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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, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of (IRS Employer I.D. No.)
incorporation or organization)
4551 Cox Road, Suite 300, 23060
Glen Allen, Virginia (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (804) 217-5800
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- ------------------- -----------------------------------------
Common Stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g)of the Act:
Title of each class Name of each exchange
on which registered
Series A 9.75% Cumulative Convertible
Preferred Stock, $.01 par value NASDAQ National Market
Series B 9.55% Cumulative Convertible
Preferred Stock, $.01 par value NASDAQ National Market
Series C 9.73% Cumulative Convertible
Preferred Stock, $.01 par value NASDAQ National Market
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
As of March 26, 2002, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $34,470,114 at a closing
price on The New York Stock Exchange of $3.17. Common stock outstanding as of
March 26, 2002 was 10,873,853 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement to be filed pursuant to Regulation
14A within 120 days from December 31, 2001, are incorporated by reference into
Part III.
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DYNEX CAPITAL, INC.
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I
Item 1. BUSINESS............................................................1
Item 2. PROPERTIES.........................................................11
Item 3. LEGAL PROCEEDINGS..................................................11
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................11
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..............................................11
Item 6. SELECTED FINANCIAL DATA............................................12
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................13
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.........27
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................28
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.........................................28
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................28
Item 11. EXECUTIVE COMPENSATION.............................................29
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT...................................................29
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................29
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K.....................................................29
SIGNATURES...................................................................31
PART I
Item 1. BUSINESS
General
Dynex Capital, Inc. (the "Company") was incorporated in the
Commonwealth of Virginia in 1987. The Company is a financial services company,
which invests in a portfolio of securities and investments backed principally by
single family mortgage loans, commercial mortgage loans, manufactured housing
installment loans and delinquent property tax receivables. These loans were
funded primarily by the Company's loan production operations or purchased in
bulk in the market. Historically, the Company's loan production operations have
included single-family mortgage lending, which was sold in 1996, commercial
mortgage lending and manufactured housing lending. Through its specialty finance
business, the Company also has provided for the purchase and leaseback of single
family model homes to builders and the purchase and management of delinquent
property tax receivables. Loans funded through the Company's production
operations have generally been pooled and pledged (i.e. securitized) as
collateral for non-recourse bonds ("collateralized bonds"), which provided
long-term financing for such loans while limiting credit, interest rate and
liquidity risk. The Company has elected to be treated as a real estate
investment trust ("REIT") for federal income tax purposes under the Internal
Revenue Code of 1986, as amended, and, as such, must distribute substantially
all of its taxable income to shareholders. Provided that the Company meets all
of the proscribed Internal Revenue Code requirements for a REIT, the Company
will generally not be subject to federal income tax.
Since 1999, as a result of disruptions in the fixed income markets, the
Company has focused its efforts on conserving its capital base and repaying its
outstanding recourse obligations, including both borrowings and letters of
credit. To that end, the Company has not paid a dividend on its common stock
since 1998 and suspended regular dividends on its preferred stock in the third
quarter of 1999. The Company sold both its manufactured housing
lending/servicing operations and its model home purchase/leaseback business
during 1999 and in 2000 the Company phased-out its commercial lending
operations. Since 2000, the Company's business operations have been essentially
limited to the management of its investment portfolio and the active collection
of its portfolio of delinquent property tax receivables. As of December 31,
2001, the Company had paid off all its recourse obligations (borrowings and
letters of credit) except for $58.0 million of its senior notes due July 15,
2002 (the "Senior Notes") and $0.2 million related to a capital lease. Based on
its projected cash flow from its investment portfolio and the projected proceeds
from a securitization the Company is planning in the second quarter of 2002, the
Company projects that it will payoff its Senior Notes and capital lease in
accordance with their contractual terms. At such time, the Company will have no
recourse obligations remaining, and not be subject to any contractual
restrictions on its business or investment activities.
During the fourth quarter of 1999, the board of directors (the "Board")
engaged a financial advisor to analyze and review various alternatives for the
Company. Such effort resulted in the Company entering into a merger agreement in
the fourth quarter of 2000 whereby all of the outstanding equity securities of
the Company would be acquired by a privately owned fund for $90 million. When
the purchaser failed to satisfy various requirements in the merger agreement,
the Company terminated such agreement in January 2001. Since such date, the
Company has received other inquiries for the purchase of all or a portion of its
outstanding equity securities; none of these inquiries were on terms that the
Board felt were adequate and, as a result, were not pursued. The Company is not
actively soliciting merger proposals.
In March 2001, the Company amended the terms of its Senior Notes to
allow for up to $26 million in distributions to holders of its equity
securities. In conjunction with such amendment, the Company also agreed to
purchase $49.6 million of its Senior Notes from certain holders at discounted
prices beginning in March 2001. The Company completed the $49.6 million in
purchases over a ten-month period at a cumulative discount of $4.2 million.
During 2001, the Company completed two tender offers for shares of its preferred
stock having an aggregate liquidation preference of $40.9 million for a total
purchase price of $20.0 million. The Company believes that these tender offers
provided liquidity to those preferred shareholders desiring to sell their
shares, contributed to the improvement in the market prices of both the
Company's preferred and common shares, and improved the book value per common
share. Pursuant to a settlement agreement with an insurance company that
guaranteed a portion of the outstanding Senior Notes, the Company is effectively
precluded from further distributions on its equity securities until the Senior
Notes are paid in full.
The Board continues to evaluate strategies to improve shareholder
value. Given the improvement in the market value of the Company's equity
securities since January 2001, the Board feels that it is unlikely that any
offer will be made by a third party that would be at a level that would be
approved by both the Board and the requisite percentage of shareholders. The
Board has also reviewed possible liquidation scenarios, but the illiquid nature
of many of the Company's remaining assets and the lack of buyers for many of
such assets makes such an alternative impractical over any reasonable time
horizon.
As a result, the Board has requested management of the Company to
analyze various business directions for the Company to pursue on a going forward
basis once the remaining Senior Notes are paid in full, which the Company
expects to be completed on or before July 15, 2002. Based on a review of such
alternatives by the Board in February 2002, the Company has engaged an advisor
to assist it in evaluating the feasibility of the Company forming or acquiring a
depository institution. The Company had taken preliminary steps in that
direction in January 1999 when it visited with and submitted a draft business
plan to the Office of Thrift Supervision ("OTS"). However, the Company was
advised by the OTS that the risk profile of the Company's lines of business at
such time (essentially the origination and securitization of commercial mortgage
loans, manufactured housing loans and sub-prime auto loans) was not compatible
with the regulatory guidelines of the OTS. As a result, the Company did not
formally submit an application for a thrift charter at that time.
The Company sees the benefits of forming or acquiring a depository
institution as follows: (i) as future investments (i.e., loans and/or
securities) would be owned by the depository institution (which has access to
deposits insured by the Federal Deposit Insurance Corporation and to borrowings
from the Federal Home Loan Bank System), there would be reduced liquidity risk
to the Company in the future, a risk that has historically caused considerable
losses to specialty finance companies including the Company; (ii) the depository
institution is not dependent on the public or private markets for funding; (iii)
given that the Company's net operating and capital loss carry-forwards exceed
$180 million in the aggregate (the "NOL"), the fact that depository institutions
are subject to state and federal income taxes should not be a detriment to
financial results for the foreseeable future; (iv) while owning and operating a
depository institution would probably require the Company to give up its REIT
status, the Company will not for the foreseeable future realize any material
benefits from maintaining REIT status (certain of the Company's subsidiaries
will maintain REIT status as required while their respective securitizations are
outstanding); and (v) regulatory guidelines would likely require an investment
strategy that would be of lower risk than the Company's historic investment
strategies.
The Company also sees various drawbacks to forming or acquiring a
depository institution as follows: (i) a depository institution is highly
regulated, and such regulation limits and restricts the activities and
operations of a depository institution; (ii) the Company would become a bank or
thrift holding company and subject to various restrictions and regulations;
(iii) depository institutions operate in a very competitive environment; (iv)
the Company may not be able to achieve a return on the equity invested in a
depository institution that enhances shareholder value relative to other
alternatives for the Company; (v) the Company currently has no experience in
managing a depository institution; and (vi) the annual dividend rate on each of
the three series of preferred stock outstanding would increase by an amount
equal to approximately 0.50%.
To the extent the Company pursues forming or acquiring a depository
institution, the Company would likely use the majority of its cash flow until
the NOL is fully utilized to invest in the depository institution. While subject
to significant uncertainty, the Company projects that the NOL will not be fully
utilized until at least 2010. However, as the Company believes that the two
tender offers and partial dividend on its preferred stock during 2001 did
contribute to the improvement in the liquidity and the market prices of both the
Company's preferred and common shares, it is likely that the Company would
allocate a portion of its cash flow in the future to make distributions on its
preferred stock. Such distributions would be in the form of dividends and/or
periodic tender offers. Any such distributions (and assuming that no equity
securities were issued) would likely delay further the full utilization of the
NOL. The Company is precluded from making any distributions on its common stock
until all dividends are current on its preferred stock. However, if the Company
does pursue forming or acquiring a depository institution, the Company would
most likely minimize any future dividends on its common stock and either retain
earnings or purchase its common stock in an effort to grow earnings per common
share.
At this time, the Company has not developed a business plan for a
depository institution to submit to a regulatory agency. However, the Company
does not anticipate that the Company would encounter the same response from the
regulatory agency as it did in early 1999 because the Company is no longer in
commercial mortgage lending, manufactured housing lending, or sub-prime auto
lending (the Company currently has no loan origination operations). Any business
plan for a depository institution would thus be based on lending or investment
strategies that are compatible with the regulatory requirements. Further, to the
extent the Company does pursue a depository institution, the Board may appoint
additional directors that have recent oversight or operating experience with
depository institutions.
Prior to December 31, 2000, the Company operated the majority of its
lending and servicing activities out of a taxable affiliate, Dynex Holding, Inc.
