10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on November 14, 1997
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 September 30, 1997
|_| Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(formerly Resource Mortgage Capital, Inc.)
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10900 Nuckols Road, 3rd Floor, 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 October 31, 1997, the registrant had 44,497,047 shares of common
stock of $.01 value outstanding, which is the registrant's only class of common
stock.
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DYNEX CAPITAL, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DYNEX CAPITAL, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands except share data)
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands except share data)
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(amounts in thousands except share data)
DYNEX CAPITAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1997 (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., its wholly-owned subsidiaries, and certain
other entities. As used herein, the "Company" refers to Dynex Capital, Inc.
(Dynex) and each of the entities that is consolidated with Dynex for financial
reporting purposes. A portion of the Company's operations are operated by
taxable corporations that are consolidated with Dynex for financial reporting
purposes, but are not consolidated for income tax purposes. All significant
intercompany balances and transactions have been eliminated in consolidation.
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
Sheets at September 30, 1997 and December 31, 1996, the Consolidated Statements
of Operations for the three and nine months ended September 30, 1997 and 1996,
the Consolidated Statement of Shareholders' Equity for the nine months ended
September 30, 1997, the Consolidated Statements of Cash Flows for the nine
months ended September 30, 1997 and 1996 and related notes to consolidated
financial statements are unaudited. Operating results for the nine months ended
September 30, 1997 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1997. 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, 1996.
Certain amounts for 1996 have been reclassified to conform with the presentation
for 1997.
NOTE 2--NET INCOME PER COMMON SHARE
Net income per common share as shown on the consolidated statements of
operations for the three and nine months ended September 30, 1997 and 1996 is
presented on both a primary net income per common share and fully diluted net
income per common share basis. Fully diluted net income per common share assumes
the conversion of the convertible Preferred Stock into common stock, using the
if-converted method, and dilutive Stock Appreciation Rights, using the Treasury
Stock method. The average number of shares is increased by the assumed
conversion of convertible items, but only if these items are dilutive. For the
three and nine months ended September 30, 1997 and 1996, the Company's Series A
and Series B Preferred Stock and Stock Appreciation Rights were dilutive, while
the Series C Preferred Stock was anti-dilutive. As a result of the two-for-one
split of the Company's common stock discussed in Note 8, the Company's Preferred
Stock is convertible into two shares of common stock for one share of Preferred
Stock. The following table summarizes the average number of shares of common
stock and equivalents used to compute primary and fully diluted net income per
common share for the three and nine months ended September 30, 1997 and 1996:
NOTE 3--PORTFOLIO ASSETS
The Company has classified collateral for collateralized bonds and all mortgage
securities as available-for-sale. The following table summarizes the Company's
amortized cost basis and fair value of collateral for collateralized bonds and
mortgage securities held at September 30, 1997 and December 31, 1996, and the
related average effective interest rates (calculated excluding unrealized gains
and losses) for the month ended September 30, 1997 and December 31, 1996:
Mortgage securities with an aggregate principal balance of $846,747 were sold
during the nine months ended September 30, 1997 for an aggregate net gain of
$592. The specific identification method is used to calculate the basis of
mortgage securities sold. Gain on sale of assets also includes premiums received
of $7,805 for various call and put options written during the nine months ended
September 30, 1997, and which were offset by $125 of premiums paid on various
call options purchased during the same period. These options were generally for
a period of three months or less, and expires out-of-the money. No such
positions remained outstanding at September 30, 1997.
NOTE 4--ADOPTION OF FINANCIAL ACCOUNTING STANDARDS
In January 1997, the Company adopted the Financial Accounting Standards Board
Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" (FAS No. 125). FAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities based on consistent application of a
financial components approach that focuses on control of the respective assets
and liabilities. It distinguishes transfers of financial assets that are sales
from transfers that are secured borrowings. FAS No. 125 is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996. The impact of adopting FAS No. 125 did not
result in a material change to the Company's financial position and results of
operations.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting No. 128, "Earnings Per Share" (FAS No. 128). FAS No. 128
supersedes APB Opinion No. 15, "Earnings Per Share", and specifies the
computation, presentation, and disclosure requirements for earnings per share
(EPS) for entities with publicly held common stock or potential common stock.
FAS No. 128 will replace Primary EPS and Fully Diluted EPS with Basic EPS and
Diluted EPS, respectively. FAS No. 128 will require dual presentation of Basic
EPS and Diluted EPS on the face of the income statement for all entities with
complex capital structures. FAS No. 128 also will require a reconciliation of
the numerator and denominator of the Basic EPS to the numerator and denominator
of the Diluted EPS computation. FAS No. 128 will be effective for financial
statements for both interim and annual periods ending after December 15, 1997.
Earlier application of this statement is not permitted. The Company has
determined that this statement will not result in a material change to the
Company's financial position and results of operations.
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting No. 129, "Disclosure of Information
about Capital Structure" (FAS No. 129). FAS No. 129 summarizes
previously issued disclosure guidance contained within APB Opinions No.
10 and 15, as well as FAS No. 47. There will be no changes to the
Company's disclosures pursuant to the adoption of FAS No. 129. This
statement is effective for financial statements for periods ending after
December 15, 1997.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting No. 130, "Reporting Comprehensive Income" (FAS No. 130).
FAS No. 130 requires companies to classify items of other comprehensive income
by their nature in a financial statement and display the accumulated balance of
other comprehensive income separately from retained earnings and additional
paid-in capital in the equity section of a statement of financial position. This
statement is effective for financial statements issued for fiscal years
beginning after December 15, 1997. The impact of adopting FAS No. 130 has not
been determined.
On January 28, 1997, the Securities and Exchange Commission adopted rules to
clarify and expand existing disclosure requirements about derivatives and other
financial instruments as well as derivative commodity instruments. These rules
require enhanced disclosure of accounting policies for derivative financial
instruments and derivative commodity instruments. These rules also expand
existing disclosure requirements to include quantitative and qualitative
information about market risk inherent in market risk sensitive instruments. The
quantitative and qualitative disclosures of market risk are effective for all
fiscal years ending after June 15, 1997 if the company's market capitalization
exceeds $2.5 billion or the company is a bank or thrift. For all other
companies, the disclosures are required in filings that include audited
financial statements for fiscal years ended after June 15, 1998. Accounting
policy disclosures are required in quarterly reports filed for periods ending
after June 15, 1997. Following are the Company's derivative accounting policy
disclosures.
