10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on August 14, 2000
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarter ended June 30, 2000
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4551 Cox Road, Suite 300, Glen Allen, Virginia 23060
(Address of principal executive offices) (Zip Code)
(804) 217-5800
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days: |X| Yes |_| No
On July 31, 2000, the registrant had 11,446,206 shares of common stock of
$.01 value outstanding, which is the registrant's only class of common stock.
DYNEX CAPITAL, INC.
FORM 10-Q
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at June 30, 2000 and
December 31,
1999.............................................................3
Consolidated Statements of Operations for the three and six months
ended June 30, 2000 and
1999.............................................................4
Consolidated Statement of Shareholders' Equity for
the six months ended June 30,
2000.............................................................5
Consolidated Statements of Cash Flows for
the six months ended June 30, 2000 and
1999.............................................................6
Notes to Unaudited Consolidated Financial
Statements.......................................................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations..................................................18
Item 3. Quantitative and Qualitative Disclosures about Market
Risk........................................................32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...........................................35
Item 2. Changes in Securities and Use of Proceeds...................36
Item 3. Defaults Upon Senior Securities.............................36
Item 4. Submission of Matters to a Vote of Security Holders.........36
Item 5. Other Information...........................................36
Item 6. Exhibits and Reports on Form 8-K............................36
SIGNATURES...........................................................37
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands except share data)
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the six months ended June 30, 2000
(amounts in thousands)
DYNEX CAPITAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
(amounts in thousands except share data)
NOTE 1--BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. The consolidated financial statements include the
accounts of Dynex Capital, Inc. and its qualified REIT subsidiaries (together,
"Dynex REIT"). While the Company was actively originating loans, the operations
for the loan production was primarily conducted through Dynex Holding, Inc.
("DHI"), a taxable affiliate of Dynex REIT. Currently the Company's property tax
receivable operations are conducted through DHI. Dynex REIT owns all the
outstanding non-voting preferred stock of DHI which represents a 99% economic
ownership interest in DHI. The common stock of DHI represents a 1% economic
ownership of DHI and is owned by certain officers of Dynex REIT. In light of
these factors, DHI is accounted for under a method similar to the equity method.
Under this method, Dynex REIT's original investment in DHI is recorded at cost
and adjusted by Dynex REIT's share of earnings or losses and decreased by
dividends received. References to the "Company" mean Dynex Capital, Inc., its
consolidated subsidiaries, and DHI and its consolidated subsidiaries. All
significant intercompany balances and transactions with Dynex REIT's
consolidated subsidiaries have been eliminated in consolidation of Dynex REIT.
In the opinion of management, all material adjustments, consisting of
normal recurring adjustments, considered necessary for a fair presentation of
the consolidated financial statements have been included. The Consolidated
Balance Sheet at June 30, 2000, the Consolidated Statements of Operations for
the three and six months ended June 30, 2000 and 1999, the Consolidated
Statement of Shareholders' Equity for the six months ended June 30, 2000, the
Consolidated Statements of Cash Flows for the six months ended June 30, 2000 and
1999 and related notes to consolidated financial statements are unaudited.
Operating results for the six months ended June 30, 2000 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2000. For further information, refer to the audited consolidated financial
statements and footnotes included in the Company's Form 10-K for the year ended
December 31, 1999.
Certain reclassifications have been made to the financial statements for
1999 to conform to presentation for 2000.
NOTE 2 -- SIGNIFICANT RISKS AND UNCERTANTIES
The Company's business strategy has historically relied on access to
financing sources such as warehouse lines of credit and repurchase agreements,
and the asset-backed securities market, to finance its activities. During 1999
and continuing into 2000, the Company's access to these sources of financing was
substantially impaired. As a result of this environment, in order to lower the
Company's capital requirements and reduce the need for short-term financing, the
Company sold both its manufactured housing lending operations and model home
purchase/leaseback business during 1999, and decided not to extend existing
forward commitments on commercial mortgage loans. In addition, in order to repay
outstanding recourse borrowing obligations, and in some cases in lieu of
securitization, the Company decided to sell as whole loans its commercial loans
held in inventory and certain other securities. The sale of the two production
operations has significantly lowered the Company's capital requirements and
reduced the need for short-term financing. On a long-term basis, competitive
pressures, including competing against larger companies which generally have
significantly lower costs of capital and access to the financing sources, and
the lack of access to capital in a cost effective manner, are expected to
continue to hamper the Company's ability to compete profitably in the
marketplace for at least the balance of the year.
The Company has recourse debt of approximately $244,606 as of June 30,
2000, of which $139,170 comes due in 2000 (see Note 5, Recourse Debt). Given the
Company's operating performance and prospects, the Companys access to
additional credit has been limited, and there is generally less willingness of
the Compan's current lenders to grant extensions. This lack of willingness to
extend credit has forced the Company to liquidate a number of its investments,
in some cases at terms less favorable than had the Company been able to find
alternative funding sources for these investments. As a result of the loan sales
completed in July 2000 of substantially all of the Company's remaining loans
held for sale, the Company repaid recourse debt in the approximate amount of
$98,026, and has further provided cash collateral in the amount of $24,722 to
support letters of credit issued on its behalf. The Company has no remaining
warehouse debt outstanding as a result of the loan sales.
In addition, the Company is currently in violation of certain covenants in
the 1994 Senior Notes, principally related to minimum senior unsecured ratings
and minimum net worth requirements, and the receipt of a going concern opinion
from its auditors. The Company has not received waivers for these covenant
violations. The remaining amount outstanding of approximately $1,760 is due
August 31, 2000. The Company expects to repay this amount on that date.
The senior unsecured notes due July 2002 (the "2002 Notes"), with an
outstanding balance of $97,250 at June 30, 2000, contain covenants which provide
for the acceleration of amounts outstanding should Dynex REIT default under
other credit agreements in amounts in excess of $10,000, and such amounts
outstanding under the other credit agreements are accelerated by the respective
lender. No such defaults or accelerations exist as of June 30, 2000.
The 2002 Notes also include covenants restricting dividend payments by
Dynex REIT. Generally, Dynex REIT may make dividend payments to the extent such
payments are necessary for the Company to maintain REIT status. The Company may
also declare and pay dividends on the Preferred Stock provided that for the four
previous fiscal quarters, Dynex REIT meets certain coverage requirements. The
Company has failed to meet these coverage requirements for the second quarter
2000, and expects to continue to fail these coverage requirements for the
balance of the year.
As of July 31, 2000, the Company also has $58,703 outstanding under
repurchase agreements substantially all with one counterparty, which amount is
collateralized with collateral having a current estimated market value of
$71,433.
NOTE 3--NET INCOME PER COMMON SHARE
Net income per common share is presented on both a basic net income per
common share and diluted net income per common share basis. Diluted net income
per common share assumes the conversion of the convertible preferred stock into
common stock, using the if-converted method, and stock appreciation rights
("SARs"), using the treasury stock method, but only if these items are dilutive.
As a result of the two-for-one split in May 1997 and the one-for-four reverse
split in July 1999 of Dynex REIT's common stock, the preferred stock is
convertible into one share of common stock for two shares of preferred stock
The following table reconciles the numerator and denominator for both the
basic and diluted net income per common share for the three and six months ended
June 30, 2000 and 1999.
NOTE 4 -- COLLATERAL FOR COLLATERALIZED BONDS AND SECURITIES
The following table summarizes Dynex REIT's amortized cost basis and fair
value of investments classified as available-for-sale, as of June 30, 2000 and
December 31, 1999, and the related average effective interest rates:
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 housing, fixed-rate loans
on multifamily and commercial properties, manufactured housing installment loans
secured by either a UCC filing or a motor vehicle title and fixed-rate
automobile installment contracts. All collateral for collateralized bonds is
pledged to secure repayment of the related collateralized bonds. All principal
and interest (less servicing-related fees) on the collateral is remitted to a
trustee and is available for payment on the collateralized bonds. Dynex REIT's
exposure to loss on collateral for collateralized bonds is generally limited to
the amount of collateral pledged to the collateralized bonds in excess of the
amount of the collateralized bonds issued, as the collateralized bonds issued by
the limited-purpose finance subsidiaries are non-recourse to Dynex REIT.
