------------ ------------------- ------------------- --------------------
Commercial (1) $ 224,264 $ 674,086 $ 290,988
Manufactured housing 494,081 482,979 265,906
Specialty finance 140,763 196,224 168,965
------------------------------------------------ ------------------- ------------------- --------------------
Total fundings through direct production 859,108 1,353,289 725,859
Secured funding notes (2) 13,654 149,189 -
Securities acquired through bond calls 224 455,714 493,152
Single family fundings through bulk purchases - 562,045 1,271,479
------------------------------------------------ ------------------- ------------------- --------------------
Total fundings $ 872,986 $ 2,520,237 $ 2,490,490
------------------------------------------------ ------------------- ------------------- --------------------
Principal amount of loans and securities
securitized or sold $ 738,711 $ 1,891,075 $ 2,278,633
------------------------------------------------ ------------------- ------------------- --------------------
(1) Included in commercial fundings were $136.7 million, $228.6 million, and $49.2 million of
multifamily construction loans closed during years ended December 31, 1999, 1998 and 1997, respectively. As
of December 31, 1999, $414.5 million of multifamily construction loans have closed, of which only the amount
drawn for these loans of $115.5 million is included in the balance of the loans held for sale or
securitization at December 31, 1999.
(2) Secured by automobile installment contracts
During 1999, the Company funded $224.3 million of commercial loans
consisting of $136.7 million of construction loans, $57.3 million of multifamily
loans and $30.3 million in other types of commercial loans. The majority of the
multifamily loans funded in 1999 consist of mortgage loans on properties that
have been allocated low income housing tax credits. As of March 31, 2000,
commitments to fund commercial loans were approximately $26.0 million.
Prior to the sale of the manufactured housing lending operations to Bingham
Financial Services Corporation ("Bingham") (NASDAQ: BSFC) in December 1999, the
Company funded $494.1 million of manufactured housing loans during 1999. The
Company sold $77.3 million of such loans to Bingham as part of the sale
transaction. The Company securitized a total of $601.8 million of its
manufactured housing loans (including current and prior years' production)
through the issuance of collateralized bonds during 1999.
At December 31, 1999, the Company owned the right to call $353.9 million of
securities previously issued by the Company once the outstanding balance of such
securities reaches 10% or less of the original amount issued.
The Company did not purchase any loans on a bulk basis in 1999, compared to
$562.0 million of single family adjustable-rate ("ARM") loans bulk purchased in
1998. All of the single family ARM loans purchased in 1998 were securitized
through the issuance of collateralized bonds.
During June 1998, the Company entered into a series of agreements with
AutoBond Acceptance Corporation ("AutoBond") (OTC: AUBD) to purchase "funding
notes" secured by automobile contracts originated by AutoBond. The gross amount
of funding notes purchased by the Company was $162.8 million. In February 1999,
the Company suspended purchasing the funding notes as a result of the findings
of compliance reviews done by third parties and other breeches of the
agreements. As a result, AutoBond and related entities sued the Company in the
district court of Travis County, Texas. On March 9, 2000, a jury entered a
verdict in favor of AutoBond in an amount approximating $69 million. On April
17, 2000, based on motions filed by the Company, the judge presiding over the
matter in Travis County proposed a judgement of approximately $27 million (which
includes estimated prejudgment interest), in lieu of the approximate $69 million
jury verdict. As a result, the Company recorded a litigation provision of $27.0
million effective for the year ended December 31, 1999. See Item 3. Legal
Proceedings.
Asset Servicing
As mentioned above, the Company's philosophy is generally to service assets
that it has originated due to the retention of a portion of the credit risk on
that asset. The Company established the capability to service both commercial
and manufactured housing loans funded through its production operations in 1996.
The manufactured housing servicing operations, and the associated $1.1 billion
servicing portfolio, were sold in December 1999. The Company has retained credit
risk on these loans through overcollateralization of approximately $110 million.
As of December 31, 1999, the 60-plus day delinquencies on these $1.1 billion of
loans was 1.42%. As of December 31, 1999, the Company had a commercial servicing
portfolio totaling $1.2 billion. There were no delinquencies in the commercial
loan servicing portfolio as of December 31, 1999. The Company may sell its
commercial loan servicing portfolio during 2000.
During 1997, the Company established a servicing function in Pittsburgh,
Pennsylvania, to manage the collection of the Company's delinquent property tax
receivables. The Company's responsibilities as servicer include contacting
property owners, collecting voluntary payments, and foreclosing, rehabilitating
and selling remaining properties if collection efforts fail. During 1999, the
Company also established a satellite servicing office in Cleveland, Ohio. As of
December 31, 1999, the Company had a servicing portfolio of $84.6 million of
property tax receivables in seven states.
Securitization
The Company historically has used funds provided by its senior notes, bank
borrowings, repurchase agreements and equity to finance loan production when
loans are initially funded. When a sufficient volume of loans was accumulated,
generally between $300 million and $1 billion in principal amount, the loans
were securitized through the issuance of mortgage or asset-backed securities in
the form of collateralized bonds. The length of time between when the Company
committed to fund the loan and when it securitized the loan varied depending on
certain factors, including the length of the loan commitment (the Company has
committed to fund various commercial and multifamily loans on a forward-basis),
the loan volume by product type, market forces (e.g., whether there exists in
the market place sufficient purchasers of these types of mortgage or
asset-backed securities), and variations in the securitization process. In
adverse market conditions, the Company may be unable to securitize the loans.
Though the Company utilizes primarily committed facilities to finance its loan
production prior to securitization, in adverse market conditions, the Company
may have to sell loans at losses in order to repay these facilities. In the
current environment, the Company is unable to economically securitize commercial
mortgage loans. As a result, commercial mortgage loans remaining in the
Company's inventory as of December 31, 1999 are now considered held for sale.
Since late 1995, the Company's predominate securitization structure has
been collateralized bonds. Generally, for accounting and tax purposes, the loans
and securities financed through the issuance of collateralized bonds are treated
as assets of the Company, and the collateralized bonds are treated as debt of
the Company. The Company earns the net interest spread between the interest
income on the securities and the interest and other expenses associated with the
collateralized bond financing. The net interest spread is directly impacted by
the levels of prepayments of the underlying mortgage loans and, to the extent
collateralized bond classes are variable-rate, may be affected by changes in
short-term rates. The Company retains an investment in the collateralized bonds,
typically referred to as the overcollateralization.
Master Servicing
The Company performs the function of master servicer for certain of the
securities it has issued. The master servicer's function typically includes
monitoring and reconciling the loan payments remitted by the servicers of the
loans, determining the payments due on the securities and determining that the
funds are correctly sent to a trustee or investors for each series of
securities. Master servicing responsibilities also include monitoring the
servicers' compliance with its servicing guidelines. As master servicer, the
Company is paid a monthly fee based on the outstanding principal balance of each
such loan master serviced or serviced by the Company as of the last day of each
month. As of December 31, 1999, the Company master serviced $3.0 billion in
securities.
Investment Portfolio
The core of the Company's earnings is derived from its investment
portfolio. The Company's strategy for its investment portfolio is to create a
diversified portfolio of high quality assets that in the aggregate generates
stable income in a variety of interest rate and prepayment environments and
preserves the Company's capital base. In many instances, the investment strategy
involves not only the creation of the asset, but also structuring the related
securitization or borrowing to create a stable yield profile and reduce interest
rate and credit risk.
The Company continuously monitors the aggregate cash flow, projected net
yield and market value of its investment portfolio under various interest rate
and prepayment environments. While certain investments may perform poorly in an
increasing or decreasing interest rate environment, certain other investments
may perform well, and others may not be impacted at all. Generally, the Company
adds investments to its portfolio which are designed to increase the
diversification and reduce the variability of the yield produced by the
portfolio in different interest rate environments.
Credit Quality. Excluding certain securities where the risk is primarily
the rate of prepayments and not credit, 90.0 % of the Company's investments
relate to securities rated AA or AAA by at least one nationally-recognized
rating agency. These ratings are based on AAA rated bond insurance, third-party
guarantees, mortgage pool insurance or subordination. On securities where the
Company has retained a portion of the credit risk below the investment grade
level (BBB), the Company's exposure to credit losses below the investment grade
level was $229.3 million as of December 31, 1999. This credit exposure is
reduced by reserves, discounts and third party guarantees of $49.9 million.
Composition. The following table presents the balance sheet composition of
the investment portfolio at fair market value by investment type and the
percentage of the total investments as of December 31, 1999 and 1998.