Off-balance-sheet instruments used for interest rate risk management
The Company enters into interest rate swaps, interest rate caps, financial
forwards and futures and financial options to manage its sensitivity to interest
rate risk. This is accomplished by using these instruments to offset the
inherent price or interest rate risk of specific on-balance-sheet assets or
liabilities. These instruments are designated as hedges on the trade date and
are highly correlated with the financial instrument being hedged. If a hedged
instrument is sold or matures, or the criteria that was executed at the time the
hedge instrument was entered into no longer exists, the risk management position
is no longer accounted for as a hedge. Under these circumstances, the
accumulated change in market value of the hedge is recognized in current income
to the extent that the hedge results have not been offset by the effects of
interest rate or price changes of the hedged item.
The Company also enters into off-balance-sheet contracts to hedge anticipated
transactions. If it is determined that an anticipated transaction that has been
hedged will not occur, the results of the hedge will be recognized currently.
Interest revenue or interest expense on hedge transactions is accrued over the
term of the agreement as an adjustment to the yield or cost of the related asset
or liability. Transaction fees are deferred and amortized to interest revenue or
interest expense over the term of the agreement. Realized gains and losses are
deferred and amortized over the life of the hedged transaction as interest
revenue or interest expense, and any unamortized amounts are recognized as
income or loss at the time of disposition of the assets or liabilities being
hedged. Amounts payable to or receivable from counterparties are included in the
financial statement line of the item being hedged.
NOTE 5 -- NOTES PAYABLE
On July 14, 1997, the Company issued $100,000 of 7.875% senior unsecured notes
maturing on July 15, 2002. The notes will pay interest semi-annually in arrears
on January 15 and July 15, commencing on January 15, 1998. The net proceeds were
initially used to reduce short-term debt related to financing loans held for
securitization during the accumulation period.
NOTE 6 -- OTHER MATTERS
During the three and nine months ended September 30, 1997, the Company issued
404,300 and 778,300 shares, respectively, of its common stock pursuant to a
registration statement filed with the Securities and Exchange Commission. The
net proceeds from the issuance were approximately $5,722 and $10,864 for the
three and nine months ended September 30, 1997, respectively. The Company also
issued 532,049 and 1,258,199 shares of its common stock pursuant to its dividend
reinvestment program for net proceeds of $7,430 and $17,094 during the three and
nine months ended September 30, 1997, respectively.
NOTE 7- CHANGE OF COMPANY NAME
Effective April 25, 1997, the Company changed its name from Resource
Mortgage Capital, Inc. to Dynex Capital, Inc.
NOTE 8 -- STOCK SPLIT
At the annual meeting of shareholders, held on April 24, 1997, the shareholders
approved an amendment to the Articles of Incorporation to effect a two-for-one
split of the issued and outstanding shares of the Company's $0.01 par value
common stock to holders of record on May 5, 1997 and also to increase the number
of authorized shares of common stock to 100,000,000. As a result of the split
approximately 21.3 million additional common shares were issued. All references
in the accompanying financial statements to the number of shares and per share
amounts for 1996 and 1997 have been restated to reflect the stock split.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Summary
Dynex Capital, Inc. (the "Company") is a mortgage and consumer finance
company which uses its loan production operations to create investments for its
portfolio. Currently, the Company's primary loan production operations include
the origination of mortgage loans secured by multifamily and commercial
properties and the origination of loans secured by manufactured homes. The
Company will generally securitize the loans funded as collateral for
collateralized bonds, limiting its credit risk and providing long-term financing
for its portfolio. The Company has elected to be treated as a real estate
investment trust ("REIT") for federal income tax purposes and, as such, must
distribute substantially all of its taxable income to shareholders and will
generally not be subject to federal income tax.
The Company's principal source of earnings is net interest income on its
investment portfolio. The Company's investment portfolio consists principally of
collateral for collateralized bonds, adjustable-rate mortgage ("ARM") securities
and loans held for securitization. The Company funds its portfolio investments
with both borrowings and cash raised from the issuance of equity. For the
portion of the portfolio investments funded with borrowings, the Company
generates net interest income to the extent that there is a positive spread
between the yield on the interest-earning assets and the cost of borrowed funds.
The cost of the Company's borrowings may be increased or decreased by interest
rate swap, cap or floor agreements. For the portion of the balance sheet that is
funded with equity, net interest income is primarily a function of the yield
generated from the interest-earning asset.
Business Focus and Strategy
The Company's overall level of earnings is dependent upon (i) the spread
between interest earned on its investment portfolio and the cost of borrowed
funds to finance those investments; and (ii) the aggregate amount of
interest-earning assets that the Company has on its balance sheet. The Company
strives to create a diversified portfolio of investments that in the aggregate
generates stable income in a variety of interest rate and prepayment rate
environments and preserves the capital base of the Company. In many instances,
the Company's investment strategy involves not only the creation or acquisition
of the asset, but also the structuring of the related borrowings through the
securitization process to create a stable yield profile.
Investment Portfolio Strategies
The Company adheres to the following business strategies in managing its
investment portfolio:
using its loan origination capabilities to provide assets for its
investment portfolio, generally at a lower effective cost than if
investments of comparable risk profiles were purchased in the secondary
market;
securitizing its loan production to provide long-term financing for its
investment portfolio and to reduce the Company's liquidity, interest rate
and credit risk;
utilizing leverage to finance purchases of loans and investments in line
with prudent capital allocation guidelines which are designed to balance
the risk in certain assets, thereby increasing potential returns to
shareholders while seeking to protect the Company's equity base;
structuring borrowings to have interest rate adjustment indices and
interest rate adjustment periods that, on an aggregate basis, generally
correspond (within a range of one to six months) to the interest rate
adjustment indices and interest rate adjustment periods of the related
asset; and
utilizing interest rate caps, swaps and similar instruments and
securitization vehicles with such instruments embodied in the structure to
mitigate the risk of the cost of its variable rate liabilities increasing
at a faster rate than the earnings on its assets during a period of rising
interest rates.