During the six months ended June 30, 2000, Dynex REIT securitized $71,209
of collateral, through the issuance of one series of collateralized bonds. The
collateral consisted of fixed-rate funding notes and securities secured by
fixed-rate automobile installment contracts acquired by AutoBond Acceptance
Corporation ("AutoBond"). The securitization was accounted for as a financing of
the underlying collateral pursuant to Statement of Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("FAS No. 125") as Dynex REIT retained call rights which were
substantially in excess of a clean-up call as defined by this accounting
standard. The funding notes were previously classified as Securities in the
Company's financial statements. As a result of the settlement of the AutoBond
litigation in June 2000 (see Note 9), the Company received 100% of the
outstanding stock of the entities which issued the funding notes and securities,
and which owns all of the underlying automobile installment contracts (the
"AutoBond Entities"). These entities are included in the consolidated financial
statements of the Company.
Securities. Funding Notes and Securities consisted of fixed-rate funding
notes and securities secured by fixed-rate automobile installment contracts
acquired by AutoBond. Adjustable-rate mortgage securities ("ARM") consist of
mortgage certificates secured by ARM loans. Fixed-rate mortgage securities
consist of mortgage certificates secured by mortgage loans that have a fixed
rate of interest for at least one year from the balance sheet date. 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.
Sale of Investments. Securities with an aggregate principal balance of
$34,448 were sold during the six months ended June 30, 2000 for an aggregate
loss of $13,892. The specific identification method is used to calculate the
basis of securities sold. Loss on sale of investments at June 30, 2000 also
includes realized losses of $1,586 related to the sale of $115,231 of commercial
loans during the six months ended June 30, 2000. Loss on sale of investments for
the six months ended June 30, 1999 includes (i) realized losses of $1,662
related to the sale of $22,062 of commercial loans (ii) realized gains of $1,512
on various derivative trading positions entered into during the six months ended
June 30, 1999 and (iii) realized gains of $210 related to the sale of $15,972 of
securities during the six months ended June 30, 1999.
During the six months ended June 30, 2000, Dynex REIT also recognized
losses of $67,214 related to (i) the permanent impairment in the carrying value
of certain securities, (ii) write-downs to market value of commercial and
multifamily loans held for sale and (iii) the accrual of losses related to
contingent obligations on its off-balance sheet tax-exempt bond positions. As a
result of the receipt of 100% of the outstanding stock of the AutoBond Entities
in connection with the settlement of the AutoBond litigation, Dynex REIT
recorded permanent impairment charges of $15,036 to record the underlying
automobile installment contracts at their current fair market value. The market
value for these automobile contracts was based on management's' estimate. The
market value for commercial and multifamily loans held for sale was determined
based on bids accepted by the Company. These loan sales were completed in July
2000. Losses on contingent obligations were accrued related to Dynex REIT's
performance obligations as "funding facility issuer" on approximately $244,603
of tax-exempt bonds. As discussed in Note 9, the Company was party to a
conditional bond repurchase agreements whereby the Company had the option to
purchase $167,800 of such bonds in June. The Company did not exercise this
option and the counterparty to the agreement retained $30,500 in cash collateral
as settlement as provided for in the related agreements. Dynex REIT expects to
settle the remaining $76,803 tax-exempt bond position during the third quarter.
Dynex REIT 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, including collateral for collateralized bonds, are
determined by calculating the present value of the projected cash flows of the
instruments, using discount rates, prepayment rates and credit loss assumptions
established by management. Discount rates used are those which management
believes would be used by willing buyers of these financial instruments at
prevailing market rates. The discount rate used in the determination of fair
value of the collateral for collateralized bonds was 16% and 18% at June 30,
2000 and December 31, 1999, respectively. Variations in market discount rates,
prepayment rates and credit loss assumptions may materially impact the resulting
fair values of the Company's financial instruments. Since the fair value of
Dynex REIT's financial instruments is based on estimates, actual gains and
losses recognized may differ from those estimates recorded in the consolidated
financial statements.
NOTE 5 -- RECOURSE DEBT
Dynex REIT utilizes repurchase agreements, notes payable and secured credit
facilities (together, "recourse debt") to finance certain of its investments.
The following table summarizes Dynex REIT's recourse debt outstanding at June
30, 2000 and December 31, 1999:
Secured Debt. At June 30, 2000 and December 31, 1999, recourse debt
consisted of $45,587 and $163,045, respectively, of recourse repurchase
agreements secured by investments, $98,220 and $263,190, respectively,
outstanding under secured credit facilities which are secured by loans held for
sale, securities and other investments, and $786 and $990, respectively, of
amounts outstanding under a capital lease. At June 30, 2000, substantially all
recourse debt in the form of repurchase agreements had maturities within sixty
days and bear interest at rates indexed to one-month London InterBank Offered
Rate ("LIBOR"). If the counterparty to the repurchase agreement fails to return
the collateral, the ultimate realization of the security by Dynex REIT may be
delayed or limited.
At June 30, 2000, Dynex REIT had two committed secured credit facilities
aggregating $198,700 to finance the funding of loans and securities, which
expire prior to December 31, 2000. The following table summarizes the material
terms of these facilities.
The $195,000 secured credit facility agented by Chase Bank of Texas (the
"Chase Facility") has been converted to a non-revolving facility, and in
addition to the $89,537 borrowed, includes $79,052 of letters of credit issued
to support Dynex REIT's obligations as funding facility issuer on its remaining
$76,803 tax-exempt bond position. In July 2000, the Company sold loans held for
sale which generated sufficient proceeds to fully repay the $89,537 outstanding
borrowings at June 30, 2000, and provide an additional $24,722 of cash escrow as
collateral for the $79,052 of letters of credit. Dynex REIT expects to fully
satisfy its obligations under the Chase Facility by its maturity date.
Unsecured Debt. Since 1994, Dynex REIT has issued three series of unsecured
notes payable totaling $150,000. These notes payable had an outstanding balance
at June 30, 2000 of $100,740. The Company has $97,250 outstanding of its July
2002 senior notes (the "2002 Notes") and $3,490 million outstanding on notes
issued in September 1994 (the "1994 Notes"). The 2002 Notes mature July 15,
2002. The 1994 Notes amortize monthly at approximately $1,700 per month, with
the final payment due on August 31, 2000. The Company is in violation of certain
covenants in the 1994 Notes including the minimum net worth requirement and the
covenant requiring an unqualified audit opinion. The Company has not received
waivers for these defaults; however, the holders of the 1994 Notes have not
accelerated the remaining amounts due.
The 2002 Notes also include covenants restricting dividend payments by
Dynex REIT. Generally, Dynex REIT may make dividend payments to the extent such
payments are necessary for the Company to maintain REIT status. The Company may
also declare and pay dividends on the Preferred Stock provided that for the four
previous fiscal quarters, Dynex REIT meets certain coverage requirements. The
Company has failed to meet these coverage requirements for the second quarter
2000, and expects to continue to fail these coverage requirements for the
balance of the year.
NOTE 6-- ADOPTION OF FINANCIAL ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS No. 133"). FAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. In June 1999, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133" ("FAS No. 137"). FAS
No. 137 amends FAS No. 133 to defer its effective date to all fiscal quarters of
all fiscal years beginning after June 15, 2000. In June 2000, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an amendment of FASB Statement No. 133" ("FAS No. 138"). FAS No.
138 amends FAS No. 133's accounting for certain derivative instruments and
certain hedging activities. FAS No. 138 is effective for all fiscal quarters of
all fiscal years beginning after June 15, 2000. The Company does not believe the
adoption of FAS No. 133 will have a material impact on its financial statements.
NOTE 7--DERIVATIVE FINANCIAL INSTRUMENTS
Dynex REIT may enter into interest rate swap agreements, interest rate cap
agreements, interest rate floor agreements, financial forwards, financial
futures and options on financial futures ("Interest Rate Agreements") to manage
its sensitivity to changes in interest rates. These Interest Rate Agreements are
intended to provide income and cash flow to offset potential reduced net
interest income and cash flow under certain interest rate environments. At trade
date, these instruments are designated as either hedge positions or trade
positions.