("DHI"), and its subsidiaries, which were not consolidated for financial
reporting or tax purposes but were accounted for in the Company's financial
statement in a manner similar to the equity method. In December 2000, certain
DHI subsidiaries were sold to Company, and DHI was liquidated into the Company
in a taxable liquidation transaction. Since that time, the surviving assets and
liabilities and operations of DHI have been included in the consolidated
financial results of the Company. Prior to 2000, the consolidated results of DHI
have been included under the equity method of accounting.
Business Focus and Strategy
The Company's business plan prior to its redirection in 1999 as
outlined above, was to create a diversified investment portfolio that in the
aggregate generated stable income for the Company in a variety of interest rate
environments and preserved the capital base of the Company. The Company had
historically focused on markets where it believed that it could create
investments for its portfolio at a lower cost than if those investments were
purchased in the secondary market. The markets that the Company has historically
participated in have included single family mortgage lending, commercial
mortgage lending, manufactured housing lending, and various specialty finance
businesses, including purchase/leaseback of model homes and the purchase and
collection of delinquent property tax receivables. During 1998, the Company also
had entered into an arrangement to purchase funding notes secured by sub-prime
auto loans coupled with an option to buy a majority interest in AutoBond
Acceptance Corporation ("AutoBond"), the counter-party on such funding notes. As
previously indicated, the Company has either sold or phased-out its various
lending businesses, terminated its relationship with AutoBond, and is now
primarily focused on collecting its delinquent property tax receivables,
repaying its remaining recourse debt, and improving shareholder value.
The Company's principal source of earnings historically has been its
net interest income from its investment portfolio. The Company had generally
created investments for its portfolio through the issuance of non-recourse
collateralized bonds secured by a pledge of the assets generated or acquired by
its production operations. Commensurate with its shift in its business plan in
1999, the Company's investment portfolio has been declining as the result of
sales and pay-downs, with little additional investment having been made by the
Company over the past two years. The Company's remaining investment portfolio
consists primarily of collateral for collateralized bonds and delinquent
property tax receivables. The Company funds its investment portfolio primarily
through non-recourse collateralized bonds and funds raised from the issuance of
equity. For the portion of the investment portfolio funded with collateralized
bonds or other borrowings, the Company generates net interest income to the
extent that there is a positive spread between the yield on the interest-earning
assets and the cost of the borrowed funds. The cost of the Company's borrowings
may be increased or decreased by interest rate swap, cap or floor agreements.
For the other portion of the investment portfolio funded with equity, net
interest income is primarily a function of the yield generated from the
interest-earning asset.
At December 31, 2001, the Company owned the right to call
adjustable-rate and fixed-rate mortgage pass-through securities previously
issued and sold by the Company once the outstanding balance of such securities
reached a call trigger, generally either 10% or less of the original amount
issued or a specified date. The aggregate projected callable balance of such
securities at the time of the projected call is approximately $325 million,
relating to 20 securities. The Company may or may not elect to call one or more
of these securities when eligible to call. During 2001, three securities reached
their call trigger, and the Company did not exercise its right to call any of
the securities. The Company has initiated the call on three securities in 2002
for approximately $31 million, and may initiate the call of eleven additional
securities in 2002 with an estimated balance of $148 million, seven of which the
company owns the call rights and four for which the company expects to purchase
the call rights. The Company may call additional securities in the future.
The Company also owns the right to purchase or redeem generally by
class the collateralized bonds on its balance sheet once the outstanding balance
of such bonds reaches 35% or less of the original amount issued or a specified
date. The Company purchased all the classes of one series of collateralized
bonds during 2001, and re-offered the bonds at a lower effective interest rate.
The Company expects that two series of collateralized bonds will be redeemed in
2002, and that the Company will resecuritize the underlying collateral, which
consists principally of single-family mortgage loans.
Lending Operations
The Company had generally been a vertically integrated lender,
performing the sourcing, underwriting, funding, and servicing of loans to
maximize efficiency and provide superior customer service. The Company had
principally focused on loan products that maximize the advantages of the REIT
tax election and had emphasized direct relationships with the borrower and
minimized, to the extent practical, the use of origination intermediaries. The
Company had historically utilized internally generated guidelines to underwrite
loans for all product types and maintained centralized loan pricing, and
performed the servicing function for loans on which the Company has credit
exposure.
The Company's funding activity for 2001 included the purchase of
approximately $8.7 million of delinquent property tax receivables under a
previously executed contract to purchase. The Company purchased $7.6 million of
such tax receivables in 2000. The Company's loan funding activity during 2000
also consisted of funding approximately $29.5 million related to prior
multifamily loan commitments. The Company has no remaining commitments to fund
loans or other assets.
Primary Servicing
The Company no longer services, on a primary basis, any of the assets
included in its investment portfolio other than $3.3 million of commercial
mortgage loans currently held for sale and its portfolio of delinquent property
tax receivables. During 1997, the Company established a servicing function in
Pittsburgh, Pennsylvania, to manage the collection of the Company's delinquent
property tax receivables. The Company's responsibilities as servicer include
collecting voluntary payments from property owners, and if collection efforts
fail, foreclosing, stabilizing and selling the underlying properties. During
1999, the Company also established a satellite servicing office in Cleveland,
Ohio. As of December 31, 2001, the Company had a servicing portfolio with an
aggregate redemptive value of approximately $138 million of delinquent property
tax receivables in five states, but with the majority in Pennsylvania and Ohio.
The Company plans to offer during 2002 third-party collection services
to taxing jurisdictions for the collection of delinquent property tax
receivables. The Company plans to initially target jurisdictions in Ohio and
Pennsylvania; however, there can no assurance such effort will be successful.
Master Servicing
The Company performs the function of master servicer for certain of the
securities it has issued. The master servicer's function typically includes
monitoring and reconciling the loan payments remitted by the servicers of the
loans, determining the payments due on the securities and determining that the
funds are correctly sent to a trustee or investors for each series of
securities. Master servicing responsibilities also include monitoring the
servicers' compliance with its servicing guidelines. As of December 31, 2001,
the Company monitored the performance of twelve third-party servicers of single
family loans; the performance of GMAC Commercial Mortgage Corporation as the
servicer of the Company's securitized commercial mortgage loans, and Origen
Financial, LLC as the servicer of the Company's manufactured housing loans.
As master servicer, the Company is paid a monthly fee based on the
outstanding principal balance of each such loan master serviced or serviced by
the Company as of the last day of each month. As of December 31, 2001, the
Company master serviced $1.7 billion in securities.
Securitization
Since late 1995, the Company's predominate securitization structure has
been collateralized bonds. Generally, for accounting and tax purposes, the loans
financed through the issuance of collateralized bonds are treated as assets of
the Company, and the collateralized bonds are treated as debt of the Company.
The Company earns the net interest spread between the interest income on the
loans and the interest and other expenses associated with the collateralized
bond financing. The net interest spread is directly impacted by the credit
performance of the underlying loans, by the level of prepayments of the
underlying loans and, to the extent collateralized bond classes are
variable-rate, may be affected by changes in short-term rates. The Company's
investment in the collateralized bonds is typically referred to as the
over-collateralization. The Company analyzes and values its investment in
collateralized bonds on a "net investment basis" (i.e., the excess of the
collateral pledged over the outstanding collateralized bonds, and the resulting
net cash flow to the Company), as further discussed below.
Investment Portfolio
Composition. The following table presents the balance sheet composition
of the investment portfolio by investment type and the percentage of the total
investments as of December 31, 2001 and 2000. Collateral for collateralized
bonds and securities are presented at estimated fair value, other investments
are presented at amortized cost, and loans held for sale are presented at the
lower of cost or market.
- --------------------------------------------- ---------------------------------------------------------------
As of December 31,
2001 2000
------------------------------- -------------------------------
(amounts in thousands) Balance % of Total Balance % of Total
- --------------------------------------------- ----------------- ------------- ----------------- -------------
Investments:
Collateral for collateralized bonds $2,404,157 96.9% $3,042,158 97.8%
Securities:
Adjustable-rate mortgage securities 1,740 0.1 4,266 0.1
Fixed-rate mortgage securities 1,245 0.1 1,400 0.0
Derivative and residual securities 2,523 0.1 3,698 0.1
Other investments 63,553 2.6 42,284 1.4
Loans 7,315 0.2 19,102 0.6
- --------------------------------------------- ----------------- ------------- ----------------- -------------
Total investments $2,480,533 100% $3,112,908 100%
- --------------------------------------------- ----------------- ------------- ----------------- -------------
Collateral for collateralized bonds. Collateral for collateralized
bonds represents the single largest investment in the Company's portfolio.
Collateral for collateralized bonds is composed primarily by adjustable-rate and
fixed-rate mortgage loans secured by first liens on single-family homes,
fixed-rate mortgage loans secured by multifamily residential housing properties
and commercial properties, manufactured housing installment loans secured by
either a UCC filing or a motor vehicle title, and property tax receivables.
Interest margin on the net investment in collateralized bonds (defined as the
principal balance of collateral for collateralized bonds less the principal
balance of the collateralized bonds outstanding) is derived primarily from the
difference between (i) the cash flow generated from the collateral pledged to
secure the collateralized bonds and (ii) the amounts required for payment on the
collateralized bonds and related insurance and administrative expenses.
Collateralized bonds are generally non-recourse to the Company. The Company's
yield on its net investment in collateralized bonds is affected primarily by
changes in interest rates, prepayment rates and credit losses on the underlying
loans. The Company may retain for its investment portfolio certain classes of
the collateralized bonds issued and in the past has pledged such classes as
collateral for repurchase agreements.
ARM securities. Another segment of the Company's portfolio is the
investments in adjustable-rate mortgage ("ARM") securities. The interest rates
on the majority of the Company's ARM securities reset every six months and the
rates are subject to both periodic and lifetime limitations.