Lending Strategies
The Company strives to be a vertically integrated lender by performing the
sourcing, underwriting, funding and servicing of loans to maximize efficiency
and provide superior customer service and generally adheres to the following
business strategies in its lending operations:
developing loan production capabilities to originate and acquire
financial assets in order to create attractively priced investments for
its portfolio, generally at a lower cost than if investments with
comparable risk profiles were purchased in the secondary market;
focusing on loan products that maximize the advantages of the
REIT tax election;
emphasizing direct relationships with the borrower and minimize,
to the extent practical, the use of origination intermediaries;
using internally generated guidelines to underwrite loans for all
product types and maintain centralized loan pricing; and
performing the servicing function for loans on which the Company has
credit exposure; emphasizing the use of early intervention, aggressive
collection and loss mitigation techniques in the servicing process to
manage and seek to reduce delinquencies and to minimize losses in its
securitized loan pools.
RESULTS OF OPERATIONS
Three and Nine Months Ended September 30, 1997 Compared to Three and Nine Months
Ended September 30, 1996. The increase in the Company's earnings during the
three and nine months ended September 30, 1997 as compared to the same period in
1996 is primarily the result of the increase in the net interest margin. The
increase in the Company's earnings during the nine months ended September 30,
1997 was also a result of the increase of the gain on sale of assets. These
increases in the Company's earnings were offset partially by both declines in
the one-time gain on sale of single-family operations recognized during the nine
months ended September 30, 1996 and an increase in general and administrative
expenses during 1997.
Net interest margin for the nine months ended September 30, 1997 increased to
$62.7 million, or 13%, over the $55.4 million for the same period for 1996. Net
interest margin for the three months ended September 30, 1997 increased to $20.8
million, or 10%, over $19.0 million for the same period in 1996. These increases
were primarily the result of (i) the overall growth in total interest-earning
assets, (ii) an increase in the Company's equity base and (iii) improved
performance in the Company's other mortgage securities. The net interest spread
on the Company's investment portfolio increased to 1.56% for the nine months
ended September 30, 1997 from 1.52% for the same period in 1996. The increase in
net interest spread for the nine months ended September 30, 1997 relative to the
same period in 1996 is primarily the result of the increased investment in other
mortgage and the increased spread on ARM securities, offset by a decrease in the
net spread on net investment in collateralized bonds (defined as collateral for
collateralized bonds less collateralized bonds) and fixed-rate mortgage
securities. The net interest margin decrease to 1.39% for the three months ended
September 30, 1997 from 1.49% for the three months ended September 30, 1996. The
decrease in the net interest spread for the three months ended September 30,
1997 relative to the same period in 1996 was primarily a result of a decrease in
the net spread on the net investment in collateralized bonds and the issuance of
$100 million of 7.875% senior unsecured notes during July 1997.
The gain on the sale of single-family operations was a one-time gain related
to the sale of the Company's single-family correspondent, wholesale and
servicing business on May 13, 1996. The gain (loss) on sale of assets, net of
associated costs, for the nine months ended September 30, 1997 increased to $8.3
million gain, as compared to a $2.9 million loss for the nine months ended
September 30, 1996. The increase in the net gain is primarily the result of
premiums received of $7.8 million on call and put options written during the
nine months ended September 30, 1997 and the sale of certain investments which
generated a net gain of $0.6 million. During the nine months ended September 30,
1996, the Company sold certain underperforming securities in its investment
portfolio which resulted in a $5.3 million loss. In addition, the carrying value
of certain other mortgage securities was reduced during June 1996 as anticipated
future prepayment rates were expected to result in the Company receiving less
cash than its remaining basis in those investments.
General and administrative expenses increased $1.7 million, or 11%, to $17.4
million for the nine months ended September 30, 1997 as compared to the same
period for 1996. The increase is a result of the growth in the current
production operations offset partially by the expense reductions resulting from
the sale of the single-family production operations in May 1996. General and
administrative expenses increased $2.0 million, or 45%, for the three months
ended September 30, 1997 versus the same period for 1996 due to the costs
associated with the Company's current production operations. General and
administrative expenses should continue increasing on a quarterly basis during
the remainder of 1997 and into 1998 as the Company continues to build its
production infrastructure.
The following table summarizes the average balances of the Company's
interest-earning assets and their average effective yields, along with the
Company's average interest-bearing liabilities and the related average effective
interest rates, for each of the periods presented.
Average Balances and Effective Interest Rates
The Company's overall yield on interest-earning assets increased to 7.89% for
the nine months ended September 30, 1997 from 7.62% for the same period in 1996.
The weighted average borrowing costs also increased to 6.33% for the nine months
ended September 30, 1997 from 6.10% for the nine months ended September 30,
1996. The increase in borrowing costs was due to the 0.25% increase in short
term interest rates during March 1997 as well as the issuance of $100 million of
7.875% senior unsecured notes during July 1997. For the respective three months,
the yield on interest-earnings assets rose 0.07% to 7.71% during the three
months ended September 30, 1997 compared to 7.64% for the three months ended
September 30, 1996. The weighted average borrowing costs also rose to 6.32% for
the three months ended September 30, 1997 from 6.15% for the same period in
1996. The reasons for the increases for the three months ended September 30,
1997 are the same as those for the nine months ended September 30, 1997. As a
result, the net spread decreased to 1.39% for the three months ended September
30, 1997, versus 1.49% for the three months ended September 30, 1996.
Individually, the net interest spread on collateralized bonds decreased 59
basis points, from 167 basis points for the nine months ended September 30,
1996, to 108 basis points for the nine months ended September 30, 1997. This
decline was primarily due to the securitization of lower coupon collateral,
principally A+ quality single-family ARM loans during 1997 coupled with the
prepayments of higher coupon collateral during the three months ended September
30, 1997. In addition, the spread on the net investment in collateralized bonds
decreased due to higher premium amortization caused by higher prepayments during
the nine months ended September 30, 1997 than during the same period in 1996.