For Interest Rate Agreements designated as hedge instruments, Dynex REIT
evaluates the effectiveness of these hedges periodically against the financial
instrument being hedged under various interest rate scenarios. The revenues and
costs associated with interest rate swap agreements are recorded as adjustments
to interest income or expense on the asset or liability being hedged. For
interest rate cap agreements, the amortization of the cost of the agreements is
recorded as a reduction in the net interest income on the related investment.
The unamortized cost is included in the carrying amount of the related
investment. Revenues or cost associated with futures and option contracts are
recognized in income or expense in a manner consistent with the accounting for
the asset or liability being hedged. Amounts payable to or receivable from
counterparties are included in the financial statement line of the item being
hedged. Interest Rate Agreements that are hedge instruments and hedge an
available for sale investment which is carried at its fair value are also
carried at fair value, with unrealized gains and losses reported as accumulated
other comprehensive income.
As a part of Dynex REIT's interest rate risk management process, Dynex REIT
may be required periodically to terminate hedge instruments. Any realized gain
or loss resulting from the termination of a hedge is amortized into income or
expense of the corresponding hedged instrument over the remaining period of the
original hedge or hedged instrument as a yield adjustment.
If the underlying asset, liability or commitment is sold or matures, or the
criteria that was executed at the time the hedge instrument was entered into no
longer exists, the Interest Rate Agreement is no longer accounted for as a
hedge. Under these circumstances, the accumulated change in the market value of
the hedge is recognized in current income to the extent that the effects of
interest rate or price changes of the hedged item have not offset the hedge
results.
During the quarter ended June 30, 2000, Dynex REIT liquidated its interest
rate caps and interest rate swap agreements at losses in order to enhance its
liquidity position. As a result, Dynex REIT recognized losses of approximately
$3,394 during the quarter, while generating cash proceeds of $793 from the
sales. The notional balance of these positions was $2.3 billion. As a result of
the sales, Dynex REIT now no longer has any hedges related to the reset lag
inherent in its ARM assets (which generally reset every six months to one year)
relative to it's financing for such assets (which generally resets monthly), and
for the lifetime interest rate caps embedded in such ARM assets.
For Interest Rate Agreements entered into for trading purposes, realized
and unrealized changes in fair value of these instruments are recognized in the
consolidated statements of operations as trading activities in the period in
which the changes occur or when such trade instruments are settled. Amounts
payable to or receivable from counterparties, if any, are included on the
consolidated balance sheets in accrued expenses and other liabilities.
NOTE 8 -- COMMITMENTS
The Company makes various representations and warranties relating to the
sale or securitization of loans. To the extent the Company were to breach any of
these representations or warranties, and such breach could not be cured within
the allowable time period, the Company would be required to repurchase such
loans, and could incur losses. In the opinion of management, no material losses
are expected to result from any such representations and warranties.
The Company has made various representations and warranties relating to the
sale of various production operations. To the extent the Company were to breach
any of these representations or warranties, and such breach could not be cured
within the allowable time period, the Company would be required to cover any
losses and expenses up to certain limits. In the opinion of management, no
material losses are expected to result from any such representations and
warranties.
As of June 30, 2000, Dynex REIT is obligated under noncancelable operating
leases with expiration dates through 2005. Rent expense under those leases was
$248 and $133, respectively for the six months ended June 30, 2000 and 1999. The
future minimum lease payments under these noncancelable leases are as follows:
the remainder of 2000--$102; 2001--$208; 2002--$215; 2003--$221; 2004--$228 and
2005--$96.
Dynex REIT has facilitated the issuance of tax-exempt multifamily housing
bonds ("TEBs"), the proceeds of which are used to fund construction or moderate
rehabilitation loans on multifamily properties. These TEBs are sold to third
party investors. Dynex REIT has entered into various standby commitments and
similar agreements whereby Dynex REIT is required to pay principal and interest
to the TEB bondholders in the event there is a payment shortfall on the mortgage
loan underlying each such TEB, and in certain cases is required to purchase the
TEB if such TEB cannot be successfully re-marketed to third party investors.
Dynex REIT has facilitated the issuance of approximately $76,803 of TEBs by
providing pursuant to the Chase Facility letters of credit of $79,052 at June
30, 2000. Dynex REIT has an obligation to purchase the TEBs once the letters of
credit expire. Approximately $20,900 of letters of credit expire during the
second half of 2000, approximately $44,000 expire in 2001 and approximately
$14,152 expire in 2002. As of July 31, 2000, Dynex REIT has provided $24,722 in
cash, and loans and other investments with a book value of approximately $25,000
as collateral for such letters of credit. Dynex REIT's interest in the above
TEBs is currently held for sale. The facility under which such letters of credit
were issued matures on September 29, 2000. If Dynex REIT is not successful in
selling its interest in the TEBs by such date, the lenders have the right to
demand additional cash collateral at maturity to fully collateralize the $79,052
in letters of credit outstanding.
On June 15, 2000, the Company was released from its obligation to purchase
pursuant to various conditional bond repurchase obligations associated with
$167,800 of TEBs on multifamily properties that had undergone moderate
rehabilitation. The Company did not exercise this option and the counterparty to
the agreement retained $30,500 in cash collateral as settlement as provided for
in the related agreements. Such amount was charged to earnings during the second
quarter. The Company has no further obligation relative to these TEBs.
NOTE 9 -- LITIGATION
On February 8, 1999, AutoBond Acceptance Corporation ("AutoBond"), AutoBond
Master Funding Corporation V ("Funding"), and its three principal common
shareholders (collectively, the "Plaintiffs") commenced an action in the
District Court of Travis County, Texas (250th Judicial District) against the
Company and James Dolph (collectively, the "Defendants") alleging that the
Company breached the terms of the Credit Agreement, dated June 9, 1998, by and
among AutoBond, Funding and the Company. The terms of the Credit Agreement
provided for the purchase by the Company of funding notes issued by Funding, and
collateralized by automobile installment contracts ("Auto Contracts") acquired
by AutoBond. The Company suspended purchasing the funding notes in February 1999
on grounds that AutoBond and Funding had violated certain provisions of the
Credit Agreement.
On June 9, 2000, the Company settled the matter with AutoBond for a cash
payment of $20,000. In return for the payment, the Company received a complete
release of all claims against it by AutoBond, and ownership of the AutoBond
subsidiaries which own the underlying automobile installment contracts, and that
issued the securities that were purchased from AutoBond.
The Company is also subject to other lawsuits or claims which arise in the
ordinary course of its business, some of which seek damages in amounts which
could be material to the financial statements. Although no assurance can be
given with respect to the ultimate outcome of any such litigation or claim, the
Company believes the resolution of such lawsuits or claims will not have a
material effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
NOTE 10 -- RELATED PARTY TRANSACTIONS
Dynex REIT has a credit arrangement with DHI whereby DHI and any of DHI's
subsidiaries can borrow funds from Dynex REIT to finance its operations. Under
this arrangement, Dynex REIT can also borrow funds from DHI. The terms of the
agreement allow DHI and its subsidiaries to borrow up to $50 million from Dynex
REIT at a rate of Prime plus 1.0%. Dynex REIT can borrow up to $50 million from
DHI at a rate of one-month LIBOR plus 1.0%. This agreement has a one-year
maturity which is extended automatically unless notice is received from one of
the parties to the agreement within 30 days of the anticipated termination of
the agreement. As of June 30, 2000 and December 31, 1999, net borrowings due to
DHI under this agreement totaled $19,293 and $26,720, respectively. Net interest
expense under this agreement was $754 and $69 for the six months ended June 30,
2000 and 1999, respectively.
Dynex REIT had a funding agreement with Dynex Commercial, Inc. ("DCI"), an
operating subsidiary of DHI, whereby Dynex REIT paid DCI a fee. Dynex REIT paid
DCI $158 and $1,471, respectively under this agreement for the six months ended
June 30, 2000 and 1999.