Fixed-rate mortgage securities. Fixed-rate mortgage securities consist
of securities that have a fixed-rate of interest over their remaining life. The
Company's yields on these securities are primarily affected by changes in
prepayment rates.
Derivative and residual securities. Derivative and residual securities
consist primarily of interest-only securities ("I/Os"), principal-only
securities ("P/Os") and residual interests that were generally created as a
result of the Company's securitizations. An I/O is a class of a collateralized
bond or a mortgage pass-through security that pays to the holder substantially
all interest. A P/O is a class of a collateralized bond or a mortgage
pass-through security that pays substantially all principal to the holder.
Residual interests represent the excess cash flows on a pool of mortgage
collateral after payment of principal, interest and expenses of the related
mortgage-backed security or repurchase arrangement. Residual interests may have
little or no principal amount and may not receive scheduled interest payments.
The yields on these securities are affected primarily by changes in prepayment
rates and by changes in short-term interest rates.
Other investments. Other investments consist primarily of delinquent
property tax receivables. For December 31, 2000, other investments also includes
a $9.5 million installment note receivable received in connection with the sale
of the Company's single family mortgage operations in May 1996. One pool of the
delinquent property tax receivables was previously pledged as collateral for
collateralized bonds, and in 2001 was reclassified to other investments
commensurate with the repayment of the associated collateralized bonds
outstanding to third parties. During 2001, the Company collected approximately
$16.8 million on its delinquent property tax receivables, with collections of
$8.3 million relating to Allegheny County, Pennsylvania, $7.5 million related to
Cuyahoga County, Ohio and $1.0 million relating to various other jurisdictions.
Loans. As of December 31, 2001, loans consist principally of consumer
installment loans that were previously securitized, mezzanine loans secured by
healthcare properties, and participation in first mortgage loans secured by
multifamily and commercial mortgage loans. As of December 31, 2000, loans
consisted primarily of multifamily permanent and construction mortgage loans and
mezzanine loans secured by healthcare properties. As of December 31, 2001 and
2000, loans with a carrying value of $3.7 million and $19.1 million,
respectively, are considered held for sale and are carried at the lower of cost
or market.
Collateralized Bond Securities
The Company analyzes and values its investment in collateral for
collateralized bonds on a net investment basis. The Company, through its
subsidiaries, pledges collateral (i.e., single-family mortgage loans,
manufactured housing mortgage loans, or commercial mortgage loans) for
collateralized bond obligations that are issued based on the pledge of such
collateral. These collateralized bonds are recourse only to the collateral
pledged, and not to the Company. The structure created by the pledge of
collateral and sale of the associated collateralized bonds is referred to
hereafter as a "collateralized bond security". The "net investment in
collateralized bond securities" generally represents the principal balance of
the collateral pledged (plus any premiums and related costs and less any
discounts) less the outstanding balance of the associated collateralized bonds
owned by third parties. The Company generally has sold the investment grade
classes of the collateralized bonds to third parties, and has retained the
portion of the collateralized bond security that is below investment grade. The
Company estimates the fair value of its net investment in collateralized bond
securities as the present value of the projected cash flow from the collateral,
adjusted for the impact of and assumed level of future prepayments and credit
losses, less the projected principal and interest due on the bonds owned by
third parties. Below is a summary as of December 31, 2001, by each series where
the fair value exceeds $0.5 million of the Company's net investment in
collateralized bond securities. As previously indicated the Company master
services the majority of its collateralized bond securities. Monthly payment
reports for those securities master-serviced by the Company may be found on the
Company's website at www.dynexcapital.com.
- ----------------------------------------------------------------------------------------------------------------------
(amounts in Principal
thousands) Principal balance of Principal Amortized Cost
balance of collateralized Balance of Basis of Net
Collateralized Bond Collateral Type collateral bonds Net Investment Investment
Series (1) pledged outstanding to
third parties
- ----------------------------------------------------------------------------------------------------------------------
MERIT Series 11A Single-family loans ;
manufactured housing loans $ 454,982 $ 405,075 $ 49,907 $54,937
MERIT Series 12-1 Manufactured housing loans 283,666 254,087 29,579 27,545
MERIT Series 12-2 Single-family loans 400,259 375,374 24,885 36,466
MERIT Series 13 Manufactured housing loans 344,545 300,379 44,166 39,768
MERIT Series 14-1 Single-family loans 158,443 157,524 919 4,554
MERIT Series 14-2 Single-family loans 3,136 - 3,136 3,192
MCA One Series 1 Commercial mortgage loans 88,097 83,354 4,743 (517)
CCA One Series 2 Commercial mortgage loans 300,033 277,930 22,103 8,551
CCA One Series 3 Commercial mortgage loans 415,169 369,881 45,288 58,430
- ----------------------------------------------------------------------------------------------------------------------
2,448,330 2,223,604 224,726 232,926
On-balance sheet reserves for credit losses (27,163) (27,163)
- ----------------------------------------------------------------------------------------------------------------------
$2,448,330 $2,223,604 $197,563 $205,763
- ----------------------------------------------------------------------------------------------------------------------
(1) MERIT stands for MERIT Securities Corporation; MCA stands for Multifamily
Capital Access One, Inc. (now known as Commercial Capital Access One, Inc.); and
CCA stands for Commercial Capital Access One, Inc. Each such entity is a wholly
owned limited purpose subsidiary of the Company.
The following table summarizes the fair value of the Company's net
investment in collateralized bond securities, the various assumptions made in
estimating value, the unrealized gain (loss) on the Company's net investment and
the cash flow received from such net investment during 2001.
- -----------------------------------------------------------------------------------------------------------------------------
Fair Value Assumptions ($ in thousands)
------------------------------------------------------------
Cash flows
Weighted-average Projected cash Fair value of Unrealized received in
Collateralized Bond prepayment speeds Losses flow termination net gain (loss) 2001, net (2)
Series date investment (1)
- -----------------------------------------------------------------------------------------------------------------------------
MERIT Series 11A 40%-60% CPR on SF
loans; 10% CPR 3.5% annually on Anticipated
on MH loans MH loans final maturity $ 52,416 $ (2,521) $22,042
in 2025
MERIT Series 12-1 9% CPR 2.8% annually on MH Anticipated
Loans final maturity 3,492 (24,053) 794
in 2027
MERIT Series 12-2 35% CPR 0.55% annually Anticipated
call date in 2002 39,565 3,099 19,814
MERIT Series 13 10% CPR 4.0% annually Anticipated
final maturity 4,027 (35,742) 926
in 2026
MERIT Series 14-1 35% CPR 0.2% annually Anticipated
call date in 2002 7,311 2,757 7,207
MERIT Series 14-2 50% CPR 10.0% annually Anticipated
call date in 2002 2,959 (233) 2,717
MCA One Series 1 (3) Losses of $2,096 in Anticipated
2004, $1,500 in final maturity 1,466 1,983 63
2006 and $1,000 in in 2018
2008
CCA One Series 2 (4) 0.60% annually Anticipated
beginning in 2003 call date in 2012 8,113 (438) 1,724
CCA One Series 3 (4) 0.60% annually Anticipated
beginning in 2004 call date in 2009 20,556 (37,875) 2,778
- -----------------------------------------------------------------------------------------------------------------------------
139,905 (93,023) 58,065
On-balance sheet reserves for credit losses 27,163
- -----------------------------------------------------------------------------------------------------------------------------
$139,905 $(65,860) $58,065
- -----------------------------------------------------------------------------------------------------------------------------
(1) Calculated as the net present value of expected future cash flows,
discounted at 16%. Expected cash flows were based on the level of interest rates
as of December 31, 2001, and incorporates the resetting of the interest rates on
the adjustable rate assets to a level consistent with the respective index level
as of December 31, 2001. Increases or decreases in interest rates and index
levels from December 31, 2001 would impact the calculation of fair value, as
would differences in actual prepayment speeds and credit losses versus the
assumptions set forth above.
(2) Cash flows received by the Company during the year, equal to the excess
of the cash flows received on the collateral pledged, over the cash flow
requirements of the collateralized bond security
(3) Computed at 0% CPR through June 2008, then 20% CPR thereafter
(4) Computed at 0% CPR until the respective call date
Investment Portfolio Risks
The Company is exposed to several types of risks inherent in its
investment portfolio. These risks include credit risk (inherent in the loans
before securitization and the security structure after securitization),
prepayment/interest rate risk (inherent in the underlying loan) and margin call
risk (inherent in the security if it is used as collateral for recourse
borrowings).
Credit Risk. Credit risk is the risk of loss to the Company from the
failure by a borrower (or the proceeds from the liquidation of the underlying
collateral) to fully repay the principal balance and interest due on a loan. A
borrower's ability to repay, or the value of the underlying collateral, could be
negatively influenced by economic and market conditions. These conditions could
be global, national, regional or local in nature. When a loan is funded and
becomes part of the Company's investment portfolio, the Company has all of the
credit risk on the loan should it default. Upon securitization of the pool of
loans, the credit risk retained by the Company is generally limited to its net
investment in the collateralized bond structure (also know as
over-collateralization) and subordinated securities that it may retain from the
securitization. The Company provides for reserves for expected losses based on
the current performance of the respective pool of loans; however, if losses are
experienced more rapidly due to market conditions than the Company has provided
for in its reserves, the Company may be required to provide for additional
reserves for these losses.
The Company evaluates and monitors its exposure to credit losses and
has established reserves and discounts for probable credit losses based upon
anticipated future losses on the loans, general economic conditions and
historical trends in the portfolio. For its securitized loans, the Company
considers its credit exposure to include over-collateralization and subordinated
securities retained from a securitization. As of December 31, 2001, the
Company's credit exposure on subordinated securities retained or as to
over-collateralization was $233.0 million. The Company has reserves and
discounts of $79.5 million relative to this credit exposure.