The net interest spread on ARM securities increased by 31 basis points, from 115
basis points for the nine months ended September 30, 1996, to 146 basis points
during the same period in 1997. This increase is primarily attributed to the ARM
securities in the Company's portfolio during 1997 having a higher margin than
those ARM securities in the Company's portfolio in 1996. The net interest spread
on fixed-rate mortgage securities decreased to 204 basis points for the nine
months ended September 30, 1997, from 502 basis points for the same period in
1996. This decrease is attributable to the purchase of lower yielding fixed-rate
securities during the nine months ended September 30, 1997. The net interest
spread on other mortgage securities increased to 1160 basis points for the nine
months ended September 30, 1997 from 604 basis points for the nine months ended
September 30, 1996. This increase is due to the purchase of higher yielding
residual trusts during the twelve months ended September 30, 1997. The net
interest spread on other portfolio assets decreased 7 basis points, from 230
basis points from the nine months ended September 30, 1996, to 223 basis points
for the nine months ended September 30, 1997, due primarily to higher borrowing
costs associated with the Company's single-family model home purchase and
leaseback business.
PORTFOLIO RESULTS
The core of the Company's earnings is derived from the Company's investment
portfolio. The Company's investment strategy is to create a diversified
portfolio of securities that in the aggregate generates stable income in a
variety of interest rate and prepayment rate environments and preserves the
capital base of the Company. The Company has pursued its strategy of
concentrating on its production activities to create investments with attractive
yields. In many instances, the Company's investment strategy has involved not
only the creation or acquisition of the asset, but also structuring the related
borrowings through the securitization process to create a stable yield profile.
Approximately $3.9 billion of the Company's investment portfolio as of
September 30, 1997 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. Generally, during a
period of rising 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 securities which
are generally limited to 1% every six months, while the associated borrowings
have no such limitation. As interest rates stabilize and the ARM securities
reset, the net interest margin may be restored to its former level as the yields
on the ARM securities 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 securities 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 cost or proceeds of interest rate swap, cap or
floor agreements.
Interest Income and Interest-Earning Assets
The Company's average interest-earning assets were $4.3 billion for the nine
months ended September 30, 1997, an increase of approximately 8% from $4.0
billion of average interest-earning assets during the same period of 1996. Total
interest income rose approximately 12%, from $228.8 million for the nine months
ended September 30, 1996 to $255.5 million for the same period of 1997. Overall,
the yield on interest-earning assets rose to 7.89% for the nine months ended
September 30, 1997 from 7.62% for the nine months ended September 30, 1996, as
the investment in higher yielding assets grew. On a quarter to quarter basis,
average interest-earning assets for the quarter ended September 30, 1997 were
$4.8 billion versus $4.3 billion for the quarter ended June 30, 1997. This
increase in average interest-earnings assets was primarily the result of $518
million of loans funded through the production operations during the quarter
ended September 30, 1997. Total interest income for the quarter ended September
30, 1997 was $92.7 million versus $85.7 million for the quarter ended June 30,
1997. This increase in total interest income was due to the growth in average
interest-earning assets despite the decline in average asset yield for the
quarter ended September 30, 1997 versus the quarter ended June 30, 1997. As
indicated in the table below, average asset yields for these periods were 7.93%
and 7.71%, respectively, which were 1.96% and 1.87% higher than the average
daily London InterBank Offered Rate ("LIBOR") for six-month deposits ("six-month
LIBOR") during those periods. The decrease in the average asset yield from the
second quarter is due to the purchase of lower coupon collateral, principally A+
quality single-family ARM loans during the second and the third quarters of 1997
along with prepayments of higher coupon loans underlying the collateral for
collateralized bonds and ARM securities during both quarters. The majority of
the ARM loans underlying the Company's ARM securities and collateral for
collateralized bonds are indexed to and reset based upon the level of six-month
LIBOR. The Company expects that the yield on the ARM loans that are collateral
for certain collateralized bonds will trend upward during the fourth quarter
since the majority of the ARM loans securitized during June 1997 were not
fully-indexed and should reset upwards during the next three months.
Earning Asset Yield
($ in millions)
The net yield on average interest-earning assets decreased to 1.97% for the
three months ended September 30, 1997, compared to 2.25% for the three months
ended June 30, 1997 and 2.07% for the three months ended September 30, 1996. The
decrease for the three months ended September 30, 1997 from the three months
ended September 30, 1996 was primarily a result of the securitization of lower
coupon collateral and the increase in borrowings rates. The issuance of $100
million of senior unsecured notes in July 1997 at 7.875% was the primary cause
of the decrease from the prior three month period. The net yield percentages
presented below exclude non-interest collateralized bonds expenses such as
provision for credit losses. If non-interest collateralized bond expenses were
included, the net yield on average interest-earning assets would be 1.73% for
the three months ended September 30, 1997 and 1.98% and 1.85% for the three
months ended June 30, 1997 and September 30, 1996, respectively.
Net Yield on Average Interest-Earning Assets
($ in millions)
The average asset yield is reduced for the amortization of the net premium on
the Company's investment portfolio. By creating its investments through its
production operations, the Company believes that premium amounts are less than
if the investments were acquired in the market. As indicated in the table below,
net premiums on the Company's ARM securities, fixed-rate securities and
collateral for collateralized bonds at September 30, 1997 were $57.9 million, or
approximately 1.59% of the aggregate investment portfolio balance as compared to
$60.8 million and 1.60% at September 30, 1996. The mortgage principal repayment
rate for the Company (indicated in the table below as "CPR Annualized Rate") was
approximately 29% for the three months ended September 30, 1997. CPR stands for
"constant prepayment rate" and is a measure of the annual prepayment rate on a
pool of loans.
Premium Basis and Amortization (1)
($ in millions)
Interest Expense and Cost of Funds
The Company's largest expense is the interest cost on borrowed funds. Funds
to finance the investment portfolio are generally borrowed in the form of
repurchase agreements or non-recourse collateralized bonds, both of which are
primarily indexed to one-month LIBOR. The Company may use interest rate swaps,
caps and financial futures to manage its interest rate risk. The net cost of
these instruments is included in the cost of funds table below as a component of
interest expense for the period to which it relates. For the three-month period
ended September 30, 1997 as compared to the same period in 1996, interest
expense increased to $69.0 million from $57.2 million while the average cost of
funds also increased to 6.32% compared to 6.15%. The increased average cost of
funds for the third quarter of 1997 compared to the third quarter of 1996 was
due mainly to the increase in one-month LIBOR from 5.46% at September 30, 1996
to 5.65% at September 30, 1997. On a quarter to quarter basis, the cost of funds
remained relatively flat at 6.32% for the three months ended September 30, 1997
compared to 6.34% for the three months ended June 30, 1997.