Dynex REIT had note agreements with Dynex Residential, Inc. ("DRI"), an
operating subsidiary of DHI, whereby DRI and its subsidiaries could borrow up to
$287,000 from Dynex REIT on a secured basis to finance the acquisition of model
homes from single family home builders. The interest rate on the notes was
adjustable and was based on 30-day LIBOR plus 2.875%. During 1999, $4,577 of the
notes was assumed by SMFC Funding Corporation ("SMFC"), a subsidiary of DHI. The
remainder of the notes were paid off at the time of the sale of DRI on November
10, 1999. The outstanding balance of the notes as of June 30, 2000 and December
31, 1999 was $626 and $4,274, respectively. Interest income recorded by Dynex
REIT on the notes for the six months ended June 30, 2000 and 1999 was $140 and
$6,958, respectively.
Dynex REIT has entered into subservicing agreements with DCI, Dynex
Commercial Services, Inc. ("DCSI"), Dynex Financial, Inc. ("DFI" - previously a
subsidiary of DHI) and GLS Capital Services, Inc ("GLS") to service commercial,
single family, and consumer loans and property tax receivables. All of these
entities, with the exception of DFI, are subsidiaries of DHI. For servicing the
commercial loans, DCI or DSCI, as applicable, receives an annual servicing fee
of 0.02% of the aggregate unpaid principal balance of the loans. For servicing
the single family mortgage, consumer and manufactured housing loans, DFI
received annual fees ranging from sixty dollars ($60) to one hundred forty-four
dollars ($144) per loan and certain incentive fees. The subservicing agreement
with DFI was terminated due to the sale of DFI on December 20, 1999. A new
subservicing agreement was entered into with Bingham Financial Services
Corporation, the new parent of DFI. For servicing the property tax receivables,
GLS receives an annual servicing fee of 0.72% of the aggregate unpaid principal
balance of the property tax receivables. Servicing fees paid by Dynex REIT under
such agreements were $143 and $1,264 during the six months ended June 30, 2000
and 1999, respectively.
During 1999, the Company made a loan to Thomas H. Potts, president of the
Company, as evidenced by a promissory note in the aggregate principal amount of
$934,500 with interest accruing on the outstanding balance at the rate of Prime
plus one-half percent annum (the "Note"). Mr. Potts directly owns 399,502 shares
of common stock of the Company, all of which has been pledged as collateral to
secure the Note. As of June 30, 2000, the outstanding balance of the Note was
$925,000.
NOTE 11 -- INVESTMENT IN AND NET ADVANCES TO DYNEX HOLDING, INC.
Investment in and net advances to DHI accounted for under a method similar
to the equity method amounted to $3,873 and $4,814 at June 30, 2000 and December
31, 1999, respectively. The results of operations and financial position of DHI
are summarized below:
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Dynex Capital, Inc. (the "Company") is a financial services company which
invests in a portfolio of securities and investments backed principally by
single family mortgage loans, commercial mortgage loans and manufactured housing
installment loans. Such loans have been funded generally by the Company's loan
production operations or purchased in bulk in the market. Loans funded through
the Company's production operations have generally been pooled and pledged as
collateral using a collateralized bond security structure, which provides
long-term financing for the loans while limiting credit, interest rate and
liquidity risk.
FINANCIAL CONDITION
- - --------------------------------------------------------------- ----------------
June 30, December 31,
(amounts in thousands except per share data) 2000 1999
- - --------------------------------------------------------------- ----------------
Investments:
Collateral for collateralized bonds $ 3,409,281 $ 3,700,714
Securities 11,972 129,331
Other investments 38,367 48,927
Loans held for sale 127,559 232,384
Non-recourse debt - collateralized bonds 3,171,819 3,282,378
Recourse debt 244,606 537,098
Shareholders' equity 177,197 325,072
Book value per common share 3.82 16.74
- - --------------------------------------------------------------- ----------------
Collateral for collateralized bonds Collateral for collateralized bonds
consists primarily of securities backed by adjustable-rate and fixed-rate
mortgage loans secured by first liens on single family properties, fixed-rate
loans secured by first liens on multifamily and commercial properties,
manufactured housing installment loans secured by either a UCC filing or a motor
vehicle title, fixed-rate automobile installment contracts and property tax
receivables. As of June 30, 2000, the Company had 28 series of collateralized
bonds outstanding. The collateral for collateralized bonds decreased to $3.4
billion at June 30, 2000 compared to $3.7 billion at December 31, 1999. This
decrease of $0.3 billion is primarily the combined result of $255.7 million in
paydowns on collateral and a $78.8 million increase in the unrealized loss on
collateral for collateralized bonds during the six months ended June 30, 2000.
These decreases were partially offset by the securitization of $71.2 million of
fixed-rate funding notes secured by fixed-rate automobile installment contracts
during the second quarter of 2000.
Securities Securities consist primarily of fixed-rate "funding notes and
securities" secured by automobile installment contracts and adjustable-rate and
fixed-rate mortgage-backed securities. Securities also include derivative and
residual securities. Derivative securities are classes of collateralized bonds,
mortgage pass-through certificates or mortgage certificates that pay to the
holder substantially all interest (i.e., an interest-only security), or
substantially all principal (i.e., a principal-only security). Residual
interests represent the right to receive the excess of (i) the cash flow from
the collateral pledged to secure related mortgage-backed securities, together
with any reinvestment income thereon, over (ii) the amount required for
principal and interest payments on the mortgage-backed securities or repurchase
arrangements, together with any related administrative expenses. Securities
decreased to $12.0 million at June 30, 2000 compared to $129.3 million at
December 31, 1999. This decrease was primarily the result of the securitization
of $71.2 million of fixed-rate funding notes during the second quarter of 2000.
Securities also decreased due to $19.3 million of paydowns and $31.6 million of
sales during the six months ended June 30, 2000.
Other investments Other investments consists primarily of property tax
receivables and a note receivable received in connection with the sale of the
Company's single family mortgage operations in May 1996. Other investments
decreased from $48.9 million at December 31, 1999 to $38.4 million at June 30,
2000. This decrease is primarily the result of the receipt of the $9.5 million
annual principal payment on the note receivable from the 1996 sale of the single
family mortgage operations.
Loans held for sale Loans held for sale decreased from $232.4 million at
December 31, 1999 to $127.6 million at June 30, 2000. This decrease was
primarily due to the sale or writedown of certain commercial loans held for
sale. In addition, the Company sold the remaining $3.5 million of manufactured
housing loans during the first quarter of 2000. These decreases were partially
offset by $15.8 million of new loan fundings during the six months ended June
30, 2000 which were primarily draws on existing multifamily construction loans.
Non-recourse debt Collateralized bonds issued by Dynex REIT are recourse
only to the assets pledged as collateral, and are otherwise non-recourse to
Dynex REIT. Collateralized bonds decreased slightly from $3.3 billion at
December 31, 1999 to $3.2 billion at June 30, 2000. This decrease was primarily
a result of paydowns on all collateralized bonds of $255.5 million during the
six months ended June 30, 2000. This decrease was partially offset by Dynex REIT
adding $41.7 million of collateralized bonds during the six months ended June
30, 1999. In addition, Dynex REIT sold $112.4 million of previously retained
collateralized bonds during the six months ended June 30, 2000.
Recourse debt Recourse debt decreased to $244.6 million at June 30, 2000
from $537.1 million at December 31, 1999. This decrease was primarily due to the
sale of $112.4 million of retained collateralized bonds and $115.2 million of
loans, during the six months ended June 30, 2000, which had been financed with
$91.3 million of repurchase agreements and $98.0 million of notes payable,
respectively. In addition, $71.2 million of fixed-rate funding notes were
securitized as collateral for collateralized bonds during the second quarter of
2000. These funding notes were previously financed by $27.3 million of notes
payable. Also during the six months ended June 30, 2000, Dynex REIT paid off
approximately $30.3 million of notes payable as a result of $33.7 million of
paydowns on investments.