- -------------------------------------------- --------------------------------------------------------------
As of December 31,
1999 1998
------------------------------- ------------------------------
(amounts in thousands) Balance % of Total Balance % of Total
- -------------------------------------------- ----------------- ------------- ---------------- -------------
Investments:
Collateral for collateralized bonds $ 3,700,714 90.0% $ 4,293,528 86.6%
Securities:
Funding Notes and Securities 95,027 2.3 122,009 2.5
Adjustable-rate mortgage securities 11,410 0.3 47,728 1.0
Fixed-rate mortgage securities 9,623 0.2 28,981 0.6
Derivative and residual securities 11,651 0.3 18,894 0.4
Other securities - - 26,372 0.5
Other investments 48,927 1.2 30,371 0.6
Loans held for sale or securitization 232,384 5.7 388,782 7.8
- -------------------------------------------- ----------------- ------------- ---------------- -------------
Total investments $ 4,109,736 100% $ 4,956,665 100%
- -------------------------------------------- ----------------- ------------- ---------------- -------------
Collateral for collateralized bonds. Collateral for collateralized bonds
represents the single largest investment in the Company's portfolio. Collateral
for collateralized bonds is composed primarily of securities backed primarily by
adjustable-rate and fixed-rate mortgage loans secured by first liens on single
family homes, fixed-rate mortgage loans secured by multifamily residential
housing properties and commercial properties, manufactured housing installment
loans secured by either a UCC filing or a motor vehicle title, and property tax
receivables. Interest margin on the net investment in collateralized bonds
(defined as the principal balance of collateral for collateralized bonds less
the principal balance of the collateralized bonds outstanding) is derived
primarily from the difference between (i) the cash flow generated from the
collateral pledged to secure the collateralized bonds and (ii) the amounts
required for payment on the collateralized bonds and related insurance and
administrative expenses. Collateralized bonds are generally non-recourse to the
Company. The Company's yield on its net investment in collateralized bonds is
affected primarily by changes in interest rates and prepayment rates and credit
losses on the underlying loans. The Company may retain for its investment
portfolio certain classes of the collateralized bonds issued and pledge such
classes as collateral for repurchase agreements.
Funding Notes and Securities. Funding Notes and Securities consist of
fixed-rate securities secured by fixed-rate automobile installment contracts
made to borrowers with limited access to traditional sources of credit. Such
Funding Notes and Securities were purchased from limited purpose subsidiaries of
AutoBond. The Funding Notes and Securities are carried at their estimated net
realizable value.
ARM securities. Another segment of the Company's portfolio is the
investments in ARM securities. The interest rates on the majority of the
Company's ARM securities reset every six months and the rates are subject to
both periodic and lifetime limitations. Generally, the Company finances a
portion of its ARM securities with repurchase agreements, which have a fixed
rate of interest over a term that ranges from 30 to 90 days and, therefore, are
not subject to repricing limitations. As a result, the net interest margin on
the ARM securities could decline if the spread between the yield on the ARM
security versus the interest rate on the repurchase agreement was reduced.
Fixed-rate mortgage securities. Fixed-rate mortgage securities consist of
securities that have a fixed-rate of interest for specified periods of time. The
Company's yields on these securities are primarily affected by changes in
prepayment rates. Such yields will decline with an increase in prepayment rates
and will increase with a decrease in prepayment rates. The Company generally
borrows against its fixed-rate mortgage securities through the use of repurchase
agreements. Additionally, the net interest margin the Company realizes on its
fixed-rate mortgage securities will be subject to the spread between the yield
on the fixed-rate mortgage securities and the effective interest rate on the
repurchase agreements. The effective interest rates on the repurchase agreements
generally resets within 30-day intervals.
Derivative and residual securities. Derivative and residual securities
consist primarily of interest-only securities ("I/Os"), principal-only
securities ("P/Os") and residual interests which were either purchased or were
created through the Company's production operations. An I/O is a class of a
collateralized bond or a mortgage pass-through security that pays to the holder
substantially all interest. A P/O is a class of a collateralized bond or a
mortgage pass-through security that pays to the holder substantially all
principal. Residual interests represent the excess cash flows on a pool of
mortgage collateral after payment of principal, interest and expenses of the
related mortgage-backed security or repurchase arrangement. Residual interests
may have little or no principal amount and may not receive scheduled interest
payments. Included in the residual interests at December 31, 1999 was $8.6
million of equity ownership in residual trusts which own collateral financed
with repurchase agreements, which had a fair value of $2.8 million. The
Company's borrowings against its derivative and residual securities is limited
by certain loan covenants to 3% of shareholders' equity. The yields on these
securities are affected primarily by changes in prepayment rates and by changes
in short-term interest rates.
Other securities. Other securities consisted primarily of a corporate bond
at December 31, 1998.
Other investments. Other investments consists primarily of an installment
note receivable received in connection with the sale of the Company's single
family mortgage operations in May 1996, and property tax receivables.
Loans held for sale or securitization. As of December 31, 1999, all loans
are held for sale and consist principally of multifamily permanent and
construction mortgage loans. Since these loans are held for sale, the loans are
carried at the lower of cost or market. Loans as of December 31, 1998 consisted
principally of multifamily permanent and construction mortgage loans, commercial
mortgage loans and manufactured housing loans. These loans were primarily held
for securitization as of that date.
Investment Portfolio Risks
The Company is exposed to several types of risks inherent in its investment
portfolio. These risks include credit risk (inherent in the loans before
securitization and the security structure after securitization),
prepayment/interest rate risk (inherent in the underlying loan) and margin call
risk (inherent in the security if it is used as collateral for recourse
borrowings).
Credit Risk. Credit risk is the risk of loss to the Company from the
failure by a borrower (or the proceeds from the liquidation of the underlying
collateral) to fully repay the principal balance and interest due on a loan. A
borrower's ability to repay, or the value of the underlying collateral, could be
negatively influenced by economic and market conditions. These conditions could
be global, national, regional or local in nature. When a loan is funded and
becomes part of the Company's investment portfolio, the Company has all of the
credit risk on the loan should it default. Upon securitization of the pool of
loans, the credit risk retained by the Company is generally limited to the net
investment in collateralized bonds and subordinated securities. The Company
provides for reserves for expected losses based on the current performance of
the respective pool of loans; however, if losses are experienced more rapidly
due to market conditions than the Company has provided for in its reserves, the
Company may be required to provide for additional reserves for these losses.
The Company began to retain a portion of the credit risk on securitized
mortgage loans in 1994 as mortgage pool insurance became less available in the
market and as the Company diversified into other products. The Company evaluates
and monitors its exposure to credit losses and has established reserves and
discounts for probable credit losses based upon anticipated future losses on the
loans, general economic conditions and historical trends in the portfolio. As of
December 31, 1999, the Company's credit exposure on securities rated below
investment grade or as to overcollateralization was $229.3 million. This amount
excludes funding notes and securities which are carried at estimated net
realizable value, other investments and loans held for sale or securitization
which are carried at the lower of cost or market. This amount is reduced by
on-balance sheet reserves and discounts of $19.6 million, and third party
guarantees of $30.3 million.
Prepayment/Interest Rate Risk. The interest rate environment may also
impact the Company. For example, in a rising rate environment, the Company's net
interest margin may be reduced, as the interest cost for its funding sources
(collateralized bonds, repurchase agreements, and committed lines of credit)
could increase more rapidly than the interest earned on the associated asset
financed. The Company's funding sources are substantially based on the one-month
London InterBank Offered Rate ("LIBOR") and reprice monthly, while the
associated assets are principally six-month LIBOR or one-year Constant Maturity
Treasury ("CMT") based and generally reprice every six-to-twelve months. In a
declining rate environment, net interest margin may be enhanced for the opposite
reasons. However, in a period of declining interest rates, loans in the
investment portfolio will generally prepay more rapidly (to the extent that such
loans are not prohibited from prepayment), which may result in additional
amortization expense of asset premium. In a flat yield curve environment (i.e.,
when the spread between the yield on the one-year Treasury and the yield on the
ten-year Treasury is less than 1.0%), single-family ARM loans tend to rapidly
prepay, causing additional amortization of asset premium. In addition, the
spread between the Company's funding costs and asset yields would most likely
compress, causing a further reduction in the Company's net interest margin.
Lastly, the Company's investment portfolio may shrink, or proceeds returned from
prepaid assets may be invested in lower yielding assets. The severity of the
impact of a flat yield curve to the Company would depend on the length of time
the yield curve remained flat.
The Company strives to structure its investment portfolio to provide stable
spread income in a variety of prepayment and interest rate scenarios. To manage
prepayment risk (i.e. from a decline in long-term rates on fixed rate assets, or
a flattening or inverse yield curve as to ARM assets), the Company minimizes the
amount of "interest-only" investments or premium on assets. The Company has, in
aggregate, $30.2 million of asset premium relating to assets with prepayment
lockouts or yield maintenance provision for at least seven years, and $3.9
million of asset premium on its remaining assets. In addition, future earnings
may be lower as a result of the reduction in the interest-earning assets from
increased prepayment speeds or if the Company is otherwise unable to invest in
new assets.
