-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ObeJ+xGBu49y0X2FbrmvzleW/5nUGa/Q5ceEpgbtQiysRMuxngX6AbgVk+lpdn4G onUWBukB1int1e51GWJ7iw== 0000826675-99-000014.txt : 19990518 0000826675-99-000014.hdr.sgml : 19990518 ACCESSION NUMBER: 0000826675-99-000014 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DYNEX CAPITAL INC CENTRAL INDEX KEY: 0000826675 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 521549373 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-09819 FILM NUMBER: 99628622 BUSINESS ADDRESS: STREET 1: 10900 NUCKOLS ROAD STREET 2: SUITE 650 CITY: RICHMOND STATE: VA ZIP: 23060 BUSINESS PHONE: 8049675800 MAIL ADDRESS: STREET 1: 10900 NUCKOLS ROAD STREET 2: SUITE 650 CITY: RICHMOND STATE: VA ZIP: 23060 FORMER COMPANY: FORMER CONFORMED NAME: RESOURCE MORTGAGE CAPITAL INC/VA DATE OF NAME CHANGE: 19930722 FORMER COMPANY: FORMER CONFORMED NAME: RESOURCE MORTGAGE INVESTMENT CORP DATE OF NAME CHANGE: 19930505 FORMER COMPANY: FORMER CONFORMED NAME: RAC MORTGAGE INVESTMENT CORP /VA/ DATE OF NAME CHANGE: 19930505 10-Q 1 DYNEX CAPITAL, INC. 10-Q QTR. ENDED 3-31-99 =============================================================================== 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 March 31, 1999 |_| 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 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 April 30, 1999, the registrant had 46,032,949 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 March 31, 1999 and December 31, 1998........................................................3 Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998............................................4 Consolidated Statement of Shareholders' Equity for the three months ended March 31, 1999....................................5 Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998...........................6 Notes to Unaudited Consolidated Financial Statements...............................................................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..............................................................14 Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................................................38 PART II. OTHER INFORMATION Item 1. Legal Proceedings ................................................................................41 Item 2. Changes in Securities and Use of Proceeds...............................................................41 Item 3. Defaults Upon Senior Securities.............................................................41 Item 4. Submission of Matters to a Vote of Security Holders................................................................41 Item 5. Other Information............................................................41 Item 6. Exhibits and Reports on Form 8-K.......................................41 SIGNATURES......................................................................42
PART I. FINANCIAL INFORMATION Item 1. Financial Statements DYNEX CAPITAL, INC. CONSOLIDATED BALANCE SHEETS (amounts in thousands except share data)
March 31, December 31, ASSETS 1999 1998 ------------------ ------------------ Investments: Collateral for collateralized bonds $ 4,160,921 $ 4,293,528 Securities 238,932 243,984 Other investments 34,653 30,371 Loans held for securitization 238,550 388,782 ------------------ ------------------ 4,673,056 4,956,665 Investments in and advances to Dynex Holding, Inc. 184,118 169,384 Cash 28,716 30,103 Accrued interest receivable 3,293 4,162 Other assets 16,812 18,488 ================== ================== $ 4,905,995 $ 5,178,802 ================== ================== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Non-recourse debt $ 3,653,751 $ 3,665,316 Recourse debt: Secured by collateralized bonds retained 197,698 298,695 Secured by investments 455,801 588,735 Unsecured 127,922 145,303 ------------------ ------------------ ------------------ ------------------ 4,435,172 4,698,049 Accrued interest payable 4,732 8,403 Accrued expenses and other liabilities 11,935 16,318 Dividends payable 3,228 3,228 ------------------ ----------------- 4,455,067 4,725,998 ------------------ ------------------ SHAREHOLDERS' EQUITY Preferred stock, par value $.01 per share, 50,000,000 shares authorized: 9.75% Cumulative Convertible Series A, 1,309,061 and 1,309,061 issued and outstanding, respectively 29,900 29,900 9.55% Cumulative Convertible Series B, 1,912,434 and 1,912,434 issued and outstanding, respectively 44,767 44,767 9.73% Cumulative Convertible Series C, 1,840,000 and 1,840,000 issued and outstanding, respectively 52,740 52,740 Common stock, par value $.01 per share, 100,000,000 shares authorized, 46,030,814 and 46,027,426 issued and outstanding, respectively 460 460 Additional paid-in capital 352,331 352,382 Accumulated other comprehensive loss (3,953) (3,097) Accumulated deficit (25,317) (24,348) ------------------ ------------------ 450,928 452,804 ------------------ ------------------ $ 4,905,995 $ 5,178,802 ================== ================== See notes to unaudited consolidated financial statements.
