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Published on December 15, 2005
Via
EDGAR
and USPS
December
15, 2005
Mr.
Jorge
Bonilla
Senior
Staff Accountant
Division
of Corporation Finance
Securities
and Exchange Commission
Washington,
D.C. 20549
RE: SEC
Comment Letter dated November 3, 2005 regarding Dynex Capital, Inc. Form
10-K
for Fiscal Year December 31, 2004, Form 10-Q for the Quarterly Period Ended
March 31, 2005 and Form 10-Q for the Quarterly Period Ended June 30, 2005,
File
No. 0-20507
Dear
Mr.
Bonilla:
As
requested, we are responding to the questions included in your comment letter
to
us dated November 3, 2005. For your reference, we have included each of your
comments in this letter in italics followed by our response to the
comment.
For
purposes of this letter, the “Company” refers to Dynex Capital, Inc. and its
consolidated subsidiaries.
Form
10-K for the Fiscal Year Ended December 31, 2004
Item
7 - Management’s Discussion and Analysis of Financial Condition and Results of
Operations
Non-GAAP
Information on Securitized Finance Receivables and Non-Recourse Securitization
Financing
| 1. |
Please
explain to us in sufficient details how you considered each of
the
requirements of Item 10(e) of Regulation S-K in preparing your
disclosure.
Your response should address, but not limited to, the reconciliation
requirements as the relate to your presentation of “Principal Balance of
Net Investment”, “Amortized Cost Basis of Net Investment”, “Fair Value of
Net Investment”, “Cash flows received in 2004, net” and the cumulative
$1.1 million provision for loan losses on loans in which you do
not retain
the credit risk.
|
As
the
Company discloses in its 2004 Form 10-K, the Company has securitized homogenous
pools of loans and debt securities by irrevocably transferring these assets
to
business
trusts which it created. These securitizations were credit tranched, with
the
Company
selling the investment grade bonds to third-parties while retaining the residual
or overcollateralization tranche of the trust. These trusts did not meet
the
accounting requirements of a qualified special purpose entity at the time
of
securitization. The trust is, therefore, consolidated in the Company’s financial
statements, and the loans and debt securities are included as securitized
finance receivables, with the associated bonds being presented as non-recourse
securitization financing. GAAP requires the presentation of assets and
liabilities separately on the balance sheet, and there is no comparable GAAP
measure to which the Company’s retained investment in the residual or
overcollateralization tranche (which we refer to as our “Net Investment” in the
Non-GAAP information section of the Form 10-K) can be reconciled.
The
purpose of the non-GAAP presentation of net investment in securitized finance
receivables is to provide the reader of the financial statements with an
understanding of the Company’s net retained capital investment in the trusts,
which are the largest investments in its securitized finance receivables
portfolio.
Item
10(e)(1)(i)(A) of Regulation S-K requires, with respect to financial measures
that are not calculated and presented in accordance with GAAP, a presentation,
with equal or greater prominence, of the most directly comparable financial
measures calculated and presented in accordance with GAAP. The Company has
presented the GAAP measures that relate to the non-GAAP financial measures
identified in the Commission’s comment with equal prominence in the “Non-GAAP
Information on Securitized Finance Receivables and Non-Recourse Securitization
Financing” section of “Item 1. Business” of the 2004 Form 10-K (the “Non-GAAP
Section”).
Item
10(e)(1)(i)(B) of Regulation S-K requires a reconciliation (by schedule or
other
clearly understandable method) of the differences between the non-GAAP financial
measure disclosed with the most directly comparable financial measure or
measures calculated and presented in accordance with GAAP identified in Item
10(e)(1)(i)(A).
“Principal
Balance of Net Investment” and “Amortized Cost Basis of Net
Investment”
The
first
table on page 6 of the 2004 Form 10-K presents the Principal Balance of Net
Investment in securitized finance receivables (derived as the netting of
the two
principal balance columns in that table), which represents the residual or
overcollateralization tranche, and the Amortized Cost Basis of this net
investment, both of which are non-GAAP financial measures. As the Company
presents its investments and financings on an aggregated basis, the second
table
of the Non-GAAP Section (the first table on page 7 of the Form 10-K) reconciles
the detail presented in the first table to the amounts included in the financial
statements. The Principal Balance of Net Investment in the first table are
reconciled to the financial statements by adding and subtracting the amounts
noted in the second table. The amounts in the second table also agree to
footnote disclosures in the financial statements. The Amortized Cost Basis
of
Net Investment in the first table is reconciled to the second table by
subtracting allowance for loan losses and unrealized gain/loss as set forth
in
the second table. In future filings, in order to present the reconciliation
of
the Amortized Cost Basis of Net Investment in the first table more clearly,
the
reconciliation in the second table will include a subtotal excluding allowance
for loan losses and unrealized gain/loss to allow the reader to more easily
reconcile this amount.