The Company also views its hedging activities as a tool to manage interest
rate risk. As mentioned previously, the Company finances its adjustable-rate
assets, which primarily reprice typically every six months based on six-month
LIBOR and one-year CMT and typically are limited to an interest rate adjustment
of 1% increase every six months or a 2% increase every twelve months, with
borrowings that reprice monthly indexed to one-month LIBOR and have no periodic
caps. To manage the periodic interest rate risk associated with the Company's
borrowings to the extent that interest rates rise more than 1% in a six-month
period, the Company has entered into an interest rate swap agreement that has
effectively capped the increase in the borrowing costs on $1.02 billion of
borrowings to 1% during any six-month period. The terms of the swap are such
that the Company pays the lesser of current six-month LIBOR, or six-month LIBOR,
in effect 180 days prior plus 1%, and receives current six-month LIBOR. As this
is an interest rate swap agreement, the Company recognizes the net additional
interest income or expense from the interest rate swap as an adjustment to
interest expense recognized on the borrowings. This swap agreement expires in
2001. As the adjustable-rate assets also have lifetime interest rate caps, the
Company has $1.4 billion in interest rate cap agreements (with contracted rates
between 9.0% and 11.5% based on six-month LIBOR and one-year CMT) to provide the
Company with additional cash flow should short-term rates rise significantly.
These cap agreements expire from 2001 to 2004.
Margin Call Risk. The Company uses repurchase agreements to finance a
portion of its investment portfolio. Margin call risk is the risk that the
Company will be required to provide additional collateral to the counterparties
of its secured recourse borrowings should the value of the asset pledged as
collateral for the recourse borrowings decline. Generally, the Company pledges
only investment grade rated securities or whole loans as collateral for recourse
borrowings. The value of the pledged security or loan is impacted by a variety
of factors, including the perceived credit risk of the security or loan, the
type and performance of the underlying loans in the security, current market
volatility, and the general amount of liquidity in the market place for the
asset financed. In instances where market volatility is high, there are credit
issues on the collateral, or where overall liquidity in the market has been
reduced, the Company may experience margin calls from its lenders. Depending on
the Company's current liquidity position, the Company may be forced to sell
assets to meet margin calls, which may result in losses. The Company attempts to
manage its margin call risk, and thereby limit its liquidity risk, by limiting
the amount of its recourse borrowings to less than 2.5 times equity. As of
December 31, 1999, the Company had repurchase agreements outstanding of $163.0
million. As of March 31, 2000, the Company had reduced the repurchase agreements
outstanding to approximately $81.0 million.
The Company also has liquidity risk inherent to its investment in certain
residual trusts. These trusts are subject to margin calls and the Company, at
its option, may provide additional equity to the trust to meet the margin call.
Should the Company not provide the additional equity, the assets of the trust
could be sold to meet the trusts' obligations, resulting in a potential loss to
the Company. At December 31, 1999, the total amount of such investments was $8.6
million.
Since 1996, the Company has structured all of its securitizations as
non-recourse collateralized bonds, with the financing, in effect, incorporated
into the bond structure. This structure eliminates the need for repurchase
agreements on such collateral, and consequently eliminates the margin call risk
and to a lesser degree the interest rate risk. During 1999, 1998 and 1997, the
Company issued approximately $2.1 billion, $2.0 billion and $2.6 billion,
respectively, in collateralized bonds. To the extent the Company were to issue
securities in the future, the Company plans to continue to use collateralized
bonds as its primary securitization vehicle.
FEDERAL INCOME TAX CONSIDERATIONS
General
Dynex REIT believes it has complied and, intends to comply in the future,
with the requirements for qualification as a REIT under the Internal Revenue
Code (the "Code"). To the extent that Dynex REIT qualifies as a REIT for federal
income tax purposes, it generally will not be subject to federal income tax on
the amount of its income or gain that is distributed to shareholders. DHI and
its subsidiaries, which conduct the production operations, are not qualified
REIT subsidiaries and are not consolidated with Dynex REIT for either tax or
financial reporting purposes. Consequently, the taxable income of DHI and its
subsidiaries is subject to federal and state income taxes. Dynex REIT will
include in taxable income amounts earned by DHI only when DHI remits its
after-tax earnings in the form of a dividend to Dynex REIT.
The REIT rules generally require that a REIT invest primarily in real
estate-related assets, that its activities be passive rather than active and
that it distribute annually to its shareholders substantially all of its taxable
income. Dynex REIT could be subject to income tax if it failed to satisfy those
requirements or if it acquired certain types of income-producing real property.
Although no complete assurances can be given, Dynex REIT does not expect that it
will be subject to material amounts of such taxes.
Failure to satisfy certain Code requirements could cause Dynex REIT to lose
its status as a REIT. If Dynex REIT failed to qualify as a REIT for any taxable
year, it would be subject to federal income tax (including any applicable
alternative minimum tax) at regular corporate rates and would not receive
deductions for dividends paid to shareholders. As a result, the amount of
after-tax earnings available for distribution to shareholders would decrease
substantially. While the Board of Directors intends to cause Dynex REIT to
operate in a manner that will enable it to qualify as a REIT in future taxable
years, there can be no certainty that such intention will be realized.
In December 1999, with an effective date of January 1, 2001, Congress
signed into law several changes to the provisions of the Code relating to REITs.
The most significant of these changes relates to the reduction of the
distribution requirement from 95% to 90% of taxable income and the allowance of
REITS to own 100% interest in its taxable REIT subsidiaries.
Qualification of the Company as a REIT
Qualification as a REIT requires that Dynex REIT satisfy a variety of tests
relating to its income, assets, distributions and ownership. The significant
tests are summarized below.
Sources of Income. To continue qualifying as a REIT, Dynex REIT must
satisfy two distinct tests with respect to the sources of its income: the "75%
income test" and the "95% income test". The 75% income test requires that Dynex
REIT derive at least 75% of its gross income (excluding gross income from
prohibited transactions) from certain real estate-related sources. In order to
satisfy the 95% income test, 95% Dynex REIT's gross income for the taxable year
must consist either of income that qualifies under the 75% income test or
certain other types of passive income.
If Dynex REIT fails to meet either the 75% income test or the 95% income
test, or both, in a taxable year, it might nonetheless continue to qualify as a
REIT, if its failure was due to reasonable cause and not willful neglect and the
nature and amounts of its items of gross income were properly disclosed to the
Internal Revenue Service. However, in such a case Dynex REIT would be required
to pay a tax equal to 100% of any excess non-qualifying income.
Nature and Diversification of Assets. At the end of each calendar quarter,
three asset tests must be met by Dynex REIT. Under the 75% asset test, at least
75% of the value of Dynex REIT's total assets must represent cash or cash items
(including receivables), government securities or real estate assets. Under the
"10% asset test", Dynex REIT may not own more than 10% of the outstanding voting
securities of any single non-governmental issuer, if such securities do not
qualify under the 75% asset test. Under the "5% asset test," ownership of any
stocks or securities that do not qualify under the 75% asset test must be
limited, in respect of any single non-governmental issuer, to an amount not
greater than 5% of the value of the total assets of Dynex REIT.
If Dynex REIT inadvertently fails to satisfy one or more of the asset tests
at the end of a calendar quarter, such failure would not cause it to lose its
REIT status, provided that (i) it satisfied all of the asset tests at the close
of a preceding calendar quarter and (ii) the discrepancy between the values of
Dynex REIT's assets and the standards imposed by the asset tests either did not
exist immediately after the acquisition of any particular asset or was not
wholly or partially caused by such an acquisition. If the condition described in
clause (ii) of the preceding sentence was not satisfied, Dynex REIT still could
avoid disqualification by eliminating any discrepancy within 30 days after the
close of the calendar quarter in which it arose.
Distributions. With respect to each taxable year, in order to maintain its
REIT status, Dynex REIT generally must distribute to its shareholders an amount
at least equal to 95% of the sum of its "REIT taxable income" (determined
without regard to the deduction for dividends paid and by excluding any net
capital gain) and any after-tax net income from certain types of foreclosure
property minus any "excess noncash income." The Code provides that distributions
relating to a particular year may be made in the following year, in certain
circumstances. Dynex REIT will balance the benefit to the shareholders of making
these distributions and maintaining REIT status against their impact on the
liquidity of Dynex REIT. In an unlikely situation, it may benefit the
shareholders if Dynex REIT retained cash to preserve liquidity and thereby lose
REIT status. Effective January 1, 2001, the Code has reduced the distribution
requirement from 95% of REIT taxable income to 90% of REIT taxable income.
Ownership. In order to maintain its REIT status, Dynex REIT must not be
deemed to be closely held and must have more than 100 shareholders. The closely
held prohibition requires that not more than 50% of the value of Dynex REIT's
outstanding shares be owned by five or fewer persons at anytime during the last
half of Dynex REIT's taxable year. The more than 100 shareholder rule requires
that Dynex REIT have at least 100 shareholders for 335 days of a twelve-month
taxable year. In the event that Dynex REIT failed to satisfy the ownership
requirements Dynex REIT would be subject to fines and required to take curative
action to meet the ownership requirements in order to maintain its REIT status.
For federal income tax purposes, Dynex REIT is required to recognize income
on an accrual basis and to make distributions to its shareholders when income is
recognized. Accordingly, it is possible that income could be recognized and
distributions required to be made in advance of the actual receipt of such funds
by Dynex REIT. The nature of Dynex REIT's investments is such that it expects to
have sufficient assets to meet federal income tax distribution requirements.