Cost of Funds
($ in millions)
Interest Rate Agreements
As part of the Company's asset/liability management process for its
investment portfolio, the Company enters into interest rate agreements such as
interest rate caps and swaps and financial futures contracts. These agreements
are used to reduce interest rate risk which arises from the lifetime yield caps
on the ARM securities, the mismatched repricing of portfolio investments versus
borrowed funds, and finally, assets repricing on indices such as the prime rate
which differ from the related borrowing indices. The agreements are designed to
protect the portfolio's cash flow, and to provide income and capital
appreciation to the Company in the event that short-term interest rates rise
quickly.
The following table includes all interest rate agreements in effect as of the
various quarter ends for asset/liability management of the investment portfolio.
This table excludes all interest rate agreements in effect for the Company's
loan production operations. Generally, interest rate swaps and caps are used to
manage the interest rate risk associated with assets that have periodic and
annual interest rate reset limitations financed with borrowings that have no
such limitations. Financial futures contracts and options on futures are used to
lengthen the terms of repurchase agreement financing, generally from one month
to three and six months. Amounts presented are aggregate notional amounts. To
the extent any of these agreements are terminated, gains and losses are
generally amortized over the remaining period of the original agreement.
Instruments Used for Interest Rate Risk Management Purposes (1)
($ in millions)
Net Interest Rate Agreement Expense
The net interest rate agreement expense, or hedging expense, equals the cost
of the agreements, net of any benefits received from these agreements. For the
quarter ended September 30, 1997, net hedging expense amounted to $1.35 million
compared to $1.23 million and $1.29 million for the quarters ended June 30, 1997
and September 30, 1996, respectively. Such amounts exclude the hedging costs and
benefits associated with the Company's production activities as these amounts
are deferred as additional premium or discount on the loans funded and amortized
over the life of the loans as an adjustment to their yield.
Net Interest Rate Agreement Expense
($ in millions)
Fair Value
The fair value of the available-for-sale portion of the Company's investment
portfolio as of September 30, 1997, as measured by the net unrealized gain on
investments available-for-sale, was $70.2 million above its cost basis, which
represents a $4.6 million increase from $65.6 million at September 30, 1996.
This increase in the portfolio's value is primarily attributable to the increase
in the value of the collateral for collateralized bonds relative to the
collateralized bonds issued during the last twelve months, as well as an
increase in value of the Company's ARM securities. On a quarter by quarter
basis, the fair value of the available-for-sale portion of the Company's
investment portfolio decreased $6.8 million mainly due to the fact that there
was not a securitization completed during the quarter ended September 30, 1997
to offset the effect of principal payments on the Company's investment
portfolio.
The Company's auditors, KPMG Peat Marwick LLP, have brought to the
attention of the Company that the accounting methodology that has been used by
the Company since 1994 to account for Collateral for Collateralized Bonds
("CCBs") may not comply with Statement of Financial Accounting Standards No. 115
("FAS 115"). This issue was brought to the attention of the Company's management
on November 13, 1997, and while the Company is researching the issue, no
conclusion has been reached. The issue relates solely to whether the unrealized
gain or loss on a portion of the CCBs should be shown as a component of the
Balance Sheet or whether it should be disclosed in the footnotes to the
financial statements or in Management's Discussion and Analysis of Financial
Condition and Results of Operations. There would be no change to the Company's
net income or earnings per share, nor is there a change in the underlying market
value of the Company's assets.
Currently, the Company classifies its CCBs as "available for sale" under
FAS 115 and as a consequence, the CCBs are "marked-to-market". This
mark-to-market results in an adjustment to the Company's basis in its CCBs and a
corresponding adjustment to Shareholders' Equity through an "unrealized gain on
investments available for sale". If the Company were to revise the accounting
methodology used, the Company would reclassify a portion of the CCBs out of
investments available for sale, and would record them at the lower of cost or
market value, resulting in a maximum $58 million reduction in the basis of the
CCBs as of September 30, 1997. Any such accounting change does not reflect an
actual adjustment to the value of the CCBs. Correspondingly, the change would
reduce the unrealized gain on investments available for sale, a component of
shareholders' equity on the balance sheet, by a maximum of $58 million as of
September 30, 1997. There would be no change to the Company's net income or
earnings per share, nor is there a change in the underlying market value of the
Company's assets. If such change was made, the mark-to-market value of these
CCBs would be disclosed separately in a footnote to the Company's financial
statements, or in Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Should the Company determine that the accounting methodology used does not
comply with FAS 115, the issue will be resolved during the fourth quarter and
the Company will make the required adjustments.
Credit Exposures
The Company securitizes its loan production in collateralized bonds or
pass-through securitization structures. With either structure, the Company may
use overcollateralization, subordination, reserve funds, bond insurance,
mortgage pool insurance or any combination of the foregoing as a form of credit
enhancement. With all forms of credit enhancement, the Company may retain a
limited portion of the direct credit risk after securitization.
The following table summarizes the aggregate principal amount of collateral
for collateralized bonds and pass-through securities outstanding; the maximum
direct credit exposure retained by the Company (represented by the amount of
overcollateralization pledged and subordinated securities rated below BBB or not
rated owned by the Company), net of the credit reserves maintained by the
Company for such exposure; and the actual credit losses incurred for the
quarter. The table excludes any risks related to representations and warranties
made on loans funded by the Company and securitized in mortgage pass-through
securities generally funded through 1994.
Credit Reserves and Actual Credit Losses
($ in millions)
The percentage of maximum credit exposure net of credit reserves to average
interest-earnings assets was 1.04% as of September 30, 1997, compared to 1.16%
and 0.72% at June 30, 1997 and September 30, 1996, respectively.
The following table summarizes single-family mortgage loan and manufactured
housing loan delinquencies as a percentage of the outstanding collateral balance
for those securities mentioned above in which the Company has retained a portion
of the direct credit risk. Multifamily loan collateral is not included as there
were no delinquencies as of September 30, 1997. As of September 30, 1997, the
Company believes that its credit reserves are sufficient to cover any losses
which may occur as a result of current delinquencies presented in the table
below.