DYNEX CAPITAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (amounts in thousands except share data)
Three Months Ended March 31, ----------------------------------- 1999 1998 --------------- --------------- Interest income: Collateral for collateralized bonds $ 71,238 $ 71,580 Securities 4,590 15,029 Other investments 584 1,317 Loans held for securitization 7,373 6,754 Net advances to Dynex Holding, Inc. 3,333 2,352 --------------- --------------- 87,118 97,032 --------------- --------------- Interest and related expense: Non-recourse debt 55,207 57,915 Recourse debt 16,175 20,065 Other 730 426 --------------- --------------- 72,112 78,406 --------------- --------------- Net interest margin before provision for losses 15,006 18,626 Provision for losses (3,793) (1,480) --------------- --------------- Net interest margin 11,213 17,146 Equity in net (loss) earnings of Dynex Holding, Inc. (369) 391 (Loss) gain on sale of investments and trading activities (926) 4,464 Other income 1,359 419 --------------- --------------- Net revenue 11,277 22,420 General and administrative expenses (2,008) (2,375) Net administrative fees and expenses to Dynex Holding, Inc. (5,924) (5,613) --------------- --------------- Income before extraordinary item 3,345 14,432 Extraordinary item - loss on extinguishment of debt (1,086) - --------------- --------------- Net income after extraordinary item 2,259 14,432 Dividends on preferred stock (3,228) (3,287) =============== =============== Net (loss) income available to common shareholders $ (969) $ 11,145 =============== =============== Per common share before extraordinary item: Basic $ - $ 0.25 =============== =============== Diluted $ - $ 0.25 =============== =============== Per share after extraordinary item: Basic $ (0.02) $ 0.25 =============== =============== Diluted $ (0.02) $ 0.25 =============== =============== See notes to unaudited consolidated financial statements.
DYNEX CAPITAL, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY For the three months ended March 31, 1999 (amounts in thousands)
Accumulated Additional Other Preferred Common Paid-in Comprehensive Accumulated Stock Stock Capital Loss Deficit Total ---------------------------------------------------------------------------------- Balance at December 31, 1998 $ 127,407 $ 460 $ 352,382 $ (3,097) $ (24,348) $ 452,804 Comprehensive income: Net income - three months ended March 31, 1999 - - - - 2,259 2,259 Change in net unrealized loss on investments classified as available-for-sale during the period - - - (856) - (856) ---------------------------------------------------------------------------------- Total comprehensive income - - - (856) 2,259 1,403 Issuance of common stock - - 18 - - 18 Forfeitures of restricted stock awards - - (69) - - (69) Dividends on preferred stock - - - - (3,228) (3,228) ---------------------------------------------------------------------------------- Balance at March 31, 1999 $ 127,407 $ 460 $ 352,331 $ (3,953) $ (25,317) $ 450,928 ================================================================================== See notes to unaudited consolidated financial statements.
DYNEX CAPITAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended ---------------------------------------- (amounts in thousands) March 31, 1999 1998 ------------------ ------------------ Operating activities: Net (loss) income $ (969) $ 11,145 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Provision for losses 3,793 1,480 Net loss (gain) on sale of investments and trading activities 926 (4,464) Equity in loss (earnings) of Dynex Holding, Inc. 369 (391) Amortization and depreciation 9,868 13,225 Net increase in accrued interest, other assets and other (6,430) (1,212) liabilities ------------------ ------------------ Net cash provided by operating activities 7,557 19,783 ------------------ ------------------ Investing activities: Collateral for collateralized bonds: Fundings of investments subsequently securitized (280,783) - Principal payments on collateral 396,198 533,702 Decrease in accrued interest receivable 2,987 3,636 Net increase in funds held by trustee (1,090) (56) Net decrease (increase) in loans held for securitization 149,210 (836,603) Purchase of other investments (7,237) (1,627) Payments received on other investments 2,997 5,339 Purchase of securities (23,513) (462,083) Payments received on securities 20,045 19,752 Proceeds from sales of securities 16,181 - Investment in and advances to Dynex Holding, Inc. (15,103) (15,119) Proceeds from sale of single family operations - 9,500 Capital expenditures (6) (110) ------------------ ------------------ Net cash provided by (used for) investing activities 259,886 (743,669) ------------------ ------------------ Financing activities: Collateralized bonds: Proceeds from issuance of bonds 372,189 - Principal payments on bonds (388,763) (541,962) Increase (decrease) in accrued interest payable 2,858 (1,642) (Repayments of) proceeds from recourse debt borrowings, net (251,904) 1,291,503 Net proceeds from issuance of common stock 18 2,760 Retirement of common stock - (118) Dividends paid (3,228) (19,493) ------------------ ------------------ Net cash (used for) provided by financing activities (268,830) 731,048 ------------------ ------------------ Net (decrease) increase in cash (1,387) 7,162 Cash at beginning of year 30,103 18,502 ================== ================== Cash at end of year $ 28,716 $ 25,664 ================== ================== Cash paid for interest $ 70,691 $ 76,378 ================== ================== Supplemental disclosure of non-cash activities: Collateral for collateralized bonds subsequently securitized $ 1,161,475 $ - ================== ================== See notes to unaudited consolidated financial statements.