The Company also has various other forms of credit enhancement which,
based upon the performance of the underlying loans, may provide additional
protection against losses. Specifically, $169.0 million and $139.3 million of
the commercial mortgage loans are subject to guarantees of $14.3 million and
$14.4 million, respectively, whereby losses on such loans would need to exceed
the respective guarantee amount before the Company would incur credit losses;
$308 million of the single family mortgage loans in various pools are subject to
various mortgage pool insurance policies whereby losses would need to exceed the
remaining stop loss of at least 6% on such policies before the Company would
incur losses; and $122.1 million of the single family mortgage loans are subject
to various loss reimbursement agreements totaling $30.3 million with a remaining
aggregate deductible of approximately $1.6 million. The Company is currently in
dispute with the counter-party on the loss reimbursement agreements as to what
constitutes qualifying losses. This matter is being pursued through
court-ordered arbitration scheduled to begin in May 2002.
The Company also has credit risk on the entire amount of investments
that are not securitized. Such investments include loans and other investments
that aggregated $70.9 million at December 31, 2001.
Prepayment/Interest Rate Risk. The interest rate environment may also
impact the Company. For example, in a rising rate environment, the Company's net
interest margin may be reduced, as the interest cost for its funding sources
could increase more rapidly than the interest earned on the associated asset
financed. The Company's floating-rate funding sources are substantially based on
the one-month London InterBank Offered Rate ("LIBOR") and reprice at least
monthly, while the associated assets are principally six-month LIBOR or one-year
Constant Maturity Treasury ("CMT") based and generally reprice every six to
twelve months. Additionally, the Company has approximately $184 million of
fixed-rate assets financed with floating-rate collateralized bond liabilities.
In a declining rate environment, net interest margin may be enhanced for the
opposite reasons. In a period of declining interest rates, however, loans in the
investment portfolio will generally prepay more rapidly (to the extent that such
loans are not prohibited from prepayment), which may result in additional
amortization expense of asset premium. In a flat yield curve environment (i.e.,
when the spread between the yield on the one-year Treasury security and the
yield on the ten-year Treasury security is less than 1.0%), single-family
adjustable rate mortgage ("ARM") loans tend to rapidly prepay, causing
additional amortization of asset premium. In addition, the spread between the
Company's funding costs and asset yields would most likely compress, causing a
further reduction in the Company's net interest margin. Lastly, the Company's
investment portfolio may shrink, or proceeds returned from prepaid assets may be
invested in lower yielding assets. The severity of the impact of a flat yield
curve to the Company would depend on the length of time the yield curve remained
flat.
FEDERAL INCOME TAX CONSIDERATIONS
General
The Company believes it has complied with the requirements for
qualification as a REIT under the Internal Revenue Code (the "Code"). To the
extent the Company qualifies as a REIT for federal income tax purposes, it
generally will not be subject to federal income tax on the amount of its income
or gain that is distributed as dividends to shareholders. While they were still
in existence, DHI and its subsidiaries were not qualified REIT subsidiaries and
were not consolidated with the Company for either tax or financial reporting
purposes.
DHI was liquidated pursuant to a plan of liquidation on December 31,
2000 under Sections 331 and 336 of the Code. The liquidation of DHI resulted in
the recognition of an estimated $17.5 million in capital gains for the Company,
which was wholly offset by the Company's capital loss carry-forwards. The
Company is in the process of completing its income tax return for 2001, and it
currently estimates that it has a net operating loss carry-forward of
approximately $125 million and capital loss carry-forwards of approximately $61
million at December 31, 2001. Substantially all of the $125 million in net
operating losses carry-forwards expire in 2014 and 2015, and of the $61 million
of capital loss carry-forwards, $33 million expires in 2003 and $28 million
expires in 2004.
The REIT rules generally require that a REIT invest primarily in real
estate-related assets, that its activities be passive rather than active and
that it distribute annually to its shareholders substantially all of its taxable
income. The Company could be subject to income tax if it failed to satisfy those
requirements or if it acquired certain types of income-producing real property.
Although no complete assurances can be given, the Company does not expect that
it will be subject to material amounts of such taxes.
Failure to satisfy certain Code requirements could cause the Company to
lose its status as a REIT. If the Company failed to qualify as a REIT for any
taxable year, it would be subject to federal income tax (including any
applicable alternative minimum tax) at regular corporate rates and would not
receive deductions for dividends paid to shareholders. The Company could utilize
loss carry-forwards to offset any taxable income. In addition, given the size of
its tax loss carry-forwards, the Company could pursue a business plan in the
future whereby the Company would voluntarily forego its REIT status. Once the
Company loses its status as REIT, the Company could not elect REIT status again
for five years.
In December 1999, with an effective date of January 1, 2001, Congress
signed into law several changes to the provisions of the Code relating to REITs.
The most significant of these changes relates to the reduction of the
distribution requirement from 95% to 90% of taxable income and to the ability of
REITs to own a 100% interest in taxable REIT subsidiaries. The Company had one
taxable REIT subsidiary at December 31, 2001.
Qualification of the Company as a REIT
Qualification as a REIT requires that the Company satisfy a variety of
tests relating to its income, assets, distributions and ownership. The
significant tests are summarized below.
Sources of Income. To continue qualifying as a REIT, the Company must
satisfy two distinct tests with respect to the sources of its income: the "75%
income test" and the "95% income test". The 75% income test requires that the
Company derive at least 75% of its gross income (excluding gross income from
prohibited transactions) from certain real estate-related sources. In order to
satisfy the 95% income test, 95% of the Company's gross income for the taxable
year must consist either of income that qualifies under the 75% income test or
certain other types of passive income.
If the Company fails to meet either the 75% income test or the 95%
income test, or both, in a taxable year, it might nonetheless continue to
qualify as a REIT, if its failure was due to reasonable cause and not willful
neglect and the nature and amounts of its items of gross income were properly
disclosed to the Internal Revenue Service. However, in such a case the Company
would be required to pay a tax equal to 100% of any excess non-qualifying
income.
Nature and Diversification of Assets. At the end of each calendar
quarter, three asset tests must be met by the Company. Under the 75% asset test,
at least 75% of the value of the Company's total assets must represent cash or
cash items (including receivables), government securities or real estate assets.
Under the "10% asset test", the Company may not own more than 10% of the
outstanding voting securities of any single non-governmental issuer, provided
such securities do not qualify under the 75% asset test or relate to taxable
REIT subsidiaries. Under the "5% asset test," ownership of any stocks or
securities that do not qualify under the 75% asset test must be limited, in
respect of any single non-governmental issuer, to an amount not greater than 5%
of the value of the total assets of the Company.
If the Company inadvertently fails to satisfy one or more of the asset
tests at the end of a calendar quarter, such failure would not cause it to lose
its REIT status, provided that (i) it satisfied all of the asset tests at the
close of a preceding calendar quarter and (ii) the discrepancy between the
values of the Company's assets and the standards imposed by the asset tests
either did not exist immediately after the acquisition of any particular asset
or was not wholly or partially caused by such an acquisition. If the condition
described in clause (ii) of the preceding sentence was not satisfied, the
Company still could avoid disqualification by eliminating any discrepancy within
30 days after the close of the calendar quarter in which it arose.
Distributions. With respect to each taxable year, in order to maintain
its REIT status, the Company generally must distribute to its shareholders an
amount at least equal to 90% of the sum of its "REIT taxable income" (determined
without regard to the deduction for dividends paid and by excluding any net
capital gain) and any after-tax net income from certain types of foreclosure
property minus any "excess non-cash income" (the "90% distribution
requirement"). The Code provides that in certain circumstances distributions
relating to a particular year may be made in the following year for purposes of
the 90% distribution requirement. The Company will balance the benefit to the
shareholders of making these distributions and maintaining REIT status against
their impact on the liquidity of the Company. In certain situations, it may
benefit the shareholders if the Company retained cash to preserve liquidity and
thereby lose REIT status.
Ownership. In order to maintain its REIT status, the Company must not
be deemed to be closely held and must have more than 100 shareholders. The
closely held prohibition requires that not more than 50% of the value of the
Company's outstanding shares be owned by five or fewer persons at anytime during
the last half of the Company's taxable year. The more than 100 shareholders rule
requires that the Company have at least 100 shareholders for 335 days of a
twelve-month taxable year. In the event that the Company failed to satisfy the
ownership requirements the Company would be subject to fines and required taking
curative action to meet the ownership requirements in order to maintain its REIT
status.
For federal income tax purposes, the Company is required to recognize
income on an accrual basis and to make distributions to its shareholders when
income is recognized. Accordingly, it is possible that income could be
recognized and distributions required to be made in advance of the actual
receipt of such funds by the Company. The nature of the Company's investments,
coupled with its tax loss carry-forwards, is such that the Company expects to
have sufficient assets to meet federal income tax distribution requirements.
Taxation of Distributions by the Company
Assuming that the Company maintains its status as a REIT, any
distributions that are properly designated as "capital gain dividends" will
generally be taxed to shareholders as long-term capital gains, regardless of how
long a shareholder has owned his shares. Any other distributions out of the
Company's current or accumulated earnings and profits will be dividends taxable
as ordinary income. Distributions in excess of the Company's current or
accumulated earnings and profits will be treated as tax-free returns of capital,
to the extent of the shareholder's basis in his shares and, as gain from the
disposition of shares, to the extent they exceed such basis. Shareholders may
not include on their own tax returns any of the Company's ordinary or capital
losses. Distributions to shareholders attributable to "excess inclusion income"'
of the Company will be characterized as excess inclusion income in the hands of
the shareholders. Excess inclusion income can arise from the Company's holdings
of residual interests in real estate mortgage investment conduits and in certain
other types of mortgage-backed security structures created after 1991. Excess
inclusion income constitutes unrelated business taxable income ("UBTI") for
tax-exempt entities (including employee benefit plans and individual retirement
accounts) and it may not be offset by current deductions or net operating loss
carryovers. In the event that the Company's excess inclusion income is greater
than its taxable income, the Company's distribution requirement would be based
on the Company's excess inclusion income. Dividends paid by the Company to
organizations that generally are exempt from federal income tax under Section
501(a) of the Code should not be taxable to them as UBTI except to the extent
that (i) purchase of shares of the Company was financed by "acquisition
indebtedness" or (ii) such dividends constitute excess inclusion income. In
2001, the Company paid a dividend on its preferred stocks equal to approximately
$1.6 million, representing the Company's excess inclusion income in 2000. The
Company estimates that excess inclusion income for 2001 was $1.1 million.