Taxation of Distributions by Dynex REIT
Assuming that Dynex REIT maintains its status as a REIT, any distributions
that are properly designated as "capital gain dividends" will generally be taxed
to shareholders as long-term or mid-term capital gains, regardless of how long a
shareholder has owned his shares. Any other distributions out of Dynex REIT's
current or accumulated earnings and profits will be dividends taxable as
ordinary income. Distributions in excess of Dynex REIT's current or accumulated
earnings and profits will be treated as tax-free returns of capital, to the
extent of the shareholder's basis in his shares and, as gain from the
disposition of shares, to the extent they exceed such basis. Shareholders may
not include on their own tax returns any of Dynex REIT ordinary or capital
losses. Distributions to shareholders attributable to "excess inclusion income"
of Dynex REIT will be characterized as excess inclusion income in the hands of
the shareholders. Excess inclusion income can arise from Dynex REIT's holdings
of residual interests in real estate mortgage investment conduits and in certain
other types of mortgage-backed security structures created after 1991. Excess
inclusion income constitutes unrelated business taxable income ("UBTI") for
tax-exempt entities (including employee benefit plans and individual retirement
accounts) and it may not be offset by current deductions or net operating loss
carryovers. In the unlikely event that Dynex REIT's excess inclusion income is
greater than its taxable income, Dynex REIT's distribution would be based on
Dynex REIT's excess inclusion income. Dividends paid by Dynex REIT to
organizations that generally are exempt from federal income tax under Section
501(a) of the Code should not be taxable to them as UBTI except to the extent
that (i) purchase of shares of Dynex REIT was financed by "acquisition
indebtedness" or (ii) such dividends constitute excess inclusion income. In
1999, Dynex REIT's excess inclusion income was de minimus.
Taxable Income
Dynex REIT uses the calendar year for both tax and financial reporting
purposes. However, there may be differences between taxable income and income
computed in accordance with GAAP. These differences primarily arise from timing
differences in the recognition of revenue and expense for tax and GAAP purposes.
Dynex REIT has not yet finalized the determination of its taxable income for the
year ended December 31, 1999. However, the Company believes that it has met all
of the REIT distribution requirements of the Code.
REGULATION
Prior to the sale of its manufactured housing lending operation, the
Company was an approved mortgage and consumer loan originator and servicer, and
therefore was subject to various federal and state regulations. A violation of
such regulations while the Company owned such business may still result in a
loss to the Company as a result of various representations and warranties made
by the Company in regard to the sale of such business.
Such rules and regulations, among other things, prohibit discrimination and
establish underwriting guidelines that include provisions for inspections and
appraisals, require credit reports on prospective borrowers and fix maximum loan
amounts. In particular, the Company was subject to, among other laws, the Equal
Credit Opportunity Act, Federal Truth-in-Lending Act and the Real Estate
Settlement Procedures Act and the regulations promulgated thereunder that
prohibit discrimination and require the disclosure of certain basic information
to mortgagors concerning credit terms and settlement costs. The Company's
servicing activities were also subject to, among other laws, the Fair Credit
Reporting Act and the Fair Debt Collections Practices Act. The Company's
existing consumer-related servicing activities consist of collections on the
delinquent property tax receivables. Such servicing operations are managed in
compliance with the Fair Debt Collections Practices Act.
The Company believes that it is in material compliance with all material
rules and regulations to which it is subject.
COMPETITION
The Company competes with a number of institutions with greater financial
resources in originating and purchasing loans. In addition, in purchasing
portfolio investments and in issuing securities, the Company competes with
investment banking firms, savings and loan associations, commercial banks,
mortgage bankers, insurance companies and federal agencies and other entities
purchasing mortgage assets, many of which have greater financial resources than
the Company.
EMPLOYEES
As of December 31, 1999, Dynex REIT had 31 employees and DHI had 65
employees.
Item 2. PROPERTIES
The Company's executive and administrative offices and operations offices
are both located in Glen Allen, Virginia, on properties leased by the Company
which consist of approximately 32,000 square feet. The address is 10900 Nuckols
Road, 3rd Floor, Glen Allen, Virginia 23060. The lease expires in 2003. DHI and
subsidiaries also occupy space located in Glen Allen, Virginia; Shrewesberry,
New Jersey; Cleveland, Ohio; Pittsburgh, Pennsylvania; and Versailles,
Pennsylvania. These locations consist of approximately 14,250 square feet, and
the leases associated with these properties, if any, expire in 2000 through
2001.
Item 3. LEGAL PROCEEDINGS
On February 8, 1999, AutoBond Acceptance Corporation ("AutoBond"), AutoBond
Master Funding Corporation V ("Funding"), and its three principal common
shareholders (collectively, the "Plaintiffs") commenced an action in the
District Court of Travis County, Texas (250th Judicial District) against the
Company and James Dolph (collectively, the "Defendants") alleging that the
Company breached the terms of the Credit Agreement, dated June 9, 1998, by and
among AutoBond, Funding and the Company. The terms of the Credit Agreement
provided for the purchase by the Company of funding notes issued by Funding, and
collateralized by automobile installment contracts ("Auto Contracts") acquired
by AutoBond. The Company suspended purchasing the funding notes in February 1999
on grounds that AutoBond and Funding had violated certain provisions of the
Credit Agreement. The Plaintiffs also alleged that the Defendants conspired to
misrepresent and mischaracterize AutoBond's credit underwriting criteria and its
compliance with such criteria with the intention of interfering and causing
actual damage to AutoBond's business, prospective business and contracts.
On August 26, 1999, the District Court of Travis County ordered AutoBond
and Funding, through a temporary injunction action, to cooperate with the
Company and permit the transfer of the servicing of the Auto Contracts from
AutoBond to a third party servicer selected by the Company. The servicing was
transferred on September 3, 1999.
On March 9, 2000, a jury in the AutoBond action returned a verdict in favor
of the Plaintiffs, and awarded AutoBond and Funding $18.7 million in direct lost
profits and $50.5 million in lost future profits, for a total of $69.2 million.
The Company filed on March 24, 2000 with the Court motions to set aside the
verdict and to reduce the amount of the verdict, and on the same date, AutoBond
filed a motion to the court to enter judgment. On April 17, 2000, in response to
the various motions filed, the judge presiding over the matter in Travis County
reduced the $69.2 million verdict awarded by the jury to approximately $27
million (which includes estimated prejudgment interest). As a result, the
Company recorded a litigation provision of $27.0 million for the amount of the
reduced judgment. Should AutoBond not accept the proposed judgment, the judge
has indicated that he will grant Dynex a new trial. Should AutoBond accept the
judgment, the Company is evaluating its options in the matter, which may include
the appeal of the verdict and the resulting judgment. Factors for the Company to
consider include the potential inability of the Company to post the amount of
appeal bond necessary to secure an appeal. Should Dynex REIT not be able to
secure an appeal bond for the full amount of the proposed judgement of $27
million, Texas State law would allow for Dynex REIT to present evidence to
reduce the required amount of the appeal bond or to provide other collateral for
the appeal. There can be no assurance that Dynex REIT will be allowed to post a
reduced bond.
The Company is also subject to other lawsuits or claims which arise in the
ordinary course of its business, some of which seek damages in amounts which
could be material to the financial statements. Although no assurance can be
given with respect to the ultimate outcome of any such litigation or claim, the
Company believes the resolution of such lawsuits or claims will not have a
material affect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Dynex Capital, Inc.'s common stock is traded on the New York Stock Exchange
under the trading symbol DX. The common stock was held by approximately 3,663
holders of record as of February 29, 2000. During the last two years, the high
and low closing stock prices and cash dividends declared on common stock,
adjusted for the two-for-one stock split effective May 5, 1997 and the
one-for-four reverse stock split effective August 2, 1999, were as follows:
- --------------------------------------- -------------- ------------- -----------
Cash
Dividends
High Low Declared
- --------------------------------------- -------------- ------------- -----------
1999:
First quarter $ 22 $ 11 $ -
Second quarter 16 8 1/4 -
Third quarter 13 3/16 5 1/2 -
Fourth quarter 8 5/8 6 -
1998:
First quarter $ 54 1/2 $ 47 3/4 $1.20
Second quarter 49 1/2 39 3/4 1.20
Third quarter 46 32 1/2 1.00
Fourth quarter 32 1/2 17 1/4 -
- ----------------------------------- -------------- ------------- ---------------
Item 6. SELECTED FINANCIAL DATA
(amounts in thousands except share data)
- ----------------------------------------------------------------------------------------------------------------------------
Years ended December 31, 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------
Net interest margin $ 48,015 $ 66,538 $ 83,454 $ 73,750 $ 41,778
Write-downs associated with commercial production (59,962) - - - -
operations
(Loss) gain on sale of investments and trading (12,682) (2,714) 11,584 (385) (7,060)
activities
Gain on sale of loan production operations 7,676 - - 21,512 -
Impairment charge and litigation provision - AutoBond (31,732) (17,632) - - -
Equity in net (loss) earnings of Dynex Holding, Inc. (1,923) 2,456 (1,109) (4,309) 11,600
Other income 1,673 2,852 1,716 606 294
General and administrative expenses (7,740) (8,973) (9,531) (8,365) (5,036)
Net administrative fees and expenses to Dynex (16,943) (22,379) (12,116) (9,761) (4,666)
Holding, Inc.