DYNEX CAPITAL, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS March 31, 1999 (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"). The loan production operations are primarily conducted through Dynex Holding, Inc. ("DHI"), a taxable affiliate of Dynex REIT. Dynex REIT owns all the outstanding non-voting preferred stock of DHI which represents a 99% economic ownership interest in DHI. Prior to December 1998, Dynex REIT had consolidated DHI for financial reporting purposes. 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. Dynex REIT has revised the 1998 accompanying financial statements to give retroactive effect to the change in accounting method during 1998. The accounting change had no impact on net income. Under the equity 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 Sheets at March 31, 1999 and December 31, 1998, the Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998, the Consolidated Statement of Shareholders' Equity for the three months ended March 31, 1999, the Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998 and related notes to consolidated financial statements are unaudited. Operating results for the three months ended March 31, 1999 are not necessarily indicative of the results that may be expected for the year ending December 31, 1999. 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, 1998. Certain reclassifications have been made to the financial statements for 1998 to conform to presentation for 1999. NOTE 2--EARNINGS PER SHARE Earnings per share ("EPS") as shown on the consolidated statements of operations for the three months ended March 31, 1999 and 1998 is presented on both a basic and diluted EPS basis. Diluted EPS 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 of the Company's common stock in May 1997, the preferred stock is convertible into two shares of common stock for one share of preferred stock. The following table reconciles the numerator and denominator for both the basic and diluted EPS for the three months ended March 31, 1999 and 1998.
- ------------------------------------------------------------------------------------------------------------------------ Three Months Ended March 31, ------------------------------------------------------------------ 1999 1998 - ------------------------------------------------------------------------------------------------------------------------ Weighted-Average Weighted-Average Number of Number of Shares Shares Income Income ------------- ------------- ------------- ---------------- Income before extraordinary item $ 3,345 $ 14,432 Extraordinary item - loss on extinguishment of debt (1,086) - ------------- ------------- Net income after extraordinary item 2,259 14,432 Less: Dividends paid to preferred stock (3,228) (3,287) ------------- ------------- ------------- ------------- Basic and diluted $ (969) 46,029,722 $ 11,145 45,421,134 ============= ============= ============= ============= Earnings per share before extraordinary item: Basic EPS $ - $ 0.25 ============= ============= Diluted EPS $ - $ 0.25 ============= ============= Earnings per share after extraordinary item: Basic EPS $ (0.02) $ 0.25 ============= ============= Diluted EPS $ (0.02) $ 0.25 ============= ============= Reconciliation of anti-dilutive shares: Dividends and additional shares of preferred stock: Series A $ 766 2,618,122 $ 794 2,707,591 Series B 1,119 3,824,868 1,150 3,872,464 Series C 1,343 3,680,000 1,343 3,680,000 Expense and incremental shares of stock appreciation rights 2 115,056 500 170,812 ------------- ------------- ------------- ------------- $ 3,230 10,238,046 $ 3,787 10,430,867 ============= ============= ============= ============= - -------------------------------------------------------------------------------------------------------------------------
NOTE 3--COLLATERAL FOR COLLATERALIZED BONDS AND SECURITIES The following table summarizes Dynex REIT's amortized cost basis and fair value of investments, as of March 31, 1999 and December 31, 1998, classified as available-for-sale and the related average effective interest rates:
- --------------------------------------------------------------------------------------------------------------------- March 31, 1999 December 31, 1998 - --------------------------------------------------------------------------------------------------------------------- Effective Effective Interest Interest Fair Value Rate Fair Value Rate - --------------------------------------------------------------------------------------------------------------------- Collateral for collateralized bonds: Amortized cost $ 4,157,223 7.1% $ 4,288,520 7.5% Allowance for losses (15,970) (16,593) - ------------------------------------------ ---------------- ------------- ----------------- ---------------- Amortized cost, net 4,141,253 4,271,927 Gross unrealized gains 62,454 67,236 Gross unrealized losses (42,786) (45,635) - ------------------------------------------ ---------------- ------------- ----------------- ---------------- $ 4,160,921 $ 4,293,528 - ------------------------------------------ ---------------- ------------- ----------------- ---------------- Securities: Funding notes $ 131,801 7.8% $ 122,009 8.0% Adjustable-rate mortgage securities 52,753 6.0% 58,935 6.2% Fixed-rate mortgage securities 13,813 8.4% 28,851 8.3% Derivative and residual securities 29,296 1.9% 33,480 2.9% Other securities 37,537 6.5% 28,153 7.5% - ------------------------------------------ ---------------- ------------- ----------------- ---------------- 265,200 271,428 Allowance for losses (2,647) (2,746) --------------------------------------- ---------------- ------------- ----------------- ---------------- Amortized cost, net 262,553 268,682 Gross unrealized gains 1,675 1,566 Gross unrealized losses (25,296) (26,264) - ------------------------------------------ ---------------- ------------- ----------------- ---------------- $ 238,932 $ 243,984 - ------------------------------------------ ---------------- ------------- ----------------- ----------------