Taxable Income
The Company uses the calendar year for both tax and financial reporting
purposes. However, there may be differences between taxable income and income
computed in accordance with GAAP. These differences primarily arise from timing
differences in the recognition of revenue and expense for tax and GAAP purposes.
The Company's estimated taxable income for 2001, excluding net operating losses
carried forward from prior years, was $16.9 million, comprised of $7.4 million
in ordinary income and $9.5 million of capital gain income. Such amounts were
fully offset by loss carry-forwards of a similar amount.
REGULATION
The Company's existing consumer-related servicing activities consist of
collections on the delinquent property tax receivables. The Company believes
that such servicing operations are managed in compliance with the Fair Debt
Collections Practices Act.
The Company believes that it is in material compliance with all
material rules and regulations to which it is subject.
COMPETITION
The Company competes with a number of institutions with greater
financial resources in originating and purchasing loans. In addition, in
purchasing portfolio investments and in issuing securities, the Company competes
with investment banking firms, savings and loan associations, commercial banks,
mortgage bankers, insurance companies and federal agencies and other entities
purchasing mortgage assets, many of which have greater financial resources and a
lower cost of capital than the Company.
EMPLOYEES
As of December 31, 2001, the Company had 73 employees.
Item 2. PROPERTIES
The Company's executive and administrative offices and operations
offices are both located in Glen Allen, Virginia, on properties leased by the
Company which consist of 11,194 square feet. The address is 4551 Cox Road, Suite
300, Glen Allen, Virginia 23060. The lease expires in 2005. The Company also
occupies space located in Cleveland, Ohio, and the Pittsburgh, Pennsylvania
metropolitan area. These locations consist of approximately 16,384 square feet,
and the leases associated with these properties expire in 2004.
Item 3. LEGAL PROCEEDINGS
The Company is subject to lawsuits or claims which arise in the
ordinary course of its business, some of which seek damages in amounts which
could be material to the financial statements. Although no assurance can be
given with respect to the ultimate outcome of any such litigation or claim, the
Company believes the resolution of such lawsuits or claims will not have a
material effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Dynex Capital, Inc.'s common stock is traded on the New York Stock
Exchange under the trading symbol DX. The common stock was held by approximately
3,662 holders of record as of February 28, 2002. During the last two years, the
high and low closing stock prices and cash dividends declared on common stock,
adjusted for the two-for-one stock split effective May 5, 1997 and the
one-for-four reverse stock split effective August 2, 1999, were as follows:
- ---------------------------------------------- ------------- -------------- --------------
Cash
Dividends
High Low Declared
- ---------------------------------------------- ------------- -------------- --------------
2001:
First quarter $ 1.30 $ 0.64 $ -
Second quarter 2.45 0.89 -
Third quarter 2.48 1.91 -
Fourth quarter 2.45 1.86 -
2000:
First quarter $ 9.56 $ 3.38 $ -
Second quarter 5.25 1.19 -
Third quarter 1.88 0.47 -
Fourth quarter 1.75 0.63 -
- ---------------------------------------------- ------------- -------------- --------------
Item 6. SELECTED FINANCIAL DATA
(amounts in thousands except share data)
- ------------------------------------------------------------------------------------------------------------------------------
Years ended December 31, 2001 2000 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------
Net interest margin $ 12,570 $ (3,146) $ 48,015 $ 66,538 $ 83,454
Net (loss) gain on sales, write-downs, and impairment (5,114) (78,516) (100,876) (20,346) 11,584
charges
Equity in net (loss) earnings of Dynex Holding, Inc. - (680) (1,923) 2,456 (1,109)
Other income (expense) 104 (428) 1,673 2,852 1,716
General and administrative expenses (10,526) (8,712) (7,740) (8,973) (9,531)
Net administrative fees and expenses to Dynex - (381) (16,943) (22,379) (12,116)
Holding, Inc.
Extraordinary item - gain (loss) on extinguishment of 2,972 - (1,517) (571) -
debt
- -------------------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (3,085) $ (91,863) $ (75,135) $ 19,577 $ 73,998
------------------------------------------------------------------------------------------------------------------------------
Net income (loss) available to common shareholders $ 6,246 $ (104,774) $ (88,045) $ 6,558 $ 59,178
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 225,836 $ 291,160 $ 347,298 $ 410,821 $ 346,859
- -------------------------------------------------------------------------------------------------------------------------------
Total expenses $ 228,921 $ 383,023 $ 422,433 $ 391,244 $ 272,861
- -------------------------------------------------------------------------------------------------------------------------------
Income (loss) per common share before
extraordinary item:
Basic(1) $ 0.29 $ (9.15) $ (7.53) $ 0.62 $ 5.50
Diluted(1) $ 0.29 $ (9.15 $ (7.53) $ 0.62 $ 5.50
Net income (loss) per common share after
extraordinary item:
Basic(1) $ 0.55 $ (9.15) $ (7.67) $ 0.57 $ 5.50
Diluted(1) $ 0.55 $ (9.15) $ (7.67) $ 0.57 $ 5.50
Dividends declared per share:
Common (1) $ - $ - $ - $ 3.40 $ 5.42
Series A Preferred 0.2925 - 1.17 2.37 2.71
Series B Preferred 0.2925 - 1.17 2.37 2.71
Series C Preferred 0.3649 - 1.46 2.92 2.92
- ----------------------------------------------------------------------------------------------------------------------------
December 31, 2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------
Investments (2) $ 2,480,533 $ 3,112,908 $ 4,109,736 $ 4,956,665 $ 5,211,009
Total assets 2,500,812 3,159,596 4,192,516 5,178,848 5,367,413
Non-recourse debt 2,264,213 2,856,728 3,282,378 3,665,316 3,632,079
Recourse debt 58,134 134,168 537,098 1,032,733 1,133,536
Total liabilities 2,327,749 3,002,465 3,867,444 4,726,044 4,806,504
Shareholders' equity 173,063 157,131 325,072 452,804 560,909
Number of common shares outstanding 10,873,853 11,446,206 11,444,099 46,027,426 45,146,242
Average number of common shares (1) 11,430,471 11,445,236 11,483,977 11,436,599 10,757,845
Book value per common share (1) $ 4.71 $ 0.37 $ 16.18 $ 27.75 $ 37.59
- ----------------------------------------------------------------------------------------------------------------------------
(1) Adjusted for two-for-one common stock split effective May 5, 1997 and
the one-for-four reverse common stock split effective August 2, 1999, and are
inclusive of the liquidation preference on the Company's preferred stock. (2)
Investments classified as available for sale are shown at fair value.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company is a financial services company that invests in a portfolio
of securities and investments backed principally by single-family mortgage
loans, commercial mortgage loans and manufactured housing installment loans.
Such loans have been funded generally by the Company's prior loan production
operations or purchased in bulk in the market. Loans funded through the
Company's prior production operations have generally been pooled and pledged as
collateral using a collateralized bond security structure, which provides
long-term financing for the loans while limiting credit, interest rate and
liquidity risk.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the Company's financial condition and
results of operations are based in large part upon its consolidated financial
statements, which have been prepared in conformity with accounting principles
generally accepted in the United States of America. The preparation of the
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. Actual
results could differ from those estimates.
Critical accounting policies are defined as those that are reflective
of significant judgements or uncertainties, and which may result in materially
different results under different assumptions and conditions, or by application
of which may have a material impact on the Company's financial statements. The
following are the Company's critical accounting policies, excerpt from Footnote
2 to the consolidated financial statements.
Interest Income. Interest income is recognized when earned according to
the terms of the underlying investment and when, in the opinion of management,
it is collectible. The accrual of interest on investments is discontinued or the
rate on which interest is accrued is reduced at the time the collection of
interest is considered doubtful. All interest accrued but not collected for
investments that are placed on non-accrual status or charged-off is reversed
against interest income. Interest on these investments is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual.
Investments are returned to accrual status when all the principal and interest
amounts contractually due are brought current and future payments are reasonably
assured.
Fair Value. The Company uses estimates in establishing fair value for
its financial instruments. Estimates of fair value for financial instruments may
be based on market prices provided by certain dealers. Estimates of fair value
for certain other financial instruments are determined by calculating the
present value of the projected cash flows of the instruments using appropriate
discount rates, prepayment rates and credit loss assumptions. Collateral for
collateralized bonds make up a significant portion of the Company's investments.
The estimate of fair value for collateral for collateralized bonds is determined
by calculating the present value of the projected cash flows of the instruments,
using discount rates, prepayment rate assumptions and credit loss assumptions
established by management. The discount rate used in the determination of fair
value of the collateral for collateralized bonds was 16% at December 31, 2001
and 2000. Prepayment rate assumptions at December 31, 2001 and 2000 were
generally at a "constant prepayment rate," or CPR, ranging from 35%-60% for
2001, and 28% for 2000, respectively, for collateral for collateralized bonds
consisting of single-family mortgage loans, and a CPR equivalent ranging from
9%-10% for 2001 and 7% for 2000, respectively for collateral for collateralized
bonds consisting of manufactured housing loan collateral. Commercial mortgage
loan collateral was generally assumed to repay in accordance with their
contractual terms. CPR assumptions for each year are based in part on the actual
prepayment rates experienced for the prior six-month period and in part on
management's estimate of future prepayment activity. The loss assumptions
utilized vary for each series of collateral for collateralized bonds, depending
on the collateral pledged. The cash flows for the collateral for collateralized
bonds were projected to the estimated date that the security could be called and
retired by the Company if there is economic value to the Company in calling and
retiring the security. Such call date is typically triggered on the earlier of a
specified date or when the remaining security balance equals 35% of the original
balance (the "Call Date"). The Company estimates anticipated market prices of
the underlying collateral at the Call Date.