Extraordinary item - loss on extinguishment of debt (1,517) (571) - - -
- ----------------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (75,135) $ 19,577 $ 73,998 $ 73,048 $ 36,910
- ----------------------------------------------------------------------------------------------------------------------------
Total revenue $ 350,798 $ 410,821 $ 346,859 $ 333,029 $ 250,830
- ----------------------------------------------------------------------------------------------------------------------------
Total expenses $ 425,933 $ 391,244 $ 272,861 $ 259,981 $ 213,920
- ----------------------------------------------------------------------------------------------------------------------------
Income per common share before extraordinary item:
Basic(1) $ (7.53) $ 0.62 $ 5.50 $ 6.17 $ 3.40
Diluted (1) (7.53) 0.62 5.48 5.94 3.40
Net income per common share after extraordinary item:
Basic(1) $ (7.67) $ 0.57 $ 5.50 $ 6.17 $ 3.40
Diluted (1) (7.67) 0.57 5.48 5.94 3.40
Dividends declared per share:
Common (1) $ - $ 3.40 $ 5.42 $ 4.532 $ 3.36
Series A Preferred 1.17 2.37 2.71 2.375 1.17
Series B Preferred 1.17 2.37 2.71 2.375 0.42
Series C Preferred 1.46 2.92 2.92 0.600 -
Return on average common shareholders' equity (2) (27.3%) 2.0% 17.9% 21.6% 12.5%
Total fundings $ 872,986 $2,520,237 $2,490,490 $1,508,780 $ 916,570
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------
Investments (3) $4,109,736 $4,956,665 $5,211,009 $3,918,989 $3,421,470
Total assets 4,190,896 5,178,848 5,367,413 3,980,820 3,482,702
Non-recourse debt 3,282,378 3,665,316 3,632,079 2,149,068 843,856
Recourse debt 537,098 1,032,733 1,133,536 1,294,972 2,237,571
Total liabilities 3,865,824 4,726,044 4,806,504 3,477,203 3,127,879
Shareholders' equity 325,072 452,804 560,909 503,617 354,823
Number of common shares outstanding 11,444,099 46,027,426 45,146,242 20,653,593 20,198,654
Average number of common shares (1) 11,483,977 11,436,599 10,757,845 10,222,395 10,061,386
Book value per common share (1) $ 17.53 $ 27.75 $ 37.59 $ 34.60 $ 26.11
- ----------------------------------------------------------------------------------------------------------------------------
(1) Adjusted for two-for-one common stock split effective May 5, 1997 and the one-for-four reverse common stock split effective
August 2, 1999.
(2) Excludes unrealized gain/loss on investments available-for-sale.
(3) Investments classified as available for sale are shown at fair value.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company is a financial services company which invests in a portfolio of
securities and investments backed principally by single family mortgage loans,
commercial mortgage loans and manufactured housing installment loans. Such loans
have been funded generally by the Company's loan production operations or
purchased in bulk in the market. Loans funded through the Company's production
operations have generally been pooled and pledged as collateral using a
collateralized bond security structure, which provides long-term financing for
the loans while limiting credit, interest rate and liquidity risk. FINANCIAL
CONDITION
- --------------------------------------------------------------------------------
December 31,
(amounts in thousands except per share data) 1999 1998
- ----------------------------------------------------------- --------------------
Investments:
Collateral for collateralized bonds $ 3,700,714 $ 4,293,528
Securities 127,711 243,984
Other investments 48,927 30,371
Loans held for sale securitization 232,384 388,782
Non-recourse debt 3,282,378 3,665,316
Recourse debt 537,098 1,032,733
Shareholders' equity 325,072 452,804
Book value per common share 17.53 27.75
- -------------------------------------- -------------------- --------------------
Collateral for Collateralized Bonds Collateral for collateralized bonds
consists primarily of securities backed by adjustable-rate and fixed-rate
mortgage loans secured by first liens on single family properties, fixed-rate
loans secured by first liens on multifamily and commercial properties,
manufactured housing installment loans secured by either a UCC filing or a motor
vehicle title and property tax receivables. As of December 31, 1999, Dynex REIT
had 27 series of collateralized bonds outstanding. The collateral for
collateralized bonds decreased to $3.7 billion at December 31, 1999 compared to
$4.3 billion at December 31, 1998. This decrease of $0.6 billion is primarily
the result of $1.1 billion in paydowns on collateral, offset by the net addition
of $0.6 billion of collateral as a result of the issuance of three series of
collateralized bonds during 1999.
Securities Securities consist primarily of fixed-rate "funding notes and
securities" secured by automobile installment contracts and adjustable-rate and
fixed-rate mortgage-backed securities. Securities also include derivative and
residual securities. Derivative securities are classes of collateralized bonds,
mortgage pass-through certificates or mortgage certificates that pay to the
holder substantially all interest (i.e., an interest-only security), or
substantially all principal (i.e., a principal-only security). Residual
interests represent the right to receive the excess of (i) the cash flow from
the collateral pledged to secure related mortgage-backed securities, together
with any reinvestment income thereon, over (ii) the amount required for
principal and interest payments on the mortgage-backed securities or repurchase
arrangements, together with any related administrative expenses. Securities
decreased to $127.7 million at December 31, 1999 compared to $244.0 million at
December 31, 1998. The decrease was primarily the result of $79.0 million of
paydowns and the sale of $70.7 million of securities during 1999. These
decreases were partially offset by the purchase of $23.7 million of securities
during 1999.
Other Investments Other investments consist primarily of property tax
receivables and a note receivable received in connection with the sale of the
Company's single family mortgage operations in May 1996. Other investments
increased from $30.4 million at December 31, 1998 to $48.9 million at December
31, 1999. This increase of $18.5 million is primarily the result of the purchase
of $20.5 million of property tax receivables during 1999.
Loans Held for Sale or Securitization Loans held for sale or securitization
decreased from $388.8 million at December 31, 1998 to $232.4 million at December
31, 1999. This decrease was primarily due to the securitization of $605.2
million of loans as collateral for collateralized bonds, the sale of $62.9
million of loans and the receipt of $27.7 million of paydowns during 1999. In
addition, Dynex REIT recorded $31.6 million of writedowns on the commercial
loans held for sale and wrote-off $28.4 million of deferred hedging positions
which related to expired commercial loan commitments. These decreases were
partially offset by new loan fundings from the Company's production operations
totaling $639.3 million during 1999.
Non-recourse Debt Collateralized bonds issued by Dynex REIT are recourse
only to the assets pledged as collateral, and are otherwise non-recourse to
Dynex REIT. Collateralized bonds decreased to $3.3 billion at December 31, 1999
from $3.7 billion at December 31, 1998. This decrease was primarily a result of
principal paydowns made on all collateralized bonds of $1.1 billion during 1999.
This decrease was partially offset by Dynex REIT adding $2.1 billion of
collateralized bonds during 1999. Of this $2.1 billion of collateralized bonds,
$1.5 billion related to the collapse and resecuritization of eight series of
previously issued collateralized bonds.
Recourse Debt Recourse debt decreased to $0.5 billion at December 31, 1999
from $1.0 billion at December 31, 1998. This decrease was primarily due to the
securitization of $601.8 million of manufactured housing loans as collateral for
collateralized bonds during 1999. These loans and securities were previously
financed with $190.7 million of repurchase agreements and $328.4 million of
notes payable. In addition, Dynex REIT paid off $175.8 million of notes payable
primarily as a result of the sale of the Company's model home purchase/leaseback
operations during 1999 and sold $70.7 million of securities which had been
financed with $48.1 million of repurchase agreements during 1999. Also,
repurchase agreements decreased $88.0 million as a result of the
re-securitization of the collateral on the previously retained collateralized
bonds during 1999. These decreases were partially offset by the addition of
$391.8 million of notes payable as a result of additional loan fundings during
1999.
Shareholders' Equity Shareholders' equity decreased to $334.1 million at
December 31, 1999 from $452.8 million at December 31, 1998. This decrease was a
combined result of a $45.4 million increase in the net unrealized loss on
investments available for sale from $3.1 million at December 31, 1998 to $48.5
million at December 31, 1999 and a net loss after extraordinary item of $66.1
million during 1999. Dynex REIT also declared dividends of $6.5 million during
1999, resulting in a decline in shareholder's equity of such amount. In
addition, Dynex REIT repurchased 66,100 of its common shares at an aggregate
purchase price of $0.7 million during 1999.