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 and manufactured housing installment loans secured by either a UCC filing or a motor vehicle title. 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 principal amount of collateral pledged in excess of the related collateralized bonds issued, as the collateralized bonds issued by the limited-purpose finance subsidiaries are non-recourse to Dynex REIT. During the three months ended March 31, 1999, Dynex REIT securitized $1.4 billion of collateral, through the issuance of one series of collateralized bonds. The collateral securitized was primarily single-family mortgage loans and manufactured housing loans. The securitization was accounted for as 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. Securities. Funding notes consist of fixed-rate funding notes secured by fixed-rate automobile installment contracts. 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. Other securities consists primarily of a corporate bond purchased by Dynex REIT. Sale of Investments. Securities with an aggregate principal balance of $15,971 were sold during the three months ended March 31, 1999 for an aggregate gain of $210. The specific identification method is used to calculate the basis of securities sold. Gain on sale of investments and trading activities also includes realized losses of $2,051 related to the sale or writedown of $10,764 of commercial loans during the three months ended March 31, 1999 and realized gains of $431 on various trading positions entered into during the three months ended March 31, 1999. There were no open trading positions at March 31, 1999. The Company uses estimates in establishing fair value for its financial instruments. Estimates of fair value for financial instruments may be based on market prices provided by certain dealers. Estimates of fair value for certain other financial instruments are determined by calculating the present value of the projected cash flows of the instruments using appropriate discount rates, prepayment rates and credit loss assumptions. The discount rates used are based on management's estimates of market rates, and the cash flows are projected utilizing the current interest rate environment and forecasted prepayment rates. Estimates of fair value for other financial instruments are based primarily on management's judgment. Since the fair value of the Company's financial instruments is based on estimates, actual gains and losses recognized may differ from those estimates recorded in the consolidated financial statements. NOTE 4 -- RECOURSE DEBT Dynex REIT utilizes repurchase agreements, notes payable and warehouse credit facilities (together, "recourse debt") to finance certain of its investments. The following table summarizes Dynex REIT's recourse debt outstanding at March 31, 1999 and December 31, 1998:
- ----------------------------------------------------- ------------------- ----------------- March 31, 1999 December 30, 1998 - ----------------------------------------------------- ------------------- ----------------- Recourse debt secured by: Collateralized bonds $ 197,698 $ 298,695 Securities 178,723 192,706 Other investments 165,353 142,883 Loans held for securitization 109,160 250,589 Other assets 2,565 2,557 ---------------- ---------------- 653,499 887,430 Unsecured debt: 7.875% senior notes 98,808 98,718 Series B 10.03% senior notes 26,135 26,116 Series A 9.56% senior notes 2,979 2,969 Bank credit facility - 17,500 - ----------------------------------------------------- ---------------- ---------------- $ 781,421 $ 1,032,733 - ----------------------------------------------------- ---------------- ----------------
Of the $653,499 of secured recourse debt outstanding at March 31, 1999, $271,704 was outstanding under repurchase agreements, $379,230 represented amounts outstanding under committed credit facilities and $2,565 represented amounts outstanding under a capital lease. NOTE 5 -- 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. FAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company is in the process of determining the impact of adopting FAS No. 133. NOTE 6 -- 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. Dynex REIT may also enter into forward delivery contracts and interest rate futures and options contracts for hedging interest rate risk associated with commitments made to fund loans. Gains and losses on such contracts are either (i) deferred as an adjustment to the carrying value of the related loans until the loan has been funded and securitized in a collateralized bond structure, after which the gains or losses will be amortized into income over the remaining life of the loan using a method that approximates the effective yield method, or (ii) deferred until such time as the related loans are funded and sold. 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. 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 7 - EMPLOYEE BENEFITS During the three months ended March 31, 1999, 14,215 Stock Appreciation Rights ("SARs") under the Employee Incentive Plan were forfeited. No SARs were awarded or exercised during the first quarter of 1999. The total SARs remaining to be exercised were 864,565 at March 31, 1999. The Company expensed $2 related to the Employee and Board Incentive Plans during the three months ended March 31, 1999. 