The Company estimated the fair value of certain other investments as
the present value of expected future cash flows, less costs to service such
investments, discounted at a rate of 12%.
Allowance for Losses. The Company has credit risk on certain
investments in its portfolio. An allowance for losses has been estimated and
established for current expected losses based on management's judgment. The
allowance for losses is evaluated and adjusted periodically by management based
on the actual and projected timing and amount of probable credit losses, as well
as industry loss experience. Provisions made to increase the allowance related
to credit risk are presented as provision for losses in the accompanying
consolidated statements of operations. The Company's actual credit losses may
differ from those estimates used to establish the allowance.
FINANCIAL CONDITION
Below is a discussion of the Company's financial condition.
- ------------------------------------------------------ -----------------------------------------
December 31,
(amounts in thousands except per share data) 2001 2000
- ------------------------------------------------------ -------------------- --------------------
Investments:
Collateral for collateralized bonds $2,404,157 $3,042,158
Securities 5,508 9,364
Other investments 63,553 42,284
Loans 7,315 19,102
Non-recourse debt - collateralized bonds 2,264,213 2,856,728
Recourse debt 58,134 134,168
Shareholders' equity 173,063 157,131
Book value per common share (inclusive of preferred
stock liquidation preference) $ 4.71 $ 0.37
- ------------------------------------------------------ -------------------- --------------------
Collateral for Collateralized Bonds
Collateral for collateralized bonds consists primarily of securities
backed by adjustable-rate and fixed-rate mortgage loans secured by first liens
on single family properties, fixed-rate loans secured by first liens on
multifamily and commercial properties, and manufactured housing installment
loans secured by either a UCC filing or a motor vehicle title. Collateral for
collateralized bonds in 2000 also included delinquent property tax receivables.
As of December 31, 2001, the Company had 23 series of collateralized bonds
outstanding. Collateral for collateralized bonds are considered available for
sale, and are therefore carried at estimated fair value. The collateral for
collateralized bonds decreased to $2.4 billion at December 31, 2001 compared to
$3.0 billion at December 31, 2000. This decrease of $0.6 billion is primarily
the result of pay-downs on collateral offset in part by a decrease in the
unrealized loss.
Securities
Securities at December 31, 2001 and 2000 consist primarily of
adjustable-rate (ARM) and fixed-rate mortgage-backed securities. Securities also
include derivative and residual securities. Derivative securities are classes of
collateralized bonds, mortgage pass-through certificates or mortgage
certificates that pay to the holder substantially all interest (i.e., an
interest-only security), or substantially all principal (i.e., a principal-only
security). Residual interests represent the right to receive the excess of (i)
the cash flow from the collateral pledged to secure related mortgage-backed
securities, together with any reinvestment income thereon, over (ii) the amount
required for principal and interest payments on the mortgage-backed securities
or repurchase arrangements, together with any related administrative expenses.
Securities decreased to $5.5 million at December 31, 2001, compared to $9.4
million at December 31, 2000, primarily as a result of the sale of certain ARM
securities, which were sold in order to repay recourse debt.
Other Investments
Other investments at December 31, 2001 and 2000 consist primarily of
delinquent property tax receivables. At December 31, 2000, other investments
also included a note receivable with a remaining balance of $9.5 million
received in connection with the sale of the Company's single family mortgage
operations in May 1996. Other investments increased to $63.6 million at December
31, 2001 compared to $42.2 million at December 31, 2000. This increase of $21.4
million resulted from the reclassification in 2001 of delinquent property tax
receivables previously pledged to a collateralized bond security structure and
the purchase of $8.7 million of additional property tax receivables during 2001.
These increases were offset in part by the receipt of the $9.5 million on the
note receivable, principal payments received on delinquent property tax
receivables, and impairment charges recorded.
Loans
Loans decreased to $7.3 million at December 31, 2001 from $19.1 million
at December 31, 2000 principally due to sales. The proceeds from the sales of
loans were used to repay associated recourse debt outstanding.
Non-recourse Debt
Collateralized bonds issued by the Company are recourse only to the
assets pledged as collateral, and are otherwise non-recourse to the Company.
Collateralized bonds decreased to $2.3 billion at December 31, 2001 from $2.9
billion at December 31, 2000. This decrease was primarily a result of principal
pay-downs made during the year, from the principal payments received from the
associated collateral for collateralized bonds.
Recourse Debt
Recourse debt decreased from $134.2 million at December 31, 2000 to
$58.1million at December 31, 2001. During 2001, the Company repaid a net $35.0
million of repurchase agreement financing, $2.0 million of secured warehouse
financing, and purchased a net $39.3 of the Company's Senior Notes. The purchase
of the Senior Notes was at a net discount to principal of approximately 9.5%.
Shareholders' Equity
Shareholders' equity increased from $157.1 million at December 31, 2000
to $173.1 million at December 31, 2001. This increase resulted from a $40.7
million decrease in the net unrealized loss on investments available for sale
from $124.6 million at December 31, 2000 to $83.9 million at December 31, 2001.
This increase in shareholder's equity was partially offset by a net loss of $3.1
million during the year 2001 and a $20.1 million net reduction as a result of
the completion of two preferred stock tender offers during the year. In
addition, the Company declared and paid dividends on the preferred stock of $1.6
million during the year.
RESULTS OF OPERATIONS
- ----------------------------------------------------------------- --------------------------------------------------
For the Year Ended December 31,
(amounts in thousands except per share information) 2001 2000 1999
- ----------------------------------------------------------------- ---------------- --------------- -----------------
Net interest margin before provision for losses $ 48,082 $ 31,487 $ 64,169
Provision for losses (35,512) (34,633) (16,154)
Net interest margin 12,570 (3,146) 48,015
Net loss on sales, write-downs and impairment charges:
Related to commercial production operations (680) (50,940) (59,962)
Related to sales of investments (439) (15,872) (16,858)
Impairment charges on held-to-maturity investments and
related real estate owned (9,475) - -
Related to AutoBond litigation and AutoBond securities 7,095 (11,012) (31,732)
Related to sale of loan production operations (755) (228) 7,676
Other (860) (464) -
Trading (losses) gains (3,091) - 4,176
Equity in losses of DHI - (680) (1,923)
General and administrative expenses (10,526) (8,712) (7,740)
Net administrative fees and expenses to DHI - (381) (16,943)
Extraordinary item - gain (loss) on extinguishment of debt 2,972 - (1,517)
Net loss (3,085) (91,863) (75,135)
Preferred stock benefit (charges) 9,331 (12,911) (12,910)
Net income (loss) available to common shareholders $ 6,246 $(104,774) $(88,045)
Basic net income (loss) per common share(1) $ 0.55 $ (9.15) $ (7.67)
Diluted net income (loss) per common share(1) $ 0.55 $ (9.15) $ (7.67)
Dividends declared per share:
Common $ - $ - $ -
Series A and B Preferred 0.2925 - 1.17
Series C Preferred 0.3649 - 1.46
- ----------------------------------------------------------------- ---------------- --------------- -----------------
(1) Adjusted for both the two-for-one common stock split effective May 5,
1997 and the one-for-four reverse common stock split effective August 2, 1999.
2001 Compared to 2000.
The increase in net income and net income per common share during 2001
as compared to 2000 is primarily the result of an increase in net interest
margin, a decrease in net loss on sales, write-downs, and impairment charges, an
increase in gains from extinguishment of debt, and a preferred stock benefit in
2001 versus charges in the prior year, partially offset by an increase in
trading losses and general and administrative expenses.
Net interest margin before provision for losses for the year ended
December 31, 2001 increased to $48.1 million, from $31.5 million for the same
period in 2000. The increase in net interest margin of $16.6 million, or 53%,
was the result of the reduction in the Company's average cost of funds, which
declined by approximately 0.70%, as a result of the overall decline in interest
rates during 2001 and a reduction in fees related to committed credit
facilities.
Provision for losses increased to $35.5 million in 2001, or 1.23% of
average interest earning assets, from $34.6 million in 2000, or 0.93% of average
interest earning assets. The provision for losses increased as a result of the
continued under-performance of the Company's manufactured housing loan
portfolio, all of which is collateral for collateralized bonds. Loss severity on
the manufactured housing loans continued to increase during 2001 as a result of
the saturation in the market place with both new and used (repossessed)
manufactured housing units. In addition, the Company has seen an increase in
overall default rates on its manufactured housing loans. The Company anticipates
that market conditions for manufactured housing loans will remain unfavorable
through 2002.
Net loss on sales, write-downs and impairment charges decreased from an
aggregate net loss of $78.5 million in 2000 to an aggregate net loss of $5.1
million. Net loss on sales, impairment charges and write-downs are largely
one-time items. During 2001, the Company settled various litigation for a net
benefit to the Company of $5.4 million including a net $7.1 million benefit
related to AutoBond Acceptance Corporation. The Company incurred losses in 2001
related principally to impairment charges incurred on its delinquent property
tax lien portfolio. The Company adjusted the carrying value of such portfolio by
$7.7 million due to other-than-temporary valuation adjustments, and $1.8 million
for adjustments to net realizable value on property tax liens that have been
foreclosed and represent real estate owned. The Company also wrote off $0.6
million of receivables related to the sale of its manufactured housing and model
home businesses in 1999.
During 2000, the Company incurred losses related to the phasing-out of
its commercial production operations, including the sales of substantially all
of the Company's remaining commercial and multifamily loan positions. In
addition, the Company recorded a loss of $30.3 million as a result of the
expiration of a Company owned option to purchase $167.8 million of tax-exempt
bonds secured by multifamily mortgage loans that expired in June 2000. The
Company did not exercise this option, as it did not have the ability to finance
this purchase, and the counter-party to the agreement retained $30.3 million in
cash collateral as settlement as provided for in the related agreements. The
Company recorded a charge against earnings of $30.3 million in 2000 as a result.