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“Fair
Value of Net Investment”
The
third
table in the Non-GAAP Section (the second table on page 7 of the 2004 Form
10-K)
is a presentation of the estimated fair value of each individual investment
presented in the first table. This table discloses to the reader the estimated
fair value of the Company’s net investment retained in securitized finance
receivables, including those that are securitized by loans, which are debt
securities and are not, therefore, marked to market in the financial statements
in accordance with GAAP. Differences between the Fair Value of Net Investment,
which is a non-GAAP financial measure, and the asset and liability balances
shown on the face of the financial statements and in the first two tables
represents differences in the Company’s carrying value of these investments and
their estimated fair values. Assumptions used to estimate market value are
included in the table, and information on the Net Cash Flows Received in
2004,
Net on the retained net investment from the securitization trusts for a
particular period is presented for informational purposes as a demonstration
of
reasonableness of the overall fair values presented.
“Cumulative
$1.1 Million Provision for Loan Losses”
The
Cumulative $1.1 million Provision for Loan Losses referred to in the 2004
Form
10-K is solely a component of the GAAP provision for loan losses in the
Statement of Operations and represents the amount by which the Company has
reserved for estimated losses on loans in excess of its retained credit risk,
which results from providing for estimated losses on loans that are financed
with non-recourse bonds, where a portion of such losses will ultimately be
borne
by the holders of certain of the non-recourse bonds. This amount is included
in
the Company’s allowance for loan losses. The provision of this $1.1 million is
required by GAAP as a result of accounting for securitized finance receivables
discretely from the associated securitization financing. Though the Company’s
risk is limited from an economic point of view, GAAP requires the Company
to
continue to record an allowance for loan losses. The Company, through its
subsidiary MERIT Securities Corporation, reviewed its accounting for this
matter
with Mr. Mark Northan of the Commission in connection with the preparation
of
its 2004 Form 10-K, and the Commission indicated that it did not object to
the
Company’s accounting for this matter.
Items
10(e)(1)(i)(C) and 10(e)(1)(i)(D) of Regulation S-K require statements
disclosing the reasons why the non-GAAP financial measures provide useful
information to investors and any additional purposes for management’s use of
non-GAAP measures. The Company believes that the reasons for presentation
of
non-GAAP financial measures are fully explained in the first paragraph of
the
non-GAAP disclosure section. There are no other material uses to the Company’s
management of non-GAAP financial measures other than those outlined in the
first
paragraph.
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Items
10(e)(1)(ii)(A) through (E) identify prohibited treatments and presentations
of
non-GAAP information. The Company confirms that no charges or liabilities
pertaining to securitized finance receivables or the corresponding
securitization financing that require cash settlement have been excluded
from
the non-GAAP information presented [Item 10(e)(1)(ii)(A)]. In addition, the
non-GAAP information has not been adjusted to eliminate or smooth any
non-recurring, infrequent or unusual items [Item 10(e)(1)(ii)(B)]. Non-GAAP
information also is not presented on the face of the financial statements
[Item
10(e)(1)(ii)(C)], and titles and descriptions of this information are distinct
from the titles and descriptions used to report GAAP financial measures [Item
10(e)(1)(ii)(E)]. Finally, the Company has not presented any pro forma financial
information required by Article 11 of Regulation S-X [Item
10(e)(1)(ii)(D)].
Financial
Statements
Report
of Independent Registered Public Accounting Firm
| 2. |
Please
confirm to us that you have a signed audit opinion and that you
will
include a conforming signature in future
filings.
|
The
Company has a signed audit opinion and will include a conforming signature
in
its future filings.
Note
1
Basis of Presentation
3.