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 mortgage loans, and could incur losses. In the opinion of management, no material losses are expected to result from any such representations and warranties. Dynex REIT facilitates the issuance of tax-exempt multifamily housing bonds, the proceeds of which are used to fund mortgage loans on multifamily properties. Dynex REIT is required to pay principal and interest to the bondholders in the event there is a payment shortfall from the construction proceeds. In addition, Dynex REIT is required to purchase the bonds if such bonds are not able to be remarketed by the remarketing agent. Therefore, Dynex REIT enters into standby letter of credit agreements to cover such commitments. At March 31, 1999, Dynex REIT provided letters of credit to support its obligations in amounts equal $147,451. NOTE 9 -- 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 production 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 March 31, 1999 and December 31, 1998 , net borrowings due to DHI under this agreement totaled $10,635 and $8,583, respectively. Net interest expense under this agreement was $26 and $142 for the three months ended March 31, 1999 and 1998, respectively. Dynex REIT also has a loan origination agreement with Dynex Financial, Inc. ("DFI"), an operating subsidiary of DHI, whereby Dynex REIT pays DFI on a fee plus cost basis for the origination of manufactured housing loans on behalf of Dynex REIT. During the three months ended March 31, 1999 and 1998, Dynex REIT paid DFI $4,439 and $3,713, respectively under such agreement. Dynex REIT has a funding agreement with Dynex Commercial, Inc. ("DCI"), an operating subsidiary of DHI, whereby Dynex REIT pays DCI a fee per commercial loan originated on behalf of Dynex REIT. Dynex REIT paid DCI $844 and $1,632, respectively under this agreement for the three months ended March 31, 1999 and 1998. Dynex REIT has various note agreements with Dynex Residential, Inc. ("DRI"), an operating subsidiary of DHI, and DRI's subsidiaries whereby DRI and its subsidiaries can 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 is adjustable and is based on 30-day LIBOR plus 2.875%. The outstanding balance of the note as of March 31, 1999 and December 31, 1998 was $177,498 and $159,377, respectively. Interest income recorded by Dynex REIT for the three months ended March 31, 1999 and 1998 was $3,360 and $2,493, respectively. Dynex REIT has entered into subservicing agreements with DCI and DFI to service commercial, single family, consumer and manufactured housing loans. For servicing the commercial loans, DCI 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 receives annual fees of ranging from sixty dollars ($60) to one hundred forty-four dollars ($144) per loan and certain incentive fees. Servicing fees paid by Dynex REIT under such agreements were $550 and $141 during the three months ended March 31, 1999 and 1998, respectively. Dynex REIT through its ownership of preferred stock, has a 99% economic ownership interest in DHI. NOTE 10 -- INVESTMENT IN AND ADVANCES TO DYNEX HOLDING, INC. In December 1998, Dynex REIT changed its method of accounting for its investment in DHI from the full consolidation method to a method that approximates the equity method. The accounting change had no impact on net income. For consistency purposes, Dynex REIT has revised the March 1998 financial statements to give retroactive effect to the change in accounting method. Investments in and advances to DHI accounted for under a method similar to the equity method amounted to $184,118 and $169,384 at March 31, 1999 and December 31, 1998, respectively. The results of operations and financial position of DHI are summarized below:
- --------------------------------------------------------------------------------------------- Three Months ended March 31, Condensed Income Statement Information 1999 1998 - --------------------------------------------------------------------------------------------- Total revenues $ 11,049 $ 9,671 Total expenses 11,421 9,276 Net (loss) income (372) 395 - --------------------------------------------------------------------------------------------- March 31, December 31, Condensed Balance Sheet Information 1999 1998 - --------------------------------------------------------------------------------------------- Total assets $ 225,737 $ 203,541 Total liabilities 207,753 184,267 Total equity 17,984 19,274 - ---------------------------------------------------------------------------------------------
NOTE 11 -- OTHER MATTERS During the three months ended March 31, 1999, the Company issued 3,388 shares of its common stock pursuant to its dividend reinvestment program for net proceeds of $18. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Dynex Capital, Inc. (the "Company") is a financial services company that originates primarily mortgage loans secured by multifamily and commercial properties and loans secured by manufactured homes. The Company will generally securitize the loans funded as collateral for collateralized bonds, thereby limiting its credit and liquidity risk and providing long-term financing for its investment portfolio. FINANCIAL CONDITION
- ------------------------------------------------------------------------------------------- March 31, December 31, (amounts in thousands except per share data) 1999 1998 - ------------------------------------------------------------------------------------------- Investments: Collateral for collateralized bonds $ 4,160,921 $ 4,293,528 Securities 238,932 243,984 Other investments 34,653 30,371 Loans held for securitization 238,550 388,782 Non-recourse debt - collateralized bonds 3,653,751 3,665,316 Recourse debt 781,421 1,032,733 Shareholders' equity 450,928 452,804 Book value per common share 6.90 6.94 - -------------------------------------------------------------------------------------------