Delinquency Statistics
The following table summarizes the credit rating for investments held in the
Company's portfolio assets. This table excludes the Company's other mortgage
securities (as the risk on such securities is primarily prepayment-related, not
credit-related) and other portfolio assets. The carrying balances of the
investments rated below A are net of credit reserves and discounts. The average
credit rating of the Company's mortgage investments at the end of the third
quarter of 1997 was AAA. At September 30, 1997, securities with a credit rating
of AA or better were $3.5 billion, or 98.2% of the Company's total mortgage
investments compared to 98.5% and 98.8% at June 30, 1997 and September 30, 1996,
respectively. At the end of the third quarter 1997, $535.0 million of
investments were split rated between rating agencies. Where investments were
split-rated, for purposes of this table, the Company classified such investments
based on the higher credit rating.
Portfolio Assets by Credit Rating (1)
($ in millions)
Purchase, Securitization and Sale of Portfolio Assets
During the nine months ended September 30, 1997, the Company sold various
portfolio investments due to favorable market conditions. The aggregate
principal amount of investments sold during the nine months ended September 30,
1997 was $846.7 million, consisting primarily of fixed-rate securities, which
resulted in gains of $0.6 million. Also during the nine months ended September
30, 1997, the Company exercised its call right or otherwise purchased $52.5
million of ARM securities, $790.9 million of fixed-rate mortgage securities and
$79.6 million of other mortgage securities.
LOAN PRODUCTION ACTIVITIES
The Company's primary production activities include low-income housing tax
credit multifamily, commercial and manufactured housing lending. The commercial
loans may include apartment properties which have not received low-income
housing tax, assisted living and retirement housing, limited and full service
hotels, urban and suburban office buildings, retail shopping strips and centers,
light industrial buildings and manufactured housing parks. The Company's
manufactured housing production includes installment loans, land/home loans and
inventory financing to manufactured housing dealers. In addition to these
primary sources of production, the Company also provides leases and loans to
builders for single-family homes that serve as model homes for those builders.
The Company may also purchase single-family mortgage loans on a "bulk" basis
from time to time and may originate such loans on a retail basis.
The primary purpose of the Company's production operations is to enhance the
return on shareholders' equity ("ROE") by earning a favorable net interest
spread while loans are being accumulated for securitization and creating
investments for its portfolio through the securitization process at a lower cost
than if such investments were purchased from third parties. The creation of such
investments generally involves the issuance of collateralized bonds or
pass-through securities collateralized by the loans generated from the Company's
production activities, and the retention of one or more classes of the
securities or collateralized bonds relating to such issuance. The issuance of
collateralized bonds and pass-through securities generally limits the Company's
credit and interest rate risk in contrast to retaining loans in its portfolio in
whole-loan form.
When a sufficient volume of loans is accumulated, the Company securitizes
loans through the issuance of collateralized bonds or pass-through securities.
The Company believes that securitization is an efficient and cost effective way
for the Company to (i) reduce capital otherwise required to own the loans in
whole loan form; (ii) limit the Company's exposure to credit risk on the loans;
(iii) lower the overall cost of financing the loans; and (iv) depending on the
securitization structure, limit the Company's exposure to interest rate and/or
valuation risk. As a result of the reduction in the availability of mortgage
pool insurance, and the Company's desire to both reduce its recourse borrowings
as a percentage of its overall borrowings, as well as the variability of its
earnings, the Company has utilized the collateralized bond structure for
securitizing substantially all of its loan production since the beginning of
1995.
The following table summarizes the production activity for the three and nine
month periods ended September 30, 1997 and 1996.
Loan Production Activity
($ in thousands)
The Company began funding manufactured housing loans during the second
quarter of 1996. Since commencement, the Company has opened five regional
offices in North Carolina, Georgia, Texas, Ohio and Washington and three
district offices in Michigan, Texas and South Carolina. As of September 30,
1997, the Company had $117.8 million in principal balance of manufactured
housing loans in inventory, and had commitments outstanding of approximately
$51.7 million. The majority of all manufactured housing funding volume to date
has been obtained through relationships with manufactured housing dealers and,
to a lesser extent, through direct marketing to consumers and correspondent
relationships. In the future, the Company plans to expand its sources of
origination to nearly all sources for manufactured housing loans by establishing
relationships with park owners, developers of manufactured housing communities,
manufacturers of manufactured homes, brokers and other correspondents. Once
certain volume levels are achieved at a particular region, additional district
offices may be opened in an effort to further market penetration.
The Company funded $48.5 million in multifamily loans during the three months
ended September 30, 1997 compared to $24.6 million for the three months ended
June 30, 1997 and $57.4 million for the three months ended September 30, 1996.
Principally all fundings under the Company's multifamily lending programs
consist of properties that have been allocated low income housing tax credits.
As of September 30, 1997 commitments to fund multifamily loans over the next 20
months were approximately $525.6 million. As of September 30, 1997, the Company
had $288.0 million in principal balance of multifamily loans held for
securitization.
The Company funded $47.9 million of commercial loans during the three months
ended September 30, 1997 compared to $13.7 million for the three months ended
June 30, 1997. The Company began its commercial lending operations in the first
quarter of 1997. These commercial loans consist primarily of light industrial
space and distribution centers. During October 1997, the Company securitized
$315.8 million of its multifamily and commercial loan production.
Included in specialty finance fundings for the third quarter of 1997 are
$19.7 million of model homes purchased from home builders which were
simultaneously leased back to the builders. The terms of these leases are
generally twelve to eighteen months at lease rates of typically one-month LIBOR
plus a spread. At the end of each lease, the Company will sell the home. In
addition, the Company had provided financing to home builders for model homes
for $6.3 million during the three months ended September 30, 1997. As of
September 30, 1997, the Company had leases on $99.7 million of model homes, and
had otherwise provided financing to home builders for model homes for an
additional $13.9 million.
Additionally, during the third quarter of 1997, the Company purchased $294.3
million of single-family ARM loans through various bulk purchases. This is
compared to $202.0 million purchased during the third quarter of 1996. The
Company will continue to purchase single-family loans on a bulk basis to the
extent, upon securitization, such purchases would generate a favorable return to
the Company on a proforma basis.
OTHER ITEMS
General and Administrative Expenses
General and administrative expenses ("G&A expense") consist of expenses
incurred in conducting the Company's production activities and managing the
investment portfolio, as well as various other corporate expenses. G&A expense
increased for the three-month period ended September 30, 1997 as compared to the
same period in 1996, primarily as a result of continued costs in connection with
the build-up of the production infrastructure for the manufacturing housing,
commercial lending, and specialty finance. G&A related to the production
operations is likely to increase over time as the Company expands its production
activities with current and new product types.