Shareholders' equity Shareholders' equity decreased to $177.2 million at
June 30, 2000 from $325.1 million at December 31, 1999. This decrease was a
combined result of a $68.5 million increase in the net unrealized loss on
investments available-for-sale from $48.5 million at December 31, 1999 to $117.0
million at June 30, 2000 and a net loss of $79.4 million during the six months
ended June 30, 2000.
RESULTS OF OPERATIONS
Three and Six Months Ended June 30, 2000 Compared to Three and Six Months
Ended June 30, 1999. The decrease in net income and net income per common share
during the three and six months ended June 30, 2000 as compared to the same
period in 1999 is primarily the result of a decrease in net interest margin, an
increase in the loss on sale of investments and an increase in impairment charge
/ writedowns. These decreases were partially offset by the reduction in net
administrative fees and expenses to Dynex Holding, Inc.
Net interest margin for the six months ended June 30, 2000 decreased to
$7.9 million, or 69% below the $25.8 million for the same period for 1999. Net
interest margin for the three months ended June 30, 2000 decreased to $1.9
million, or 87%, below the $14.6 million for the same period in 1999. These
decrease were primarily the result of the decline in average interest-earning
assets from $4.6 billion and $4.7 billion for the three and six months ended
June 30, 1999, respectively, to $3.9 billion and $4.0 billion for the three and
six months ended June 30, 2000. In addition, the average cost of funds increased
to 7.35% and 7.13% for the three and six months ended June 30, 2000,
respectively, from 5.85% and 6.01% for the same periods in 1999 due to an
increase in short-term interest rates, which have risen approximately 80 basis
points during the first half of 2000. In addition, provision for losses
increased to $10.8 million or 0.54% on an annualized basis of average
interest-earning assets during the six months ended June 30, 2000 compared to
$7.6 million and 0.32% during the six months ended June 30, 1999. Provision for
losses increased to $5.5 million or 0.57% on an annualized basis of average
interest-earnings assets during the three months ended June 30, 2000 compared to
$3.8 million or 0.33% during the same period in 1999. This increase in provision
for losses was a result of increasing the reserve for probable losses on various
loan pools pledged as collateral for collateralized bonds where the Company has
retained credit risk.
The net loss on sale of investments for the six months ended June 30, 2000
increased to a $17.7 million loss, as compared to a $0.1 million loss for the
same period in 1999. This increase is primarily the result of both realized
losses of $13.9 million related to the sale of $34.4 million of securities and
realized losses of $1.6 million related to the sale of $115.2 million of loans
during the first half of 2000. During the six months ended June 30, 1999, Dynex
REIT recognized losses of $1.7 million related to the sale of $22.1 million of
loans. This was partially offset by realized gains of $1.4 million in various
derivative trading positions closed during the six months ended June 30, 1999
and realized gains of $0.2 million related to the sale of $16.0 million of
securities during the six months ended June 30, 1999. The net (loss) gain of
investments for the three months ended June 30, 2000 decreased to a $4.3 million
loss, as compared to a $0.8 million gain for the same period in 1999. The
decrease for the three months ended June 30, 2000 is the combined result of
realized losses of $1.9 million relating to the sale of $93.7 million of loans
and realized losses of $3.4 million relating to the sale of various cap and swap
positions during the three months ended June 30, 2000. While during the same
period in 1999, Dynex REIT recognized gains of $1.0 million in various
derivative trading positions closed during the second quarter of 1999 offset
partially by $0.3 million of fees paid relating to the loans sold during the
first quarter of 1999.
Impairment charge / writedowns increased to $67.2 million for the three and
six months ended June 30, 2000, respectively, from $6.3 million for the three
and six months ended June 30, 1999, respectively. During the three and six
months ended June 30, 2000, Dynex REIT recognized losses of $67.2 million
related to (i) the permanent impairment in the carrying value of certain
securities, (ii) write-downs to market value of commercial and multifamily loans
held for sale and (iii) the accrual of losses related to contingent obligations
on its off-balance sheet tax-exempt bond positions. As a result of the receipt
of 100% of the outstanding stock of the AutoBond Entities in connection with the
settlement of the AutoBond litigation, Dynex REIT recorded permanent impairment
charges of $15.0 million to record the underlying automobile installment
contracts at their current fair market value. The market value for these
automobile contracts was based on management's' estimate. The market value for
commercial and multifamily loans held for sale was determined based on bids
accepted by the Company. These sales were completed in July 2000. Losses on
contingent obligations were accrued related to Dynex REIT's performance
obligations as "funding facility issuer" on approximately $244.6 million of
tax-exempt bonds. As discussed in Note 9, the Company was party to a conditional
bond repurchase agreements whereby the Company had the option to purchase $167.8
million of such bonds in June. The Company did not exercise this option and the
counterparty to the agreement retained $30.5 million in cash collateral as
settlement as provided for in the related agreements. Dynex REIT expects to
settle the remaining $76.8 million tax-exempt bond position during the third
quarter. Impairment charge / writedown for both the three and six months ended
June 30, 1999 is comprised of (i) realized losses of $2.3 million related to the
writedown of $30.6 million of commercial loans, (ii) writedowns of $1.4 million
for the permanent impairment of certain residual interest and (iii) realized
losses of $2.7 million primarily related to the write-off of hedging positions
on $64.4 million of commercial loan commitments.
Net administrative fees and expenses to DHI decreased $5.2 million, or 98%,
and $10.9 million, or 97% to $0.1 million and $0.4 million in the three and six
months ended June 30, 2000, respectively, as compared to the same periods 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 the fourth quarter of 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
The net interest spread decreased to 0.46% and 0.65% for the three and six
months ended June 30, 2000 from 1.39% and 1.22% for the same periods in 1999.
This decrease was primarily due to approximately an 80 basis point increase in
the average one-month LIBOR during the first half of 2000. This decrease in net
interest spread was partially offset by a reduction in premium amortization
expense, which decreased from $4.8 million and $10.7 million for the three and
six months ended June 30, 1999, respectively to $2.1 million and $4.1 million
for the same periods in 2000. The overall yield on interest-earning assets
increased to 7.81% and 7.78% for the three and six months ended June 30, 2000,
respectively from 7.24% for both the three and six months ended June 30, 1999.
The cost of interest-bearing liabilities increased to 7.35% and 7.13% for the
three and six months ended June 30, 2000, respectively, from 5.85% and 6.01% for
the three and six months ended June 30, 1999, respectively.
Individually, the net interest spread on collateral for collateralized
bonds decreased 66 basis points, from 128 basis points for the six months ended
June 30, 1999 to 62 basis points for the same period in 2000. This decrease was
primarily due to the increased borrowing cost during the first half of 2000
which was partially offset by lower premium amortization caused by decreased
prepayments during the six months ended June 30, 2000 compared to the same
period in 1999. The net interest spread on securities decreased 236 basis
points, from a negative 22 basis points for the six months ended June 30, 1999
to a negative 258 basis points for the six months ended June 30, 2000. 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 first half of
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 515 basis points, from 170 basis points for the six months ended June
30, 1999, to 685 basis points for the same period in 2000, primarily due to the
purchase of higher yielding property tax receivables during 1999. The net
interest spread on loans held for sale or securitization decreased 76 basis
points for the six months ended June 30, 1999 from 264 basis points to 188 basis
points for the six months ended June 30, 2000, primarily due to the increased
borrowing costs on loans due to the increase in the average one-month LIBOR
during the first half of 2000.
Interest Income and Interest-Earning Assets
Approximately $1.4 billion of the investment portfolio as of June 30, 2000
is comprised of loans or securities that have coupon rates which adjust over
time (subject to certain periodic and lifetime limitations) in conjunction with
changes in short-term interest rates. Approximately 64% of the ARM loans
underlying the ARM securities and collateral for collateralized bonds are
indexed to and reset based upon the level of six-month LIBOR; approximately 27%
are indexed to and reset based upon the level of the one-year Constant Maturity
Treasury (CMT) index. The following table presents a breakdown, by principal
balance, of the Company's collateral for collateralized bonds and ARM and fixed
mortgage securities by type of underlying loan. This table excludes other
derivative and residual securities, other securities, other investments and
loans held for sale or securitization.