RESULTS OF OPERATIONS
- ---------------------------------------------------------------- -------------------------------------------------
For the Year Ended December 31,
(amounts in thousands except per share information) 1999 1998 1997
- ---------------------------------------------------------------- ---------------- --------------- ----------------
Net interest margin $ 48,015 $ 66,538 $ 83,454
Write-downs associated with commercial production operations
(59,962) - -
(Loss) gain on sale of investments and trading activities (12,682) (2,714) 11,584
Gain on sale of loan production operations 7,676 - -
Impairment charge and litigation provision - AutoBond (31,732) (17,632) -
Equity in (losses) earnings of DHI (1,923) 2,456 (1,109)
General and administrative expenses 7,740 8,973 9,531
Net administrative fees and expenses to Dynex Holding, Inc. 16,943 22,379 12,116
Net income (loss) before preferred stock dividends (75,135) 19,577 73,998
Basic net income (loss) per common share(1) $ (7.67) $ 0.57 $ 5.50
Diluted net income (loss) per common share(1) $ (7.67) $ 0.57 $ 5.48
Dividends declared per share:
Common(1) $ - 3.40 5.42
Series A and B Preferred 1.17 2.37 2.71
Series C Preferred 1.46 2.92 2.92
- ---------------------------------------------------------------- ---------------- --------------- ----------------
(1)Adjusted for both the two-for-one common stock split effective May 5, 1997 and the one-for-four reverse common
stock split effective August 2, 1999.
1999 Compared to 1998. The decrease in net income and net income per common
share during 1999 as compared to 1998 is primarily the result of (i) a decrease
in net interest margin (ii) an increase in the loss on sale of investments and
trading activities and (iii) write-downs associated with the commercial loan
production operations. These decreases were partially offset by the reduction in
general and administrative expenses and net administrative fees and expenses to
Dynex Holding, Inc. and the gain on the sale of the model home
purchase/leaseback and the manufactured housing lending operations in 1999.
Net interest margin for the year ended December 31, 1999 decreased to $48.0
million, or 27.8%, over net interest margin of $66.5 million for the same period
in 1998. This decrease in net interest margin was primarily the result of the
decline in average interest-earning assets from $5.4 billion for the year ended
December 31, 1998 to $4.6 billion for the year ended December 31, 1999. In
addition, provision for losses increased to $16.2 million or 0.35% on an
annualized basis of interest-earnings assets during the year ended December 31,
1999, compared to $6.4 million and 0.12% during the same period in 1998. This
increase in provision for losses was a result of increasing the reserve for
probable losses on the various loan pools pledged as collateral for
collateralized bonds where the Company has retained credit risk.
During 1999, Dynex REIT recorded a loss of $31.6 million related to the
writedown of $261.9 million of multifamily and commercial loans held for sale at
December 31, 1999. In addition, the Company realized losses of $28.4 million,
which were primarily related to the write-off of previously deferred hedging
costs on $255.6 million of multifamily and commercial loan commitments which
expired and were not extended by the Company during the fourth quarter of 1999
or during the first quarter of 2000. These costs were related to now-closed
options and futures positions entered into by the Company in 1998 and 1999.
The net loss on sale of investments and trading activities for the year
ended December 31, 1999 increased to $12.7 million, as compared to $2.7 million
for the same period in 1998. The increase for the year ended December 31, 1999
is primarily the result of a $9.3 million loss on the sale of $70.7 million of
securities during 1999 and a $7.4 million loss on the sale of $58.7 million of
commercial loans during 1999. These increases were partially offset by $4.2
million of realized gains on various derivative trading positions entered into
during 1999. The loss on sale of investments and trading activities during 1998
is primarily the results of net losses recognized of $1.4 million on trading
positions entered into during 1998.
During 1999, Dynex REIT recorded an impairment charge of $4.7 million
relating to the funding notes and other AutoBond securities held by the Company
at December 31, 1999. In addition, Dynex REIT recorded a charge of $27.0 million
related to the establishment of a reserve for the AutoBond litigation discussed
in Item 3. Legal Proceedings. During 1998, Dynex REIT recorded charges to
earnings totaling $17.6 million in regard to AutoBond related assets. This
charge included an impairment charge on the funding notes of $14.0 million and
$3.6 million to other AutoBond related securities.
Net administrative fees and expenses to Dynex Holding, Inc. decreased $5.5
million, or 24.3%, to $16.9 million in the year ended December 31, 1999. This
decrease is primarily the result of decreased origination volume of the
Company's commercial loan production operations and the sale of the Company's
model home purchase/leaseback and manufactured housing loan production
operations during 1999.
1998 Compared to 1997. The decrease in net income during 1998 as compared
to 1997 is primarily the result of (i) a decrease in net interest margin, (ii) a
decrease in the gain on sale of investments and trading activities, (iii) an
impairment charge on AutoBond related assets, and (iv) an increase in net
administrative fees and expenses to Dynex Holding, Inc. The decrease in net
income per common share during 1998 as compared to 1997 is the combined result
of the decrease in net income and an increase in the average number of common
shares outstanding due to the issuance of new common stock and the partial
conversion of outstanding preferred stock.
Net interest margin for the year ended December 31, 1998 decreased to $66.5
million, or 20.3%, over net interest margin of $83.5 million for the same period
in 1997. This decrease in net interest margin was primarily the result of a $9.1
million increase in premium amortization expense during the year ended December
31, 1998 compared to the year ended December 31, 1997. The increase in premium
amortization resulted from a higher rate of prepayments in the investment
portfolio during the year ended December 31, 1998 than during the same period in
1997. In addition, the net interest spread on the investment portfolio decreased
to 1.20% for the year ended December 31, 1998 from 1.42% for the same period in
1997. The decrease in the net interest spread is also primarily the result of
higher premium amortization as a result of the increase in principal prepayments
as well as the decrease in spreads between the indices on which the
interest-earning assets (primarily six-month LIBOR and the one-year Constant
Maturity Treasury) and interest-bearing liabilities (primarily one-month LIBOR)
are based.
The (loss) gain on sale of investments and trading activities for 1998
decreased to a $2.7 million loss, as compared to a $11.6 million gain for 1997.
This decrease is primarily the result of net losses recognized of $1.4 million
on trading positions entered into during the twelve months ended December 31,
1998. The gain on sale of assets during 1997 is primarily the result of premiums
received of $9.9 million on covered call options and put options written during
1997 and gains generated of $0.6 million on the sale of certain investments.
The Company recorded charges to earnings totaling $17.6 million in regard
to AutoBond related assets. This charge included an impairment charge on the
funding notes of $14.0 million. It also included a $0.6 million charge to the
Company's investment in AutoBond common and preferred stock to its quoted market
value at December 31, 1998. The Company also fully reserved for the $3.0 million
senior convertible note it acquired from AutoBond.
Net administrative fees and expenses to DHI increased $10.3 million, or
84.7%, to $22.4 million in 1998. This increase was primarily a result of the
continued growth in the Company's production operations, primarily in the
manufactured housing and commercial lending business.
The following table summarizes the average balances of interest-earning
assets and their average effective yields, along with the average
interest-bearing liabilities and the related average effective interest rates,
for each of the periods presented.
Average Balances and Effective Interest Rates
- ----------------------------------------- ---------------------------------------------------------------------------------
(amounts in thousands) Year ended December 31,
- ----------------------------------------- ---------------------------------------------------------------------------------
1999 1998 1997
Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate
- ----------------------------------------- -------------- ------------ -------------- ----------- -------------- -----------
Interest-earning assets (1):
Collateral for collateralized bonds $ 3,828,007 7.43% $ 4,094,030 7.43% $2,775,494 7.53%
(2) (3)
Securities 226,908 6.27 565,625 7.62 1,110,646 8.36
Other investments 202,111 8.50 196,759 8.17 136,189 8.27
Loans held for sale or securitization 329,507 7.97 546,272 8.14 499,115 7.95
-------------- ------------ -------------- ----------- -------------- -----------
============== ============ ============== =========== ============== ===========
Total interest-earning assets $ 4,586,533 7.46% $ 5,402,686 7.54% $4,521,444 7.80%
============== ============ ============== =========== ============== ===========
============== ============ ============== =========== ============== ===========
Interest-bearing liabilities:
Non-recourse debt (3) $ 3,363,095 6.18% $ 3,544,898 6.41% $2,226,894 6.67%
Recourse debt - collateralized bonds 271,919 5.71 523,208 5.90 419,621 5.82
retained
-------------- ------------ -------------- ----------- -------------- -----------
3,635,014 6.14 4,068,106 6.34 2,646,515 6.53
Recourse debt secured by investments:
Securities 143,392 6.51 422,164 5.91 931,334 5.74
Other investments 145,808 6.49 108,361 6.83 24,611 7.05
Loans held for sale or 259,061 5.50 415,778 5.57 354,116 5.83
securitization
Recourse debt - unsecured 121,743 8.78 143,378 8.97 87,881 9.23
============== ============ ============== =========== ============== ===========
Total interest-bearing $ 4,305,018 6.21% $ 5,157,787 6.34% $4,044,457 6.38%
liabilities
============== ============ ============== =========== ============== ===========
============== ============ ============== =========== ============== ===========
Net interest spread on all investments 1.25% 1.20% 1.42%
(3)
============ =========== ===========
============ =========== ===========
Net yield on average interest-earning 1.63% 1.49% 2.10%
assets
============ =========== ===========
------------ ----------- -----------
- ----------------------------------------- -------------- ------------ -------------- ----------- -------------- -----------
(1) Average balances exclude adjustments made in accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," to record available for sale securities at fair
value.