Collateral for collateralized bonds Collateral for collateralized bonds consists primarily of securities backed by adjustable-rate and fixed-rate mortgage loans secured by first liens on single family properties, fixed-rate loans secured by first liens on multifamily and commercial properties, manufactured housing installment loans secured by either a UCC filing or a motor vehicle title and property tax receivables. As of March 31, 1999, the Company had 28 series of collateralized bonds outstanding. The collateral for collateralized bonds decreased to $4.2 billion at March 31, 1999 compared to $4.3 billion at December 31, 1998. This decrease of $0.1 billion is primarily the result of $396.2 million in paydowns on collateral, which was principally offset by the net addition of $0.3 million of collateral as a result of a $1.4 billion issuance of collateralized bonds in March 1999, of which $1.2 billion related to the collapse and re-securitization of seven series of previously issued collateralized bonds. Securities Securities consist primarily of fixed-rate "funding notes" secured by automobile installment contracts, adjustable-rate and fixed-rate mortgage-backed securities, and corporate bonds. 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 $238.9 million at March 31, 1999 compared to $244.0 million at December 31, 1998. This decrease was primarily the result of $20.0 million of paydowns and the sale of $16.0 million of securities during the three months ended March 31, 1999. These decreases were partially offset by the purchase of $23.5 million of securities during the three months ended March 31, 1999. Other investments Other investments consists primarily of a note receivable received in connection with the sale of the Company's single family mortgage operations in May 1996 and property tax receivables. Other investments increased from $30.4 million at December 31, 1998 to $34.7 million at March 31, 1999. This increase of $4.3 million is primarily the result of the purchase of $4.7 million of property tax receivables during the three months ended March 31, 1999. Loans held for securitization Loans held for securitization decreased from $388.8 million at December 31, 1998 to $238.6 million at March 31, 1999. This decrease was due to the securitization of $277.7 million of loans held for securitization as collateral for collateralized bonds issued during March 1999. This decrease was partially offset by new loan fundings from the Company's production operations totaling $155.1 million during the three months ended March 31, 1999. Non-recourse debt Collateralized bonds issued by Dynex REIT are recourse only to the assets pledged as collateral, and are otherwise non-recourse to Dynex REIT. Compared to December 31, 1998, the collateralized bonds remained essentially unchanged at $3.7 billion at March 31, 1999. During the first three months of 1999, Dynex REIT added $1.4 billion of collateralized bonds, of which $1.0 billion related to the collapse and re-securitization of seven series of collateralized bonds. This increase was offset by the paydowns on all collateralized bonds of $388.8 million during the three months ended March 31, 1999. Recourse debt Recourse debt decreased to $0.8 billion at March 31, 1999 from $1.0 billion at December 31, 1998. This decrease was primarily due to the securitization of $277.7 million of manufactured housing loans. These loans were previously financed by $190.7 million of repurchase agreements and $57.5 million of notes payable, as collateral for collateralized bonds during the three months ended March 31, 1999. This decrease was partially offset by the net addition of $62.6 million of notes payable resulting from additional loan fundings during the first quarter. Shareholders' equity Shareholders' equity decreased to $450.9 million at March 31, 1999 from $452.8 million at December 31, 1998. This decrease was primarily the result of a $0.9 million increase in the net unrealized loss on investments available-for-sale from $3.1 million at December 31, 1998 to $4.0 at March 31, 1999. Additionally, during the three months ended March 31, 1999, the dividends declared by Dynex REIT exceeded its earnings (based on generally accepted accounting principles) by $1.0 million, resulting in a decline in shareholders' equity of such amount. Loan Production Activity ($ in thousands)
--------------------------------------------------------------------------------------- Three Months Ended March 31, --------------------------------- 1999 1998 --------------------------------------------------------------------------------------- Commercial (1) $ 48,658 $ 203,339 Manufactured housing 108,972 83,948 Specialty finance 48,363 33,403 --------------------------------- Total fundings through direct production 205,993 320,690 Secured funding notes (2) 13,654 - Securities acquired through bond calls - 288,930 Single family fundings through bulk purchases - 562,045 --------------------------------------------------------------------------------------- Total fundings $ 219,647 $ 1,171,665 --------------------------------------------------------------------------------------- (1) Included in commercial fundings were $25.2 million and $32.7 million of multifamily construction loans which closed during the three months ended March 31, 1999 and 1998, respectively. As of March 31, 1999, $303.0 million of multifamily construction loans have closed, of which only the amount drawn for these loans of $66.0 million is included in the balance of the loans held for securitization at March 31, 1999. (2) Secured by automobile installment contracts.