Investment Portfolio Composition (1)
($ in millions)
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, fixed-rate mortgage
securities at June 30, 2000 were $34.1 million, or approximately 1.00% of the
aggregate balance of collateral for collateralized bonds, ARM securities and
fixed-rate securities. Of this $34.1 million, $32.6 million relates to the
premium on multifamily and commercial mortgage loans that have prepayment
lockouts or yield maintenance for at least seven years. Amortization expense as
a percentage of principal paydowns has increased from 1.42% for the three months
ended June 30, 1999 to 1.56% for the same period in 2000. The principal
prepayment rate for the Company (indicated in the table below as "CPR Annualized
Rate") was approximately 18% for the three months ended June 30, 2000. CPR or
"constant prepayment rate" is a measure of the annual prepayment rate on a pool
of loans. Excluded from this table are the Company's loans held for sale.
Premium Basis and Amortization
($ in millions)
Credit Exposures
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 on these
securities (represented by the amount of overcollateralization pledged and
subordinated securities owned by the Company and rated below BBB by one of the
nationally recognized rating agencies), net of the credit reserves maintained by
the Company for such exposure; and the actual credit losses incurred for each
quarter. Credit reserves maintained by the Company and included in the table
below included third-party reimbursement guarantees which totaled $29.5 million
at June 30, 2000. The table excludes any risks related to representations and
warranties made on loans funded by the Company and securitized in mortgage
pass-through securities generally funded prior to 1995. This table also excludes
any credit exposure on loans held for sale and other investments. The aggregate
outstanding principal balance of these excluded investments at June 30, 2000 was
$196.6 million. The increase in net credit exposure as a percentage of the
outstanding loan principal balance from 3.92% at June 30, 1999 to 4.49% at June
30, 2000 is related primarily to the credit exposure retained by the Company on
its manufactured housing securitization during
September 1999 offset partially by the sale of previously retained classes
from two of the Company's commercial loan securitization. The increase in net
credit exposure as a percentage of the outstanding loan principal balance from
4.25% at March 31, 2000 to 4.49% at June 30, 2000 is related primarily to the
credit exposure retained by the Company on its funding note securitization
during May.
Credit Reserves and Actual Credit Losses
($ in millions)
The following table summarizes single family mortgage loan, manufactured
housing loan, funding notes and commercial mortgage loan delinquencies as a
percentage of the outstanding collateral balance for those securities in which
Dynex REIT has retained a portion of the direct credit risk. The delinquencies
as a percentage of the outstanding collateral balance has decreased to 1.86% at
June 30, 2000 from 2.12% at June 30, 1999. 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 June 30, 2000, management believes the credit reserves are
sufficient to cover anticipated losses which may occur as a result of current
delinquencies presented in the table below.
Delinquency Statistics (1)
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS No. 133"). FAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. In June 1999, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No, 133" ("FAS No. 137"). FAS
No. 137 amends FAS No. 133 to defer its effective date to all fiscal quarters of
all fiscal years beginning after June 15, 2000. In June 2000, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an amendment of FASB Statement No. 133" ("FAS No. 138"). FAS No.
138 amends FAS No. 133's accounting for certain derivative instruments and
certain hedging activities. FAS No. 138 is effective for all fiscal quarters of
all fiscal years beginning after June 15, 2000. The Company believes that the
adoption of FAS No. 133 will not have a material impact on its financial
statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations from a variety of
sources. These sources have included cash flow generated from the investment
portfolio, including net interest income and principal payments and prepayments,
common stock offerings through the dividend reinvestment plan, short-term
warehouse lines of credit with commercial and investment banks, repurchase
agreements and the capital markets via the asset-backed securities market (which
provides long-term non-recourse funding of the investment portfolio via the
issuance of collateralized bonds). Historically, cash flow generated from the
investment portfolio has satisfied its working capital needs, and the Company
has had sufficient access to capital to fund its loan production operations, on
both a short-term (prior to securitization) and long-term (after securitization)
basis. However, market conditions since October 1998 have substantially reduced
the Company's access to capital. The Company is currently unable to access
additional short-term warehouse lines of credit to replace maturing lines, and
is unable to efficiently access the asset-backed securities market to meet its
long-term funding needs. Largely as a result of its inability to access
additional capital, the Company sold its manufactured housing and model home
purchase/leaseback operations in 1999, and ceased issuing new commitments in its
commercial lending operations. Over the first six months of 2000, the Company
has been focused on substantially reducing both its short-term debt and capital
requirements. The Company's current focus is the release of its obligations
under letters of credit and the repayment of its recourse debt, which includes
substantially all of the short-term warehouse lines of credit.
A majority of the Company's assets are pledged to secure indebtedness
incurred by Dynex REIT. Accordingly, those assets would not be available for
distribution to any general creditors or the stockholders of Dynex REIT in the
event of the liquidation, except to the extent that the liquidation proceeds of
such assets exceeds the amount of the indebtedness they secure.
Non-recourse Debt
Dynex REIT, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds to fund the majority of
its investment portfolio. The obligations under the collateralized bonds are
payable solely from the collateral for collateralized bonds and are otherwise
non-recourse to Dynex REIT. Collateral for collateralized bonds are not subject
to margin calls. The maturity of each class of collateralized bonds is directly
affected by the rate of principal prepayments on the related collateral. Each
series is also subject to redemption according to specific terms of the
respective indentures, generally when the remaining balance of the bonds equals
35% or less of the original principal balance of the bonds. At June 30, 2000,
Dynex REIT had $3.2 billion of collateralized bonds outstanding as compared to
$3.3 billion at December 31, 1999.
Recourse Debt
Secured. At June 30, 2000, Dynex REIT had two non-revolving credit
facilities aggregating $199 million, comprised of (i) a $195 million
non-revolving credit line agented by Chase Bank of Texas ("the Chase Facility"),
expiring on July 31, 2000) (which expiration date has been subsequently extended
to September 29, 2000) from a consortium of commercial banks primarily for the
warehousing of multifamily construction and permanent loans (including providing
the letters of credit for tax-exempt bonds), and (ii) a $4 million non-revolving
credit line, expiring on December 15, 2000, from Residential Funding Corporation
for the warehousing of model homes not included in the sale of the related
business. Subsequent to June 30, 2000, Dynex REIT sold certain commercial and
multifamily loans which repaid all borrowings under the Chase Facility, and
provided $24.7 million of cash collateral (in addition to the $76.8 million in
TEBs and other collateral) for the $79.1 million of letters of credit issued
pursuant to this facility that support Dynex REIT's remaining $76.8 million TEB
position. Dynex REIT is working with two prospective buyers for its remaining
tax-exempt bond position in order to release the Chase letters of credit by the
respective facility maturity date.
The following table summarizes the committed credit facilities at June 30,
2000 expiring in 2000. At June 30, 2000, Dynex REIT had $90.1 million
outstanding under its committed credit facilities expiring in 2000.
Committed Credit Facilities
At June 30, 2000
($ in millions)
Dynex REIT also uses repurchase agreements to finance a portion of its
investments, which generally have maturities of thirty-days or less. Repurchase
agreements allow Dynex REIT to sell investments for cash together with a
simultaneous agreement to repurchase the same investments on a specified date
for a price which is equal to the original sales price plus an interest
component. At June 30, 2000, outstanding obligations under all recourse
repurchase agreements totaled $46.0 million compared to $163.0 million at
December 31, 1999. Dynex REIT has provided collateral worth an estimated fair
market value of $55.8 million to support the amount of the repurchase agreement
outstanding. All of the recourse repurchase agreements are on an "overnight" or
one-day basis. Dynex REIT also has $15.5 million of non-recourse repurchase
agreements which are due September 29, 2000. The following table summarizes the
outstanding balances of recourse repurchase agreements by credit rating of the
related assets pledged as collateral to support such repurchase agreements as of
each respective quarter end. The table excludes repurchase agreements used to
finance loans held for sale.