The following table summarizes the Company's efficiency, the ratio of G&A
expense to average interest- earning assets, and the ratio of G&A expense to
average total equity.
Operating Expense Ratios
Net Income and Return on Equity
Net income increased from $16.6 million for the three months ended September
30, 1996 to $19.5 million for the three months ended September 30, 1997. Net
income available to common shareholders increased from $14.4 million to $15.8
million for the same periods, respectively. Return on common equity (excluding
the impact of the net unrealized gain on investments available-for-sale)
decreased from 19.2% for the three months ended September 30, 1996 to 18.8% for
the three months ended September 30, 1997. The decrease in the return of common
equity is a result of the issuance of new common shares through the continuous
offering program and the dividend reinvestment program.
Components of Return on Equity
($ in thousands)
Dividends and Taxable Income
The Company and its qualified REIT subsidiaries (collectively "Dynex REIT")
have elected to be treated as a real estate investment trust for federal income
tax purposes. The REIT provisions of the Internal Revenue Code require Dynex
REIT to distribute to shareholders substantially all of its taxable income,
thereby restricting its ability to retain earnings.
The Company intends to declare and pay out as dividends 100% of its taxable
income over time. The Company's current practice is to declare quarterly
dividends per share. Generally, the Company strives to declare a quarterly
dividend per share which, in conjunction with the other quarterly dividends,
will result in the distribution of most or all of the taxable income earned
during the calendar year. At the time of the dividend announcement, however, the
total level of taxable income for the quarter is unknown. Additionally, the
Company has considerations other than the desire to pay out most of its taxable
earnings, which may take precedence when determining the level of dividends.
Dividend Summary
($ in thousands, except per share amounts)
Taxable income differs from the financial statement net income which is
determined in accordance with generally accepted accounting principles ("GAAP").
For the three months ended September 30, 1997, the Company's taxable income per
share of $0.248 was lower than the Company's declared dividend per share of
$0.345. For the nine months ended September 30, 1997, the Company's estimated
taxable net income per share of $1.11 was higher than the declared dividend per
share of $1.005. The majority of the difference was caused by GAAP and tax
differences related to the sale of the single-family operations in May 1996. For
tax purposes, the sale of the single-family operations is accounted for on an
installment sale basis with annual taxable income of approximately $10 million
from 1996 through 2001. Cumulative undistributed taxable income represents
timing differences in the amounts earned for tax purposes versus the amounts
distributed. Such amounts can be distributed for tax purposes in the subsequent
year as a portion of the normal quarterly dividend. Such amounts also include
certain estimates of taxable income until such time that the Company files its
federal income tax returns for each year.
LIQUIDITY AND CAPITAL RESOURCES
The Company has various sources of cash flow upon which it relies for its
working capital needs. Sources of cash flow from operations include primarily
cash, net interest margin and the return of principal on the portfolio of
investments and the issuance of collateralized bonds. Other borrowings provide
the Company with additional cash flow in the event that it is necessary.
Historically, these sources have provided sufficient liquidity for the conduct
of the Company's operations. However, if a significant decline in the market
value of the Company's investment portfolio should occur, the Company's
available liquidity from these other borrowings may be reduced. As a result of
such a reduction in liquidity, the Company may be forced to sell certain
investments in order to maintain liquidity. If required, these sales could be
made at prices lower than the carrying value of such assets, which could result
in losses.
In order to grow its equity base, the Company may issue additional capital
stock. Management strives to issue such additional shares when it believes
existing shareholders are likely to benefit from such offerings through higher
earnings and dividends per share than as compared to the level of earnings and
dividends the Company would likely generate without such offerings. During the
three months ended September 30, 1997, the Company issued 404,300 shares of its
common stock pursuant to a registration statement filed with the Securities and
Exchange Commission. The net proceeds from the issuance were approximately $5.7
million for the three months ended September 30, 1997. The Company also issued
532,049 shares of its common pursuant to its dividend reinvestment program for
net proceeds of $7.4 million, for the three months ended September 30, 1997.
The Company borrows funds on a short-term basis to support the accumulation
of loans prior to the issuance of collateralized bonds and mortgage- or
asset-backed securities. These borrowings may bear fixed or variable interest
rates, may require additional collateral in the event that the value of the
existing collateral declines, and may be due on demand or upon the occurrence of
certain events. If borrowing costs are higher than the yields on the assets
financed with such funds, the Company's ability to acquire or fund additional
assets may be substantially reduced and it may experience losses. These
short-term borrowings consist of the Company's lines of credit and repurchase
agreements. These borrowings are paid down as the Company securitizes or sells
loans.
A substantial portion of the assets of the Company are pledged to secure
indebtedness incurred by the Company. Accordingly, those assets would not be
available for distribution to any general creditors or the stockholders of the
Company in the event of the Company's liquidation, except to the extent that the
value of such assets exceeds the amount of the indebtedness they secure.
Lines of Credit
At September 30, 1997, the Company had three credit facilities aggregating
$500 million to finance loan fundings of which $300 million expires in 1997 and
$200 million expires in 1998. One of these facilities includes several sublines
aggregating $300 million to serve various purposes, such as multifamily loan
fundings, working capital, and manufactured housing loan fundings, which may
not, in the aggregate, exceed the overall facility commitment of $100 million at
any time. Unsecured working capital borrowings under this facility are limited
to $30 million. The Company expects that these credit facilities will be
renewed, if necessary, at their respective expiration dates, although there can
be no assurance of such renewal. The lines of credit contain certain financial
covenants which the Company met as of September 30, 1997. However, changes in
asset levels or results of operations could result in the violation of one or
more covenants in the future.
Repurchase Agreements
The Company finances the majority of its investments through collateralized
bonds and repurchase agreements. Collateralized bonds are non-recourse to the
Company. Repurchase agreements allow the Company 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 September 30, 1997, the Company had outstanding
obligations of $1.1 billion under such repurchase agreements. As of September
30, 1997, $417.9 million of various classes of collateralized bonds issued by
the Company have been retained by the Company and have been pledged as security
for $429.5 million of such repurchase agreements. For financial statement
presentation purposes, the Company has classified these $429.5 million of
repurchase agreements, secured by collateralized bonds, as collateralized bonds
outstanding. The remainder of the repurchase agreements were secured by ARM
securities -- $624.3 million, fixed-rate securities -- $20.6 million, other
mortgage securities -- $5.0 and loans held for securitization -- $41.0 million.