(2) Average balances exclude funds held by trustees of $1,844, $3,189 and $2,481 for the years ended December 31, 1999,
1998 and 1997, respectively.
(3) Effective rates are calculated excluding non-interest related collateralized bond expenses and provision for credit
losses.
1999 compared to 1998. The net interest spread increased to 1.25% for the
year ended December 31, 1999 from 1.20% for the same period in 1998. This
increase was primarily due to a reduction in premium amortization expense
related to collateral for collateralized bonds, which decreased from $27.5
million for the year ended December 31, 1998 to $16.3 million for the year ended
December 31, 1999. The overall yield on interest-earnings assets decreased to
7.46% for the year ended December 31, 1999 from 7.54% for the same period in
1998. The cost of interest-bearing liabilities decreased to 6.21% for the year
ended December 31, 1999 from 6.34% for the same period in 1998.
Individually, the net interest spread on collateral for collateralized
bonds increased 20 basis points, from 109 basis points from the year ended
December 31, 1998 to 129 basis points for the same period in 1999. This increase
was primarily due to lower premium amortization caused by decreased prepayments
during the year ended December 31, 1999 compared to the same period in 1998. The
net interest spread on securities decreased 195 basis points, from 171 basis
points for the year ended December 31, 1998 to a negative 24 basis points for
the year ended December 31, 1999. This decrease was primarily the result of a
150 basis point increase during 1999 of the interest rate on the notes payable
secured by the Funding Notes, from one-month LIBOR plus 150 basis points to
one-month LIBOR plus 300 basis points, and the sale of certain higher coupon
collateral during the third quarter of 1998. In addition, several of the
Company's residual ARM trusts were placed on non-accrual status during the third
quarter of 1998. The net interest spread on other investments increased 67 basis
points, from 134 basis points for the year ended December 31, 1998 to 201 basis
points for the same period in 1999, primarily due to the purchase of higher
yielding property tax receivables during 1999. The net interest spread on loans
held for sale or securitization decreased 10 basis points, from 257 basis points
for the year ended December 31, 1998, to 247 basis points for the same period in
1999. This decrease is primarily attributable to the funding of lower coupon
collateral during 1999.
1998 compared to 1997. The net interest spread decreased to 1.20% for the
year ended December 31, 1998 from 1.42% for the same period in 1997. This
decrease was due to the reduction in interest-earning asset yields from
increased premium amortization expense and the addition of lower yielding assets
to the investment portfolio. The overall yield on interest-earning assets
decreased to 7.54% for year ended December 31, 1998, from 7.80% for the same
period in 1997 while the cost of interest-bearing liabilities remained
relatively flat for the year ended December 31, 1998 compared to the same period
in 1997.
Individually, the net interest spread on collateralized bonds increased 9
basis points, from 100 basis points for the year ended December 31, 1997 to 109
basis points for the same period in 1998. This slight increase was primarily due
to the securitization of collateral which has a lower premium as a percentage of
principal, during the second quarter of 1998. In addition, one-month LIBOR
decreased 27 basis points during the fourth quarter of 1998 which increased the
net interest spread on collateralized bonds since the ARM loans underlying the
collateralized bonds take on average three to six months to adjust to lower
interest rates. The net interest spread on securities decreased 91 basis points,
from 262 basis points for the year ended December 31, 1997 to 171 basis points
for the year ended December 31, 1998. This decrease was primarily the result of
the sale of certain higher coupon collateral during the third quarter of 1998
along with the purchase of lower coupon fixed-rate mortgage securities during
the first quarter of 1998. In addition, certain assets were placed on
non-accrual status during 1998. The net interest spread on other investments
increased 12 basis points, from 122 basis points for the year ended December 31,
1997, to 134 basis points for the year ended December 31, 1998, due primarily to
lower borrowing costs associated with the Company's single family model home
purchase and leaseback business during 1998. The net interest spread on loans
held for securitization increased 45 basis points, from 212 basis points for the
year ended December 31, 1997, to 257 basis points for the same period in 1998.
This increase is primarily attributable to lower borrowing costs as a result of
higher level of compensating cash balances during the year ended December 31,
1998 compared to the same period in 1997. Credits earned from these compensating
cash balances are used by the Company to offset interest expense.
The following tables summarize the amount of change in interest income and
interest expense due to changes in interest rates versus changes in volume:
- --------------------------------------------------------------------------------------------------------------------
1999 to 1998 1998 to 1997
- --------------------------------------------------------------------------------------------------------------------
Rate Volume Total Rate Volume Total
- --------------------------------------------------------------------------------------------------------------------
Collateral for collateralized bonds $ 245 $ (19,769) $ (19,524) $ (2,895) $ 97,943 $ 95,048
Securities (6,582) (22,280) (28,862) (7,583) (42,135) (49,718)
Other investments 667 444 1,111 (141) 4,949 4,808
Loans held for sale or securitization (870) (17,303) (18,173) 933 3,820 4,753
- --------------------------------------------------------------------------------------------------------------------
Total interest income (6,540) (58,908) (65,448) (9,686) 64,577 54,891
- --------------------------------------------------------------------------------------------------------------------
Non-recourse debt (7,905) (11,401) (19,306) (5,991) 84,638 78,647
Recourse debt - collateralized bonds (939) (14,386) (15,325) 342 6,106 6,448
retained
- --------------------------------------------------------------------------------------------------------------------
Total collateralized bonds (8,844) (25,787) (34,631) (5,649) 90,744 85,095
Recourse debt secured by investments:
Securities 2,322 (18,174) (15,852) 1,603 (30,484) (28,881)
Other investments (391) 2,481 2,090 (55) 5,804 5,749
Loans held for sale or securitization (281) (8,739) (9,020) (990) 3,514 2,524
Recourse debt - unsecured (267) (1,905) (2,172) (235) 4,986 4,751
- --------------------------------------------------------------------------------------------------------------------
Total interest expense (7,461) (52,124) (59,585) (5,326) 74,564 69,238
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Net margin on portfolio $ 921 $ (6,784) $ (5,863) $ (4,360) $ (9,987) $ (14,347)
- --------------------------------------------------------------------------------------------------------------------
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
Approximately $1.6 billion of the investment portfolio as of December 31,
1999 is comprised of loans or securities that have coupon rates which adjust
over time (subject to certain periodic and lifetime limitations) in conjunction
with changes in short-term interest rates. Approximately 64% of the ARM loans
underlying the ARM securities and collateral for collateralized bonds are
indexed to and reset based upon the level of six-month LIBOR; approximately 27%
are indexed to and reset based upon the level of the one-year Constant Maturity
Treasury (CMT) index. The following table presents a breakdown, by principal
balance, of the Company's collateral for collateralized bonds and ARM and fixed
mortgage securities by type of underlying loan. This table excludes other
derivative and residual securities, other securities, other investments and
loans held for securitization.
Investment Portfolio Composition (1)
($ 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
1999 1,048.5 430.8 121.1 2,061.5 3,661.9
- ------------------------------- ------------------ ------------------- --------------------- --------------- ---------------
(1) Includes only the principal amount of collateral for collateralized bonds, ARM securities and fixed securities.
The average asset yield is reduced for the amortization of premiums, net of
discounts on the investment portfolio. As indicated in the table below, premiums
on the collateral for collateralized bonds, ARM securities and fixed-rate
securities at December 31, 1999 were $38.3 million, or approximately 1.03% of
the aggregate balance of collateral for collateralized bonds, ARM securities and
fixed-rate securities. Of this $38.3 million, $34.5 million relates to the
premium on multifamily and commercial mortgage loans that have prepayment
lockouts or yield maintenance for at least seven years. Amortization expense as
a percentage of principal paydowns has increased to 1.43% for the year ended
December 31, 1999 from 1.24% primarily due to the multifamily and commercial
securitization during the fourth quarter of 1998. The amortization expense as a
percentage of principal paydowns decreased from 1.85% for the year ended
December 31, 1997 to 1.24% for the same period in 1998 as the investment
portfolio mix changed to assets funded primarily at par or at a discount during
1998. The principal repayment rate (indicated in the table below as "CPR
Annualized Rate") was 20 % for the year ended December 31, 1999. CPR or
"constant prepayment rate" is a measure of the annual prepayment rate on a pool
of loans. Excluded from this table are loans held for sale or securitization,
which are carried at the lower of cost or market as of December 31, 1999.
Premium Basis and Amortization
($ in millions)
- -----------------------------------------------------------------------------------------------------
Amortization
CPR Annualized Expense as a %
Net Premium Amortization Rate Principal of Principal
Expense Paydowns Paydowns
- -----------------------------------------------------------------------------------------------------
1997 $ 56.9 $ 18.4 37% $ 993.2 1.85%
1998 77.8 27.5 41% 2,215.2 1.24%
1999 38.3 16.3 20% 1,145.8 1.43%
- -----------------------------------------------------------------------------------------------------
Credit Exposures
The Company securitizes its loan production into collateralized bonds or
pass-through securitization structures. With either structure, the Company may
use overcollateralization, subordination, third-party guarantees, reserve funds,
bond insurance, mortgage pool insurance or any combination of the foregoing as a
form of credit enhancement. With all forms of credit enhancement, the Company
may retain a limited portion of the direct credit risk after securitization.