Recourse Repurchase Agreements by Rating of Investments Financed (1)
($ in millions)
Increases in short-term interest rates, long-term interest rates or market
risk could negatively impact the valuation of securities and may limit Dynex
REIT's borrowing ability or cause lenders to initiate margin calls for
securities financed using repurchase agreements. Additionally, certain
investments are classes of securities rated AA, A or BBB that are subordinated
to other classes from the same series of securities. Such subordinated classes
may have less liquidity than securities that are not subordinated and the value
of such classes is more dependent on the credit rating of the related insurer or
the credit performance of the underlying loans or receivables. In instances of a
downgrade of an insurer or the deterioration of the credit quality of the
underlying collateral, Dynex REIT may be required to sell certain investments in
order to maintain liquidity. If required, these sales could be made at prices
lower than the carrying value of the assets, which could result in losses.
Unsecured. Since 1994, Dynex REIT has issued three series of unsecured
notes payable totaling $150 million. These notes payable had an outstanding
balance at June 30, 2000 of $100.7 million. The Company has $97.3 million
outstanding of its July 2002 senior notes (the "2002 Notes") and $3.5 million
outstanding on notes issued in September 1994 (the "1994 Notes"). The 2002 Notes
mature July 15, 2002. The 1994 Notes amortize monthly at approximately $1.7
million per month, with the final payment of $1.8 million due on August 31,
2000. The Company expects to repay this amount on that date. As of June 30,
2000, the Company was in violation of certain covenants in the 1994 Notes
including the minimum net worth requirement and the covenant requiring an
unqualified audit opinion. These violations resulted in an event of default;
however, the holders of the 1994 Notes have not accelerated the remaining
amounts due.
The 2002 Notes also contain covenants which provide for the acceleration of
amounts outstanding under the 2002 Notes should Dynex REIT default under other
credit agreements in excess of $10 million, and such amounts outstanding under
the other credit agreements are accelerated by the respective lender. Dynex is
not in breach of any covenants under the 2002 Notes.
Total recourse debt decreased to $244.6 million at June 30, 2000 from
$537.1 million at December 31, 1999. This decrease was primarily due to the sale
of $112.4 million of retained collateralized bonds and $115.2 million of loans,
during the six months ended June 30, 2000, which had been financed with $91.3
million of repurchase agreements and $98.0 million of notes payable,
respectively. In addition, $71.2 million of fixed-rate funding notes were
securitized as collateral for collateralized bonds during the second quarter of
2000. These funding notes were previously financed by $27.3 million of notes
payable. Also during the six month ended June 30, 2000, Dynex REIT paid off
approximately $30.3 million of notes payable as a result of $33.7 million of
paydowns on investments.
Total Recourse Debt
($ in millions)
- - --------------------------------------------------------------------------------
Total Recourse Debt to
Total Recourse Debt Equity
- - --------------------------------------------------------------------------------
1998, Quarter 3 $ 1,614.5 321%
1998, Quarter 4 1,032.7 228%
1999, Quarter 1 781.4 173%
1999, Quarter 2 880.0 201%
1999, Quarter 3 1,215.0 285%
1999, Quarter 4 537.1 165%
2000, Quarter 1 420.7 137%
2000, Quarter 2 244.6 138%
- - --------------------------------------------------------------------------------
Table 1
Net Balance Sheet (1)
($ in thousands)
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-Q made by the Company, that are
not historical fact constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such forward-looking statements may
involve factors that could cause the actual results of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. The Company cautions the public not to place
undue reliance on forward-looking statements, which may be based on assumptions
and anticipated events that do not materialize. The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.
Factors that may cause actual results to differ from historical results or
from any results expressed or implied by forward-looking statements include the
following:
Economic Conditions. The Company is affected by general economic
conditions. The risk of defaults and credit losses could increase during an
economic slowdown or recession. This could have an adverse effect on the
Company's financial performance and the performance on the Company's securitized
loan pools.
Capital Resources. The Company relies on various credit facilities and
repurchase agreements with certain commercial and investment banking firms to
help meet the Company's short-term funding needs. The Company's access to
alternative or additional sources of financing has been significantly reduced.
Capital Markets. The Company relies on the capital markets for the sale
upon securitization of its collateralized bonds or other types of securities, to
the extent that it has loan production activity. While the Company has
historically been able to sell such collateralized bonds and securities into the
capital markets, the Company's access to capital markets in the future has been
substantially reduced.
Interest Rate Fluctuations. The Company's income depends on its ability to
earn greater interest on its investments than the interest cost to finance these
investments. Interest rates in the markets served by the Company generally rise
or fall with interest rates as a whole. A majority of the loans currently
pledged as collateral for collateralized bonds by the Company are fixed-rate.
The Company currently finances these fixed-rate assets through non-recourse
debt, approximately $215 million of which is variable rate. In addition,
significant amount of the investments held by the Company are variable rate
collateral for collateralized bonds and adjustable-rate investments. These
investments are financed through non-recourse long-term collateralized bonds and
recourse short-term repurchase agreements. The net interest spread for these
investments could decrease during a period of rapidly rising short-term interest
rates, since the investments generally have periodic interest rate caps and the
related borrowing have no such interest rate caps.
Defaults. Defaults by borrowers on loans retained by the Company may have
an adverse impact on the Company's financial performance, if actual credit
losses differ materially from estimates made by the Company at the time of
securitization. The allowance for losses is calculated on the basis of
historical experience and management's best estimates. Actual default rates or
loss severities may differ from the Company's estimate as a result of economic
conditions. Actual defaults on ARM loans may increase during a rising interest
rate environment. The Company believes that its reserves are adequate for such
risks.
Prepayments. Prepayments by borrowers on loans securitized by the Company
may have an adverse impact on the Company's financial performance. Prepayments
are expected to increase during a declining interest rate or flat yield curve
environment. The Company's exposure to rapid prepayments is primarily (i) the
faster amortization of premium on the investments and, to the extent applicable,
amortization of bond discount, and (ii) the replacement of investments in its
portfolio with lower yield securities.
Competition. The financial services industry is a highly competitive
market. Increased competition in the market could adversely affect the Company.
Regulatory Changes. The Company's business is subject to federal and state
regulation which, among other things require the Company to maintain various
licenses and qualifications and require specific disclosures to borrowers.
Changes in existing laws and regulations or in the interpretation thereof, or
the introduction of new laws and regulations, could adversely affect the
performance of the Company's securitized loan pools.
Significant Risks and Uncertainties. See Note 2 to the Company's financial
statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument due to fluctuations in
interest and foreign exchange rates and in equity and commodity prices. Market
risk is inherent to both derivative and non-derivative financial instruments,
and accordingly, the scope of the Company's market risk management extends
beyond derivatives to include all market risk sensitive financial instruments.
As a financial services company, net interest income comprises the primary
component of the Company's earnings. As a result, the Company is subject to risk
resulting from interest rate fluctuations to the extent that there is a gap
between the amount of the Company's interest-earning assets and the amount of
interest-bearing liabilities that are prepaid, mature or reprice within
specified periods. The Company's strategy is to mitigate interest rate risk
through the creation of a diversified investment portfolio of high quality
assets that, in the aggregate, preserves the Company's capital base while
generating stable income in a variety of interest rate and prepayment
environments. In many instances, the investment strategy involves not only the
creation of the asset, but also structuring the related securitization or
borrowing to create a stable yield profile and reduce interest rate risk.
The Company continuously monitors the aggregate cash flow, projected net
yield and market value of its investment portfolio under various interest rate
and prepayment assumptions. While certain investments may perform poorly in an
increasing or decreasing interest rate environment, other investments may
perform well, and others may not be impacted at all. Generally, the Company adds
investments to its portfolio that are designed to increase the diversification
and reduce the variability of the yield produced by the portfolio in different
interest rate environments.
The Company's Portfolio Executive Committee ("PEC"), which includes
executive management representatives, monitors and manages the interest rate
sensitivity and repricing characteristics of the balance sheet components
consistent with maintaining acceptable levels of change in both the net
portfolio value and net interest income. The Company's exposure to interest rate
risk is reviewed on a monthly basis by the PEC and quarterly by the Board of
Directors.