In 2001, the Company entered into three separate short positions
aggregating $1.3 billion on the June 2001, September 2001, and December 2001
ninety-day Eurodollar Futures Contracts. In addition, the Company entered into
two short positions on the one-month LIBOR futures contract. The Company entered
into these positions to, in effect, lock-in its borrowing costs on a forward
basis relative to its floating-rate liabilities. These instruments failed to
meet the hedge criteria of FAS No. 133, and were accounted for on a trading
basis. Accordingly, any gains or losses recognized on these contracts was
included in current period results. During 2001, given the continued decline in
one-month LIBOR due to reductions in the targeted Federal Funds Rate, the
Company recognized $3.1 million in losses related to these contracts.
During 2000, the Company settled the outstanding litigation with
AutoBond for $20 million. The Company had accrued a reserve as of December 31,
1999, for $27 million related to the litigation, and reversed $5.6 million of
this reserve in 2000 as a result of the settlement. In June 2000, the Company
recorded permanent impairment charges of $16.6 million on AutoBond related
securities. During the fourth quarter 2000, the Company completed the sale of
substantially all of the remaining outstanding securities and loans related to
AutoBond.
Also during 2000, the Company recorded impairment charges and loss on
sales of securities aggregating $8.5 million, relating to the write-down of
basis and then the sale of $33.9 million of securities. Such securities were
sold in order for the Company to pay-down its recourse debt outstanding. As a
result of the sale of securities, the Company either sold or terminated related
derivative hedge positions at an aggregate net loss of $7.3 million.
2000 Compared to 1999.
The decrease in net income and net income per common share during 2000
as compared to 1999 is primarily the result of a decrease in net interest
margin, which is partially offset by (i) a decrease in net loss on sales, (ii)
impairment charges and write-downs, and (iii) decreases in general and
administrative expenses and net administrative fees and expenses to DHI.
Net interest margin before provision for losses for the year ended
December 31, 2000 decreased $32.7 million, or 51% to $31.5 million, from $64.2
million for the same period for 1999. The decrease in net interest margin was
primarily the result of the decline in average interest-earning assets from $4.6
billion in 1999, to $3.7 billion in 2000. In addition, the average cost of funds
of the Company increased to 7.35% in 2000 from 6.21% in 1999 due to an overall
market increase in short-term interest rates, and to a lesser extent, fees paid
and rate increases associated with the Company's recourse borrowings.
Provision for losses increased to $34.6 million in 2000, or 0.93% of
average interest earning assets, from $16.1 million or 0.35% during 1999. The
provision for losses increased as a result of an overall increase in credit risk
retained from securities issued by the Company (principally for securities
issued in the latter portion of 1999), and a charge of $13.3 million in the
fourth quarter of 2000 due to the under-performance of the Company's securitized
manufactured housing loan portfolio. The loss severity on manufactured housing
loans increase dramatically since the end of the third quarter of 2000 as a
result of the saturation in the market place with both new and used
(repossessed) manufactured housing units. In addition, overall default rates
increased on the manufactured housing loans.
Net loss on sales, impairment charges and write-downs decreased from an
aggregated net loss of $100.9 million in 1999, to $78.5 million in 2000. During
2000, the Company incurred losses related to the phasing-out of its commercial
production operations, including the sales of substantially all of the Company's
remaining commercial and multifamily loan positions. In addition, as discussed
in Note 13 to the accompanying financial statements, the Company was party to
various conditional bond repurchase agreements whereby the Company had the
option to purchase $167.8 million of tax-exempt bonds secured by multifamily
mortgage loans which expired in June 2000. The Company did not exercise this
option, as it did not have the ability to finance this purchase, and the
counter-party to the agreement retained $30.3 million in cash collateral as
settlement as provided for in the related agreements. The Company recorded a
charge against earnings of $30.3 million in 2000 as a result.
Also during 2000, the Company recorded impairment charges and loss on
sales of securities aggregating $8.5 million, relating to the write-down of
basis and then the sale of $33.9 million of securities. Such securities were
sold in order for the Company to pay-down its recourse debt outstanding. As a
result of the sale of securities, the Company either sold or terminated related
derivative hedge positions at an aggregate net loss of $7.3 million. During
1999, the Company had gains of $4.2 million related to various
derivative-trading positions opened and closed during 1999. The Company had no
such gains in 2000.
Net administrative fees and expenses to DHI decreased $16.5 million, or
98%, to $0.4 million for the year ended December 31, 2000 as compared to the
same period in 1999. These decreases are principally a combined result of the
sale of the Company's model home purchase/leaseback and manufactured housing
loan production operations during 1999. All general and administrative expenses
of these businesses were incurred by DHI.
The following table summarizes the average balances of interest-earning
assets and their average effective yields, along with the average
interest-bearing liabilities and the related average effective interest rates,
for each of the periods presented.
Average Balances and Effective Interest Rates
(amounts in thousands) Year ended December 31,
- ------------------------------------------- --------------------------------------------------------------------------------
2001 2000 1999
Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate
- ------------------------------------------- -------------- ----------- -------------- ----------- -------------- -----------
Interest-earning assets (1):
Collateral for collateralized bonds (2) $2,826,289 7.61% $3,460,973 7.84% $3,828,007 7.43%
(3)
Securities 8,830 9.60% 55,425 6.49% 226,908 6.27
Other investments 37,185 14.69% 42,188 13.03% 202,111 8.50
Loans 4,068 12.56% 134,672 7.99% 329,507 7.97
Cash Investments 17,560 5.52% - - - -
-------------- ----------- -------------- ----------- -------------- -----------
Total interest-earning assts $2,893,932 7.70% $3,693,258 7.89% $4,586,533 7.46%
============== =========== ============== =========== ============== ===========
Interest-bearing liabilities:
Non-recourse debt (3) $2,568,716 6.41% $3,132,550 7.34% $3,363,095 6.18%
Recourse debt secured by collateralized 17,016 6.28% 65,651 7.13% 271,919 5.71%
bonds retained
-------------- ----------- -------------- ----------- -------------- -----------
2,585,732 6.41% 3,198,201 7.33% 3,635,014 6.14%
Other recourse debt - secured (4) 71,174 8.26% 119,939 5.61% 548,261 6.11%
Other recourse debt - unsecured - - 101,242 8.54% 121,743 8.78%
-------------- ----------- -------------- ----------- -------------- -----------
Total interest-bearing liabilities $2,656,906 6.46% $3,419,382 7.35% $4,305,018 6.21%
============== =========== ============== =========== ============== ===========
Net interest spread on all investments (3) 1.24% 0.54% 1.25%
=========== =========== ===========
Net yield on average interest-earning 1.77% 1.08% 1.63%
assets (3)
=========== =========== ===========
- ------------------------------------------- -------------- ----------- -------------- ----------- -------------- -----------
(1) Average balances exclude adjustments made in accordance with Statement
of Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," to record available for sale securities at fair
value. (2) Average balances exclude funds held by trustees of $507, $862, and
$1,844 for the years ended December 31, 2001, 2000, and 1999, respectively. (3)
Effective rates are calculated excluding non-interest related collateralized
bond expenses and provision for credit losses. (4) The July 2002 Senior Notes
are considered secured for all of 2001 for purposes of this table.
2001 compared to 2000
This increase was primarily due to the reduction of short-term interest
rates during 2001. A substantial portion of the Company's interest-bearing
liabilities reprice monthly, and are indexed to one-month LIBOR, which on
average decreased to 3.88% for 2001, versus 6.41% for 2000. This decrease in
one-month LIBOR accounts for a substantial portion of the overall decrease in
the cost of interest-bearing liabilities. The overall yield on interest-earnings
assets, decreased to 7.70% for the year ended December 31, 2001 from 7.89% for
the same period in 2000, following the falling-rate environment, yet lagging
relative to the Company's liabilities.
The net interest spread on collateral for collateralized bonds
increased 69 basis points, from 51 basis points for the year ended December 31,
2000 to 120 basis points for the same period in 2001 (each basis point is
0.01%). This increase was largely due to the effect of the decrease in
short-term rates during the year. The net interest spread on securities
increased to a positive 320 basis points for the year ended December 31, 2001,
from a negative 206 basis points for the year ended December 31, 2000. This
increase was primarily the result of decreased borrowing costs on securities due
to both the decrease in the average one-month LIBOR during the twelve months
ended December 30, 2001 and the repayment of all outstanding borrowings during
2001. Borrowings associated with loans were paid off during the fourth quarter
of 2000 while the loans were retained and earned an average of 1256 basis points
during 2001. In addition, cash investments during the year earned an average of
552 basis points.
2000 compared to 1999
The net interest spread for the year ended December 31, 2000 decreased
to 0.54%, from 1.25% for the year ended December 31, 1999. This decrease was
primarily due to the increased cost of interest-bearing liabilities as the
result of overall increases in short-term rates between the years. A substantial
portion of the Company's interest-bearing liabilities reprice monthly, and are
indexed to one-month LIBOR, which on average increased to 6.41% for 2000, versus
5.25% for 1999. This increase in one-month LIBOR accounts for a substantial
portion of the overall increase in the cost of interest-bearing liabilities. The
Company also experienced overall increases in borrowing costs on its recourse
debt as a result of extension fees, covenant violations and other related issues
during 2000. The overall yield on interest-earnings assets, increased to 7.89%
for the year ended December 31, 2000 from 7.46% for the same period in 1999,
benefited from the rising-rate environment, but lagging relative to the
Company's liabilities.