The following table summarizes the aggregate principal amount of collateral
for collateralized bonds and ARM and fixed-rate mortgage pass-through securities
outstanding; the direct credit exposure retained by the Company (represented by
the amount of overcollateralization pledged and subordinated securities owned by
the Company and rated below BBB by one of the nationally recognized rating
agencies), net of the credit reserves maintained by the Company for such
exposure; and the actual credit losses incurred for each year. Credit reserves
maintained by the Company and included in the table below includes third-party
reimbursement guarantees of $30.3 million. The table excludes any risks related
to representations and warranties made on loans funded by the Company and
securitized in mortgage pass-through securities generally funded prior to 1995.
This table also excludes any credit exposure on loans held for sale or
securitization, funding notes and securities, and other investments. The
increase in net credit exposure as a percentage of the outstanding loan
principal balance from 3.64% at December 31, 1998 to 4.86% at December 31, 1999
is related primarily to the credit exposure retained by the Company on its
manufactured housing securitizations issued during 1999.
Credit Reserves and Actual Credit Losses
($ in millions)
- -------------------------------------------------------------------------------------------------------------
Credit Exposure, Credit Exposure, Net of
Outstanding Loan Net Actual Credit Credit Reserves to Outstanding
Principal Balance of Credit Reserves Losses Loan Balance
- -------------------------------------------------------------------------------------------------------------
1997 $ 5,153.1 $ 86.6 $ 19.8 1.68%
1998 4,389.7 159.7 20.3 3.64%
1999 3,770.3 183.2 19.7 4.86%
- -------------------------------------------------------------------------------------------------------------
The following table summarizes single family mortgage loan, manufactured
housing loan and commercial mortgage loan delinquencies as a percentage of the
outstanding collateral balance for those securities in which Dynex REIT has
retained a portion of the direct credit risk. The delinquencies as a percentage
of the outstanding collateral decreased to 1.64% at December 31, 1999 from 2.36%
at December 31, 1998. The Company monitors and evaluates its exposure to credit
losses and has established reserves based upon anticipated losses, general
economic conditions and trends in the investment portfolio. As of December 31,
1999, management believes the level of credit reserves are sufficient to cover
any losses which may occur as a result of current delinquencies presented in the
table below.
Delinquency Statistics (1)
- --------------------------------------------------------------------------------
60 to 89 days delinquent 90 days and over
December 31, delinquent (2) Total
- --------------------------------------------------------------------------------
1997 0.51% 2.82% 3.33%
1998 0.25% 2.11% 2.36%
1999 0.27% 1.37% 1.64%
- --------------------------------------------------------------------------------
(1) Excludes funding notes and securities.
(2) Includes foreclosures, repossessions and REO.
The following table summarizes the credit rating for collateral for
collateralized bonds, securities and certain other investments held in the
investment portfolio, presented on a gross basis (i.e., the collateralized bonds
are not netted against the associated pledged collateral). This table excludes
$18.1 million of other derivative and residual securities (as the risk on such
securities is primarily prepayment-related, not credit-related), other
investments and loans held for sale or securitization. The table also excludes
the Funding Notes and Securities, aggregating $90.7 million, which are not
rated. The balance of the investments rated below A are net of credit reserves
and discounts. All balances exclude the related mark-to-market adjustment on
such assets. At December 31, 1999, securities with a credit rating of AA or
better were $3.2 billion, or 90.4% of the total.
Investments by Credit Rating (1)
($ 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%
1999 3,154.4 191.4 123.3 19.8 90.4% 5.5% 3.5% 0.6%
- ----------------- ------------- ------------- ------------- ------------- -------------- ------------- ------------- -------------
(1) Carrying value does not include funding notes and securities, derivative and residual securities, certain other investments
which are not debt securities and loans held for securitization. Balances also exclude the mark-to-market adjustment.
Carrying value also excludes $238.3 million of overcollateralization, net of $55.1 million of reserves.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS No. 133"). FAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. In June 1999, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No, 133" ("FAS No. 137"). FAS
No. 137 amends FAS No. 133 to defer its effective date to all fiscal quarters of
all fiscal years beginning after June 15, 2000. The Company is in the process of
determining the impact of adopting FAS No. 133.
LIQUIDITY AND CAPITAL RESOURCES
The Company finances its operations from a variety of sources. These
sources include cash flow generated from the investment portfolio, including net
interest income and principal payments and prepayments, common stock offerings
through the dividend reinvestment plan, short-term warehouse lines of credit
with commercial and investment banks, repurchase agreements and the capital
markets via the asset-backed securities market (which provides long-term
non-recourse funding of the investment portfolio via the issuance of
collateralized bonds). Historically, cash flow generated from the investment
portfolio has satisfied its working capital needs, and the Company has had
sufficient access to capital to fund its loan production operations, on both a
short-term (prior to securitization) and long-term (after securitization) basis.
However, market conditions since October 1998 have substantially reduced the
Company's access to capital. The Company is currently unable to access
additional short-term warehouse lines of credit to replace maturing lines, and
is unable to access efficiently the asset-backed securities market to meet its
long-term funding needs. Largely as a result of its inability to access
additional capital, the Company sold its manufactured housing and model home
purchase/leaseback operations in 1999, and ceased issuing new commitments in its
commercial lending operations. The Company is attempting to substantially reduce
both its short-term debt and capital requirements. The Company's current focus
is the repayment of its recourse debt, which includes substantially all of the
short-term warehouse lines of credit and repurchase agreements.
A substantial portion of the assets are pledged to secure indebtedness
incurred by Dynex REIT. Accordingly, those assets would not be available for
distribution to any general creditors or the stockholders of Dynex REIT in the
event of the liquidation, except to the extent that the liquidation proceeds of
such assets exceeds the amount of the indebtedness they secure.
As more fully described below, the Company was in default of certain
covenants in its secured credit facilities and its unsecured senior notes issued
in September 1994. As of April 14, 2000, the Company had not secured waivers for
all of the defaults; however, none of the respective lenders had accelerated
amounts outstanding as of that date as a result of the defaults. See further
discussion in Liquidity and Capital Resources and Notes 1 and 7 in the
accompanying consolidated financial statements.
Non-recourse Debt
Dynex REIT, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds to fund the majority of
its investment portfolio. The obligations under the collateralized bonds are
payable solely from the collateral for collateralized bonds and are otherwise
non-recourse to Dynex REIT. Collateral for collateralized bonds are not subject
to margin calls. The maturity of each class of collateralized bonds is directly
affected by the rate of principal prepayments on the related collateral. Each
series is also subject to redemption according to specific terms of the
respective indentures, generally when the remaining balance of the bonds equals
35% or less of the original principal balance of the bonds. At December 31,
1999, Dynex REIT had $3.3 billion of collateralized bonds outstanding as
compared to $3.7 billion at December 31, 1998.
Recourse Debt
Secured. At December 31, 1999, Dynex REIT had four committed credit
facilities aggregating $699 million, comprised of (i) a $195 million credit
line, expiring on May 29, 2000, from a consortium of commercial banks primarily
for the warehousing of multifamily construction and permanent loans (including
providing the letters of credit for tax-exempt bonds), (ii) a $400 million
credit line, expiring on April 28, 2000 from an investment bank primarily for
the warehousing of permanent loans on multifamily and commercial properties,
(iii) a $100 million credit line, expiring on May 10, 2000 from an investment
bank for the warehousing of the funding notes and securities , and (iv) a $4
million credit line, expiring on December 15, 2000, from a finance company for
the warehousing of model homes not included in the sale of the related business.
While Dynex REIT has received bids for the sale of a substantial portion of the
assets that secure the credit lines expiring on April 28, 2000 and May 29, 2000,
it is unlikely that Dynex REIT will be able to payoff such credit lines by the
respective maturity dates. Although, the Company will seek extensions to the
maturity dates, there can be no assurances that the lenders will agree to such
extensions. In the event that the lenders declare an event of default, the
underlying credit line agreements provide for the liquidation of the pledged
collateral. In such a scenario it is likely that the Company will suffer losses
on the sale of the collateral. For the credit line expiring May 10, 2000, Dynex
REIT and the lender executed a letter of intent dated April 10, 2000 whereby the
collateral currently pledged to the line is instead pledged to a
senior/subordinate security structure. Under the terms of the letter, the lender
will "purchase" the senior security, the proceeds of which are then used to
repay the remaining amount outstanding under the credit line. Dynex REIT will
retain the subordinate class. The security will provide for the full
amortization of the senior class before any cash flow is paid on the subordinate
class. The above lines of credit include various representations and covenants.
Dynex REIT was in violation of certain covenants on the credit lines expiring on
April 28, 2000 and May 29, 2000 relating primarily to minimum net worth and
minimum senior unsecured ratings requirements, and the receipt of a going
concern opinion from its auditors. Dynex REIT has received waivers from the
investment bank on the credit line expiring on April 28, 2000 for the minimum
senior unsecured ratings and minimum net worth requirements. Dynex REIT has not
received a waiv