Please explain to us the purpose of the disclosure in the third paragraph
that
refer to “normal recurring accruals” and “condensed” consolidated financial
statements.
The
disclosure in the third paragraph, which contains the terms referenced in
your
comment, was inadvertently included in the 2004 Form 10-K and is properly
reserved for the Company’s Quarterly Reports on Form 10-Q. The statement will be
properly excluded from future Annual Reports on Form 10-K.
Note
13 - Preferred and Common Stock.
4. We
note that you completed a recapitalization of your preferred stock in 2004.
Please reconcile this footnote to your consolidated statements of shareholders’
equity, operations and cash flows and explain to us how you accounted for
this
transaction. Tell us how you applied EITF D-42 and EITF D-53 and any other
relevant accounting literature that you used to support your accounting.
Also,
clarify whether the redemption of the preferred stock is solely at your
option.
The
Company accounted for the recapitalization in accordance with the guidance
provided in Emerging Issues Task Force (EITF) topic no. D-42, “The Effect on the
Calculation of Earnings Per Share for the Redemption or Induced Conversion
of
Preferred Stock.” EITF D-42 provides that “the excess of the fair value of the
consideration transferred to the holders of the preferred stock over the
carrying amount of the preferred stock in the registrant’s balance sheet
represents a return to the preferred stockholder and, therefore, should be
treated in a manner similar to the treatment of dividends paid to the holders
of
the preferred stock in the calculation of earnings per share.” In accordance
with EITF D-42, the Company removed the Series A, Series B and
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Series
C
preferred stock from its balance sheet and recorded the Series D preferred
stock, common stock and senior notes that were transferred as consideration
for
the redemption of the Series A, Series B and Series C preferred stock. The
fair
value of the consideration transferred was less than the liquidation preference
of the preferred stock that was exchanged (i.e., the issue price of the
preferred stock plus cumulative, unpaid dividends). This difference was,
therefore, recorded as a preferred stock benefit in the Statement of
Operations.
EITF
D-53, “Computation of Earnings Per Share for a Period That Includes a Redemption
or an Induced Conversion of a Portion of a Class of Preferred Stock,” provides
guidance on the computation and reporting of earnings per share for a period
that includes a redemption or induced conversion of only a portion of a class
of
preferred stock. Because the recapitalization completed on May 19, 2004 provided
for the redemption of all of the outstanding shares of the Series A, Series
B
and Series C preferred stock and required the approval of more than two-thirds
of the outstanding shares of each class being redeemed, EITF D-53 and the
guidance that it provides are not applicable to this transaction.
The
table
in Note 13 presents the number of shares of common stock and each series
of
preferred stock and agrees to the number of shares presented for each respective
class of stock in the consolidated balance sheets. The dividends on preferred
stock presented in the third paragraph of Note 13 agrees directly to the
consolidated statements of shareholders’ equity. The dividends-in-arrears, also
reported in the third paragraph of Note 13, is a component of the liquidation
preference reported in the consolidated balance sheets by each series of
preferred stock.
The
Series D preferred stock, which was issued as part of the May 19, 2004
recapitalization, is redeemable solely at the option of the Company as set
forth
in Section 5 of the Series D preferred stock designation. Specifically, the
Company has the option to redeem shares of Series D preferred stock in exchange
for (i) a like number of shares of common stock at any time when the closing
price of the common stock on the New York Stock Exchange has equaled or exceeded
$10 per share for a period of 20 trading days within any period of 30
consecutive trading days or (ii) cash at any time. The Series D preferred
stock
also is convertible by the holder at any time into one share of common stock,
and is convertible by the Company only upon certain conditions being met.
The
Series D preferred stock is otherwise perpetual.
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In
connection with the responses above, the Company acknowledges that:
| · |
the
Company is responsible for the adequacy and accuracy of the disclosure
in
the identified filings;
|
| · |
staff
comments or changes to disclosure in response to staff comments
do not
foreclose the Commission from taking any action with respect to
the
filings; and
|
| · |
the
Company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities
law
of the United States.
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If
you
have any additional questions or comments, you may reach me at (804) 217-5837
or
Jeffrey L. Childress, Controller, at (804) 217-5854.
Very
truly yours,
/s/
Stephen J. Benedetti
Stephen
J. Benedetti
Executive
Vice President, Chief Operating Officer
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