The Company utilizes a monthly static cash flow and yield projection under
interest rate scenarios detailed below. While the Company may use such tools,
there can be no assurance the Company will accomplish the goal of adequately
managing the risk profile of the investment portfolio.
The Company measures the sensitivity of its net interest income to changes
in interest rates. Changes in interest rates are defined as instantaneous,
parallel, and sustained interest rate movements in 100 basis point increments.
The Company estimates its interest income for the next twelve months assuming no
changes in interest rates from those at period end. Once the base case has been
estimated, cash flows are projected for each of the defined interest rate
scenarios. Those scenario results are then compared against the base case to
determine the estimated change to net interest income.
The following table summarizes the Company's net interest margin
sensitivity analysis as of June 30, 2000. This analysis represents management's
estimate of the percentage change in net interest margin given a parallel shift
in interest rates. The "Base" case represents the interest rate environment as
it existed as of June 30, 2000. The analysis is heavily dependent upon the
assumptions used in the model. The effect of changes in future interest rates,
the shape of the yield curve or the mix of assets and liabilities may cause
actual results to differ from the modeled results. In addition, certain
financial instruments provide a degree of "optionality." The model considers the
effects of these embedded options when projecting cash flows and earnings. The
most significant option affecting the Company's portfolio is the borrowers'
option to prepay the loans. The model uses a dynamic prepayment model that
applies a Constant Prepayment Rate ranging from 5.5% to 70.1% based on the
projected incentive to refinance for each loan type in any given period. While
the Company's model considers these factors, the extent to which borrowers
utilize the ability to exercise their option may cause actual results to
significantly differ from the analysis. Furthermore, its projected results
assume no additions or subtractions to the Company's portfolio, and no change to
the Company's liability structure. Historically, the Company has made
significant changes to its assets and liabilities, and is likely to do so in the
future.
Basis Point % Change in Net
Increase (Decrease) Interest Margin from
in Interest Rates Base Case
----------------------- -----------------------
+200 (10.93)%
+100 (5.42)%
Base -
-100 5.41%
-200 11.30%
The Company's investment policy sets forth guidelines for assuming interest
rate risk. The investment policy stipulates that given a 200 basis point
increase or decrease in interest rates over a twelve month period, the estimated
net interest margin may not change by more than 25% of current net interest
margin during the subsequent one year period. Based on the projections above,
the Company is in compliance with its stated policy regarding the interest rate
sensitivity of net interest margin if interest rates increase 200 basis points
over a twelve month period.
Approximately $1.4 billion of the Company's investment portfolio as of June
30, 2000 is comprised of loans or securities that have coupon rates which adjust
over time (subject to certain periodic and lifetime limitations) in conjunction
with changes in short-term interest rates. Approximately 64% and 27% of the ARM
loans underlying the Company's ARM securities and collateral for collateralized
bonds are indexed to and reset based upon the level of six-month LIBOR and
one-year CMT, respectively.
Generally, during a period of rising short-term interest rates, the
Company's net interest spread earned on its investment portfolio will decrease.
The decrease of the net interest spread results from (i) the lag in resets of
the ARM loans underlying the ARM securities and collateral for collateralized
bonds relative to the rate resets on the associated borrowings and (ii) rate
resets on the ARM loans which are generally limited to 1% every six months or 2%
every twelve months and subject to lifetime caps, while the associated
borrowings have no such limitation. As short-term interest rates stabilize and
the ARM loans reset, the net interest margin may be restored to its former level
as the yields on the ARM loans adjust to market conditions. Conversely, net
interest margin may increase following a fall in short-term interest rates. This
increase may be temporary as the yields on the ARM loans adjust to the new
market conditions after a lag period. In each case, however, the Company expects
that the increase or decrease in the net interest spread due to changes in the
short-term interest rates to be temporary. The net interest spread may also be
increased or decreased by the proceeds or costs of interest rate swap, cap or
floor agreements. The Company had no interest rate swap, cap or floor agreements
as of June 30, 2000.
Because of the 1% or 2% periodic cap nature of the ARM loans underlying the
ARM securities, these securities may decline in market value in a rising
interest rate environment. In a rapidly increasing rate environment, as was
experienced in 1994, a decline in value may be significant enough to impact the
amount of funds available under repurchase agreements to borrow against these
securities. In order to maintain liquidity, the Company may be required to sell
certain securities. Liquidity risk also exists with all other investments
pledged as collateral for repurchase agreements, but to a lesser extent.
As part of its asset/liability management process, the Company may enter
into interest rate agreements such as interest rate caps and swaps and financial
futures contracts ("hedges"). These interest rate agreements are used by the
Company to help mitigate the risk to the investment portfolio of fluctuations in
interest rates that would ultimately impact net interest income. The Company may
also utilize interest rate swaps to manage its exposure to changes in financing
rates of assets and to convert floating rate borrowings to fixed rate where the
associated asset financed is fixed rate. Interest rate caps and interest rate
swaps that the Company uses to manage certain interest rate risks represent
protection for the earnings and cash flow of the investment portfolio in adverse
markets. The Company had no hedges in place as of June 30, 2000.
Interest rate caps and interest rate swaps that the Company utilizes to
manage certain interest rate risks represent protection for the earnings and
cashflow of the investment portfolio in adverse markets. To date, market
conditions have not been adverse such that the caps and swaps have been
utilized.
The remaining portion of the Company's investments portfolio as of June 30,
2000, approximately $2.2 billion, is comprised of loans or securities that have
coupon rates that are either fixed or do not reset within the next 15 months.
The Company has limited its interest rate risk on such investments through (i)
the issuance of fixed-rate collateralized bonds and notes payable, and (ii)
equity, which in the aggregate totals approximately $1.7 billion as of the same
date. Overall, the Company's interest rate risk is related both to the rate of
change in short term interest rates, and to the level of short term interest
rates.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On February 8, 1999, AutoBond Acceptance Corporation ("AutoBond"), AutoBond
Master Funding Corporation V ("Funding"), and its three principal common
shareholders (collectively, the "Plaintiffs") commenced an action in the
District Court of Travis County, Texas (250th Judicial District) against the
Company and James Dolph (collectively, the "Defendants") alleging that the
Company breached the terms of the Credit Agreement, dated June 9, 1998, by and
among AutoBond, Funding and the Company. The terms of the Credit Agreement
provided for the purchase by the Company of funding notes issued by Funding, and
collateralized by automobile installment contracts ("Auto Contracts") acquired
by AutoBond. The Company suspended purchasing the funding notes in February 1999
on grounds that AutoBond and Funding had violated certain provisions of the
Credit Agreement.
On June 9, 2000, the Company settled the matter with AutoBond for a cash
payment of $20 million. In return for the payment, the Company received a
complete release of all claims against it by AutoBond, and ownership of the
AutoBond subsidiaries which own the underlying automobile installment contracts,
and that issued the securities that were purchased from AutoBond.
The Company is also subject to other lawsuits or claims which arise in the
ordinary course of its business, some of which seek damages in amounts which
could be material to the financial statements. Although no assurance can be
given with respect to the ultimate outcome of any such litigation or claim, the
Company believes the resolution of such lawsuits or claims will not have a
material effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
Item 2. Changes in Securities and Use of Proceeds
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's annual meeting of shareholders held on June 27, 2000, for
which proxies were solicited pursuant to Regulation 14 under the Securities
Exchange Act of 1934, the following matters were voted upon and approved by
shareholders.
1. The election of four directors for a term expiring in 2001:
J. Sidney Davenport
Thomas H. Potts
Barry S. Shein
Donald B. Vaden
2. Approval of the appointment of Deloitte & Touche LLP, independent
certified public accountants, as the Company's auditors for the year ended
December 31, 2000.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNEX CAPITAL, INC.
By: /s/ Thomas H. Potts
Thomas H. Potts, President
(authorized officer of registrant)
/s/ Stephen J. Benedetti
Stephen J. Benedetti, Treasurer and Controller
(principal accounting officer)
Dated: August 14, 2000