Individually, the net interest spread on collateral for collateralized
bonds decreased 78 basis points, from 129 basis points for the year ended
December 31, 1999 to 51 basis points for the same period in 2000. This decrease
was largely due to the effect of the increase in short-term rates during the
year. The net interest spread on securities decreased to a negative 206 basis
points for the year ended December 31, 2000, from a negative 24 basis points for
the year ended December 31, 1999. This decrease was primarily the result of
increased borrowing costs on securities due to both the increase in the average
one-month LIBOR during the nine months ended September 30, 2000 as well as an
increase in the interest spread on certain credit facilities during the past
twelve months. The net interest spread on other investments increased 427 basis
points, from 201 basis points for the year ended December 31, 1999, to 628 basis
points for the same period in 2000, primarily due to the sale or pay-down of
lower yielding investments, leaving principally the higher yielding delinquent
property tax receivables. The net interest spread on loans held for sale
decreased 83 basis points for the year ended December 31, 1999 from 247 basis
points to 164 basis points for the year ended December 31, 2000, primarily as a
result of increased borrowing costs due to (a) the increase in the average
one-month LIBOR during 2000, (b) increases in the interest spread on certain
credit facilities, (c) higher fees as a result of violation of certain covenants
under certain of these facilities in 2000, and (d) fees for extensions of these
facilities to provide additional time for the Company to sell the related
collateral, principally loans held for sale and funding notes and securities.
The following tables summarize the amount of change in interest income
and interest expense due to changes in interest rates versus changes in volume:
- --------------------------------------------------------------------------------------------------------------------
2001 to 2000 2000 to 1999
- --------------------------------------------------------------------------------------------------------------------
Rate Volume Total Rate Volume Total
- --------------------------------------------------------------------------------------------------------------------
Collateral for collateralized bonds $(7,949) $(48,496) $(56,445) $15,228 $(28,235) $(13,007)
Securities 1,199 (3,946) (2,747) 474 (11,107) (10,633)
Other investments (633) 1,461 828 6,239 (17,923) (11,684)
Loans 6,096 (16,132) (10,036) 65 (15,575) (15,510)
- --------------------------------------------------------------------------------------------------------------------
Total interest income (1,287) (67,113) (68,400) 22,006 (72,840) (50,834)
- --------------------------------------------------------------------------------------------------------------------
Non-recourse debt (25,183) (39,970) (65,153) 37,000 (14,958) 22,042
Recourse debt - collateralized bonds (499) (3,112) (3,611) 3,130 (13,986) (10,856)
retained
- --------------------------------------------------------------------------------------------------------------------
Total collateralized bonds (25,682) (43,082) (68,764) 40,130 (28,944) 11,186
Other recourse debt secured (621) (10,358) (10,979) 4,563 (29,851) (25,288)
Other recourse debt - unsecured - - - (287) (1,758) (2,045)
- --------------------------------------------------------------------------------------------------------------------
Total interest expense (26,303) (53,440) (79,743) 44,406 (60,553) (16,147)
- --------------------------------------------------------------------------------------------------------------------
Net margin on portfolio $ 25,016 $(13,673) $ 11,343 $(22,400) $(12,287) $(34,687)
- --------------------------------------------------------------------------------------------------------------------
Note: The change in interest income and interest expense due to changes in both
volume and rate, which cannot be segregated, has been allocated
proportionately to the change due to volume and the change due to rate.
This table excludes non-interest related collateralized bond expense,
other interest expense and provision for credit losses.
Interest Income and Interest-Earning Assets
Approximately $1.8 billion of the investment portfolio as of December
31, 2001, or 72%, is comprised of loans or securities that pay a fixed-rate of
interest. Approximately $691 million, or 28%, is comprised of loans or
securities that have coupon rates which adjust over time (subject to certain
periodic and lifetime limitations) in conjunction with changes in short-term
interest rates. Approximately 67% of the ARM loans underlying the ARM securities
and collateral for collateralized bonds are indexed to and reset based upon the
level of six-month LIBOR; approximately 21% are indexed to and reset based upon
the level of the one-year Constant Maturity Treasury (CMT) index. The following
table presents a breakdown, by principal balance, of the Company's collateral
for collateralized bonds and ARM and fixed mortgage securities by type of
underlying loan as of December 31, 2001, December 31, 2000 and December 31,
1999. The percentage of fixed-rate loans to all loans increased from 62% at
December 31, 2000, to 72% at December 31, 2001, as most of the prepayments in
the Company's investment portfolio have occurred in the single-family ARM
portion. The table below excludes various investments in the Company's
portfolio, including securities such as derivative and residual securities and
other securities, and non-securitized investments including other investments
and loans. Most of these excluded investments would be considered fixed-rate,
and amounted to approximately $75.2 million at December 31, 2001.
Investment Portfolio Composition (1)
($ in millions)
- ------------------ ------------------ -------------------- --------------------- --------------- ---------------
LIBOR Based ARM CMT Based Other Indices Based Fixed-Rate
December 31, Loans ARM Loans ARM Loans Loans Total
- ------------------ ------------------ -------------------- --------------------- --------------- ---------------
1999 $1,048.5 $ $430.8 $ $121.1 $2,061.5 $3,661.9
2000 758.6 309.9 97.4 1,926.3 3,092.2
2001 472.4 144.6 73.6 1,765.8 2,456.4
- ------------------ ------------------ -------------------- --------------------- --------------- ---------------
(1) Includes only the principal amount of collateral for collateralized
bonds, ARM securities and fixed securities.
The average asset yield is reduced for the amortization of premiums,
net of discounts on the investment portfolio. As indicated in the table below,
premiums on the collateral for collateralized bonds, ARM securities and
fixed-rate securities at December 31, 2001 were $22.4 million, or approximately
0.91% of the aggregate balance of the related investments. Approximately $26.8
million of this premium basis relates to multifamily and commercial mortgage
loans, with a principal balance of $803.3 million at December 31, 2001, and have
prepayment lockouts or yield maintenance provisions generally at least through
2007. Amortization expense as a percentage of principal pay-downs decreased to
1.37% for the year ended December 31, 2001 from 1.55% in 2000 as the Company
experienced lower prepayment activity during 2001 on its securitized
single-family loan portfolio which it owns above par, and higher prepayment
activity for manufactured housing loans (generally as a result of increased
defaults) owned at a discount. The principal repayment rate (indicated in the
table below as "CPR Annualized Rate") was 24% for the year ended December 31,
2001. CPR or "constant prepayment rate" is a measure of the annual prepayment
rate on a pool of loans.
Net Premium Basis and Amortization on Investments
($ in millions)
- -----------------------------------------------------------------------------------------------------
Amortization
Net CPR Annualized Expense as a %
Remaining Amortization Rate Principal of Principal
Premium Expense Paydowns Paydowns
- -----------------------------------------------------------------------------------------------------
1999 $ 38.3 $ 16.3 20% $1,145.8 1.42%
2000 30.1 8.1 20% 523.0 1.55%
2001 22.4 8.2 24% 600.8 1.37%
- -----------------------------------------------------------------------------------------------------
Credit Exposures
The Company invests in collateralized bonds or pass-through
securitization structures. Generally these securitization structures use
over-collateralization, subordination, third-party guarantees, reserve funds,
bond insurance, mortgage pool insurance or any combination of the foregoing as a
form of credit enhancement. The Company generally has retained a limited portion
of the direct credit risk in these securities. In most instances, the Company
retained the "first-loss" credit risk on pools of loans that it has securitized.
The following table summarizes the aggregate principal amount of
collateral for collateralized bonds and ARM and fixed-rate mortgage pass-through
securities outstanding; the direct credit exposure retained by the Company
(represented by the amount of over-collateralization pledged and subordinated
securities owned by the Company), net of the credit reserves and discounts
maintained by the Company for such exposure; and the actual credit losses
incurred for each year. For 2001, the table includes any subordinated security
retained by the Company, whereas in prior years the table included only
subordinated securities rated below "BBB" by one of the nationally recognized
rating agencies.
The table excludes other forms of credit enhancement from which the
Company benefits, and based upon the performance of the underlying loans, may
provide additional protection against losses as discussed above in Investment
Portfolio Risks. This table also excludes any risks related to representations
and warranties made on single-family loans funded by the Company and securitized
in mortgage pass-through securities generally funded prior to 1995. This table
also excludes any credit exposure on loans and other investments.
Credit Reserves and Actual Credit Losses
($ in millions)
- ---------------------------------------------------------------------------------------------------------
Credit Exposure, Actual Credit Exposure, Net of
Outstanding Loan Net of Credit Credit Credit Reserves to
Principal Balance Reserves Losses Outstanding Loan Balance
- ---------------------------------------------------------------------------------------------------------
1999 $ 3,770.3 $ 226.6 $ 19.7 6.01%
2000 3,245.3 186.6 26.6 5.75%
2001 2,588.4 153.5 32.6 5.93%
- ---------------------------------------------------------------------------------------------------------
The following table summarizes single family mortgage loan,
manufactured housing loan and commercial mortgage loan delinquencies as a
percentage of the outstanding collateral balance for those securities in which
Dynex has retained a portion of the direct credit risk included in the table
above. The delinquencies as a percentage of the outstanding collateral decreased
to 1.78% at December 31, 2001, from 1.96% at December 31, 2000, primarily from
decreasing delinquencies in the Company's single-family loan portfolio. The
Company monitors and evaluates its exposure to credit losses and has established
reserves based upon anticipated losses, general economic conditions and trends
in the investment portfolio. As of December 31, 2001, management believes the
level of credit reserves is sufficient to cover any losses that may occur as a
result of current delinquencies presented in the table below.
Delinquency Statistics
- -----------------------------------------------------------------------------------------------------
60 to 89 days 90 days and over
December 31, delinquent delinquent (2) Total
- -----------------------------------------------------------------------------------------------------
1999 (1) 0.27% 1.37% 1.64%
2000 0.37% 1.59% 1.96%
2001 0.28% 1.50% 1.78%
- -----------------------------------------------------------------------------------------------------
(1) Excludes funding notes and securities.
(2)Includes foreclosures, repossessions and REO.
Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("FAS") No. 133, "Accounting
for Der