Increases in either short-term interest rates or long-term interest rates
could negatively impact the valuation of mortgage securities and may limit the
Company's borrowing ability or cause various lenders to initiate margin calls
for mortgage securities financed using repurchase agreements. Additionally,
certain of the Company's ARM securities are AAA or AA rated classes that are
subordinate to related AAA rated classes from the same series of securities.
Such AAA or AA rated classes 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
mortgage loans. In instances of a downgrade of an insurer or the deterioration
of the credit quality of the underlying mortgage collateral, the Company may be
required to sell certain portfolio assets 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. Collateral for collateralized bonds
are not subject to margin calls.
To reduce the Company's exposure to changes in short-term interest rates on
its repurchase agreements, the Company may lengthen the duration of its
repurchase agreements secured by mortgage securities by entering into certain
futures and/or option contracts. As of September 30, 1997, the Company had no
such financial futures or option contracts outstanding.
Total recourse debt, which consists of repurchase agreements, notes payable
and payable for investments purchased, and which excludes collateralized bonds,
increased slightly from $1.8 billion for June 30, 1997 to $1.9 billion for
September 30, 1997 as a result of new borrowings on loans funded during the
third quarter 1997. Total recourse debt should decline during the fourth quarter
as the Company securitizes a large portion of loans held for securitization.
Total Recourse Debt
($ in millions)
Potential immediate sources of liquidity for the Company include cash
balances and unused availability on the credit facilities described above. The
potential immediate sources of liquidity increased 156% during the third quarter
of 1997 in comparison to the prior quarter due to the issuance of $100 million
of senior notes during July, which were used to pay down such short-term
borrowings related to financing loans held for securitization during the
accumulation period.
Potential Immediate Sources of Liquidity
($ in millions)
Unsecured Borrowings
The Company issued two series of unsecured notes payable totaling $50 million
in 1994. The proceeds from this issuance were used for general corporate
purposes. These notes payable have an outstanding balance at September 30, 1997
of $44 million. Principal payments are made annually in October, with quarterly
interest payments due. The notes mature between 1999 and 2001 and bear fixed
interest rates of 9.56% and 10.03%, respectively. The Company also has various
acquisition notes payable totaling $1.6 million at September 30, 1997.
On July 14, 1997, the Company issued $100 million of senior unsecured notes
maturing on July 15, 2002. The notes bear a fixed interest of 7.875% and
semi-annual interest payments in arrears on January 15 and July 15, commencing
on January 15, 1998. The net proceeds were initially used to reduce short-term
debt related to financing loans held for securitization during the accumulation
period.
The note agreements contain certain financial covenants which the Company met
as of September 30, 1997. However, changes in asset levels or results of
operations could result in the violation of one or more covenants in the future.
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 consumer demand for
manufactured housing, multifamily housing and other products which it finances.
A material decline in demand for these products and services would result in a
reduction in the volume of loans originated by the Company. The risk of defaults
and credit losses could increase during an economic slowdown or recession. This
could have an adverse effect on the Company's financial performance and the
performance on the Company's securitized loan pools.
Capital Resources. The Company relies on various credit facilities and
repurchase agreements with certain investment banking firms to help meet the
Company's short-term funding needs. The Company believes that as these
agreements expire, they will continue to be available or will be able to be
replaced; however no assurance can be given as to such availability or the
prospective terms and conditions of such agreements or replacements.
Interest Rate Fluctuations. The Company's income depends on its ability to
earn greater interest on its investments than the interest cost to finance these
investments. Interest rates in the markets served by the Company generally rise
or fall with interest rates as a whole. A majority of the loans currently
originated by the Company are fixed-rate. The profitability of a particular
securitization may be reduced if interest rates increase substantially before
these loans are securitized. In addition, the majority of the investments held
by the Company are variable rate collateral for collateralized bonds and
adjustable-rate investments. These investments are financed through non-recourse
long-term collateralized bonds and recourse short-term repurchase agreements.
The net interest spread for these investments could decrease during a period of
rapidly rising interest rates, since the investments generally have periodic
interest rate caps and the related borrowing have no such interest rate caps.
Defaults. Defaults by borrowers on loans retained by the Company may have an
adverse impact on the Company's financial performance, if actual credit losses
differ materially from estimates made by the Company at the time of
securitization. The allowance for losses is calculated on the basis of
historical experience and management's best estimates. Actual defaults may
differ from the Company's estimate as a result of economic conditions. Actual
defaults on ARM loans may increase during a rising interest rate environment.
The Company believes that its reserves are adequate for such risks.
Prepayments. Prepayments by borrowers on loans retained by the Company may
have an adverse impact on the Company's financial performance, if prepayments
differ materially from estimates made by the Company. The prepayment rate is
calculated on the basis of historical experience and management's best
estimates. Actual rates of prepayment may vary as a result of the prevailing
interest rate. Prepayments are expected to increase during a declining interest
rate environment. The Company's exposure to more rapid prepayments is (i) the
faster amortization of premium on the investments 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's market
share within the industry and hamper the Company's efforts to expand its
production sources.
Regulatory Changes. The Company's business is subject to federal and state
regulation which, among other things require the Company to maintain various
licenses and qualifications and require specific disclosures to borrowers.
Changes in existing laws and regulations or in the interpretation thereof, or
the introduction of new laws and regulations, could adversely affect the
Company's operation and the performance of the Company's securitized loan pools.
New Production Sources. The Company has expanded both its manufactured
housing and commercial lending businesses. The Company is incurring or will
incur expenditures related to the start-up of these businesses, with no
guarantee that production targets set by the Company will be met or that these
businesses will be profitable. Various factors such as economic conditions,
interest rates, competition and the lack of the Company's prior experience in
these businesses could all impact these new production sources.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
None
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/ Lynn K. Geurin
Lynn K. Geurin, Executive Vice
President and Chief Financial
Officer
(principal accounting officer)
Dated: November 14, 1997