Direct loan production for the first three months of 1999 totaled $206.0 million compared to $320.7 million for the same period in 1998. This decrease in loan production was due to decreased origination volume of commercial loans during 1999. This decreased volume was partially offset by increased origination volume of both manufactured housing loans and specialty finance loans during 1999. Additionally, the Company funded $13.7 million of funding notes during the three months ended March 31, 1999. There were no bulk purchases or bond calls during the first three months of 1999 compared to $562.0 million of bulk purchases and $288.9 million of bond calls during the same period in 1998. RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------------------------- Three Months Ended March 31, ----------------------------------- (amounts in thousands except per share information) 1999 1998 - -------------------------------------------------------------------------------------------------- Net interest margin $ 11,213 $ 17,146 Equity in net (loss) earnings of Dynex Holding, Inc. (369) 391 (Loss) gain on sale of investments and trading activities (926) 4,464 General and administrative expenses 2,008 2,375 Net administrative fees and expenses to Dynex Holding, Inc. 5,924 5,613 Net income 2,259 14,432 Basic net income per common share (0.02) 0.25 Diluted net income per common share (0.02) 0.25 Dividends declared per share: Common $ - $ 0.30 Series A and B Preferred 0.585 0.60 Series C Preferred 0.730 0.73 - --------------------------------------------------------------------------------------------------
Three Months Ended March 31, 1999 Compared to Three Months Ended March 31, 1998. The decrease in net income during the three months ended March 31, 1999 as compared to the same period in 1998 is primarily the result of a decrease in net interest margin and a decrease in the gain on sale of investments and trading activities. The decrease in net income per common share during the three months ended March 31, 1999 as compared to the same period in 1998 is primarily the result of the decrease in net income for the first quarter of 1999. Net interest margin for the three months ended March 31, 1999 decreased to $11.2 million, or 35% below the $17.1 million for the same period for 1998. This decrease was primarily the result of the net interest spread on the investment portfolio decreasing to 1.07% for the three months ended March 31, 1999 from 1.19% for the three months ended March 31, 1998. The decrease in the net interest spread for the three months ended March 31, 1999 relative to the same period in 1998 is primarily the result of the amortization of premium from the commercial securitization in December 1998 and the decline in yield on the loans underlying the collateral for collateralized bonds, which have reset to lower rates due to the 0.75% reduction in short-term interest rates in the latter half of 1998. Also, the investment portfolio continues to be impacted by prepayments, as average interest-earning assets declined from $5.1 billion in the first quarter of 1998 to $4.8 billion in the first quarter of 1999. In addition, provision for losses increased to $3.8 million or 0.31% on an annualized basis of average interest-earning assets during the three months ended March 31, 1999 compared to $1.5 million and 0.12% during the three months ended March 31, 1998. This increase in provision for losses was a result of increasing the provision for potential losses on the commercial loans that collateralize the securitization issued in December 1998 and increasing the reserves for potential losses on single family and manufactured housing loans. The (loss) gain on sale of investments and trading activities for the first quarter of 1998 decreased to a $0.9 million loss, as compared to a $4.5 million gain for the first quarter of 1998. This decrease is primarily the result of a $2.1 million loss related to the sale or writedown of $10.8 million of commercial loans during the three months ended March 31, 1999. This decrease was partially offset by a $0.2 million gain related to the sale of $16.0 million of securities and a $0.4 million gain on various trading positions closed during the three months ended March 31, 1999. The gain on sale of investments and trading activities for the first quarter of 1998 is primarily the result of gains recognized of $4.6 million on trading positions entered into during the first quarter of 1998. Net administrative fees and expenses to DHI increased $0.3 million, or 6%, to $5.9 million in the first quarter 1999. This increase is primarily the result of the continued growth in the Company's production operations, primarily in the manufactured housing business. The following table summarizes the average balances of interest-earning assets and their average effective yields, along with the average interest-bearing liabilities and the related average effective interest rates, for each of the periods presented. Average Balances and Effective Interest Rates
- ---------------------------------------------------------------------------------------------------------------- Three Months Ended March 31, ----------------------------------------------------------- 1999 1998 - ---------------------------------------------------------------------------------------------------------------- Average Effective Average Effective Balance Rate Balance Rate ---------------------------- ----------------------------- Interest-earning assets: (1) Collateral for collateralized bonds (2) (3) $ 3,974,145 7.17% $ 3,917,023 7.31% Securities 265,579 6.91 705,872 8.52 Other investments 205,000 7.69 197,749 7.71 Loans held for securitization 372,759 7.91 299,547 9.02 ---------------------------- ----------------------------- Total interest-earning assets $ 4,817,483 7.24% $ 5,120,191 7.59% ============================ ============================= Interest-bearing liabilities: Non-recourse debt (3) $ 3,512,582 6.20% $ 3,424,160 6.62% Recourse debt - collateralized bonds retained 285,406 5.49 501,937 5.88 ---------------------------- ----------------------------- 3,797,988 6.15 3,926,097 6.52 Recourse debt secured by investments: Securities 179,341 5.93 506,244 5.61 Other investments 152,081 5.98 78,218 7.01 Loans held for securitization 293,986 5.60 141,047 2.93 Recourse debt - unsecured 153,318 8.25 139,541 8.87 ================= =========== ============================= Total interest-bearing liabilities $ 4,576,714 6.17% $ 4,791,147 6.40% ================= =========== ============================= Net interest spread on all investments (3) 1.07% 1.19% =========== ============ Net yield on average interest-earning assets (3) 1.38% 1.60% =========== ============ - -------------------------------------------------------------------------------------------------------------------- (1) Average balances exclude adjustments made in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" to record available-for-sale securities at fair value. (2) Average balances exclude funds held by trustees of $1,898 and $2,190 for the three months ended March 31, 1999 and March 31, 1998, respectively. (3) Effective rates are calculated excluding non-interest related collateralized bond expenses and provision for credit losses.
The net interest spread declined to 1.07% for the three months ended March 31, 1999 from 1.19% for the same period in 1998. This decrease was primarily due to the amortization of premium from the commercial securitization in December 1998 and the decline in yield on ARM loans, which have reset to lower rates due to the 0.75% reduction in the target Federal Funds rate in the latter half of 1998. The overall yield on interest-earning assets also decreased to 7.24% for the three months ended March 31, 1999 from 7.59% for three months ended March 31, 1998 while the cost of interest-bearing liabilities decreased to 6.17% from 6.40% for the three months ended March 31, 1999 and 1998, respectively. Individually, the net interest spread on collateral for collateralized bonds increased 23 basis points, from 79 basis points for the three months ended March 31, 1998 to 102 basis points for the same period in 1999. This increase was primarily due to a 58 basis point decrease in the effective average one-month LIBOR from 5.74% for the quarter ended March 31, 1998 to 5.16% for the quarter ended March 31, 1999 since the ARM loans underlying the collateralized bonds take on average three to six months to adjust to lower interest rates. The net interest spread on securities decreased 193 basis points, from 291 basis points for the three months ended March 31, 1998 to 98 basis points for the three months ended March 31, 1999. This decrease was primarily the result of the sale of certain higher coupon collateral during the third quarter of 1998. In addition, certain assets were placed on non-accrual status subsequent to the first quarter of 1998. The net interest spread on other investments increased 101 basis points, from 70 basis points for the three months ended March 31, 1998, to 171 basis points for the same period in 1999, due to a higher interest rate paid by Dynex Residential, Inc. ("DRI"), an operating subsidiary of DHI, to Dynex REIT in conjunction with the Company's single family model home purchase and leaseback business, effective as of January 1, 1999. The net interest spread on loans held for securitization decreased 378 basis points, from 609 basis points from the three months ended March 31, 1998, to 231 basis points for the same period in 1999. This decrease is primarily attributable to higher borrowing costs under certain credit facilities, and the reduced benefit of compensating balance credits relative to the larger amount of recourse debt on loans held for securitization. Interest Income and Interest-Earning Assets Average interest-earning assets declined to $4.8 billion for the three months ended March 31, 1999, a decrease of approximately 6% from $5.1 billion of average interest-earning assets during the same period of 1998. This decrease in average interest-earning assets was primarily the result of $2.2 billion of principal payments during the twelve months ended March 31, 1999. In addition, $246.2 million of investments were sold during the same period. These decreases were partially offset by loans originations of $1.2 billion for the twelve months ended March 31, 1999. In addition, Dynex REIT purchased $176.3 million of securities and $79.4 million of other investments during the twelve months ended March 31, 1999. Dynex REIT also exercised call rights on $166.8 million of securities during the same period. Also, Dynex REIT purchased $562.0 million of single family loans through bulk purchases during the latter part of March 1998. Total interest income decreased approximately 10%, from $97.2 million for the three months ended March 31, 1998 to $87.1 million for the same period of 1999. This decrease in total interest income was due to both the decline in average interest-earnings assets and to a decline in the yield on interest-earning assets. Overall, the yield on interest-earning assets declined to 7.24% for the three months ended March 31, 1999 from 7.59% for the three months ended March 31, 1998, due primarily to an overall decrease in interest rates during the latter half of 1998 and the first quarter of 1999. Earning Asset Yield ($ in millions)
- ---------------------------- ---------------------------------------------------------------------- Average Interest- Average Interest- Interest Income Earnings Asset Yield Earning Assets (2) - ---------------------------- ---------------------------------------------------------------------- 1997, Quarter 2 $ 4,321.1 $ 84.9 (1) 7.86% 1997, Quarter 3 4,801.2 91.8 (1) 7.65% 1997, Quarter 4 5,143.0 99.2 (1) 7.72% 1998, Quarter 1 5,120.2 97.2 7.59% 1998, Quarter 2 5,780.5 110.0 7.61% 1998, Quarter 3 5,571.7 104.5 (1) 7.50% 1998, Quarter 4 5,138.3 95.9 7.46% 1999, Quarter 1 4,817.5 87.1 7.24% - ---------------------------- ---------------------------------------------------------------------- (1) Interest income includes amounts related to the gross interest income on certain securities which are accounted for net of the related interest expense. (2) Interest income excludes amounts related to the net interest income on advances to DHI.
Approximately $2.4 billion of the investment portfolio as of March 31, 1999 is comprised of loans or securities that have coupon rates which adjust over time (subject to certain periodic and lifetime limitations) in conjunction with changes in short-term interest rates. Approximately 63% of the ARM loans underlying the ARM securities and collateral for collateralized bonds are indexed to and reset based upon the level of six-month LIBOR; approximately 29% are indexed to and reset based upon the level of the one-year Constant Maturity Treasury (CMT) index. The following table presents a breakdown, by principal balance, of the Company's collateral for collateralized bonds and fixed and ARM mortgage securities by type of underlying loan. This table excludes other derivative and residual securities, other securities, other investments and loans held for securitization. Investment Portfolio Composition (1) ($ in millions)
- --------------------------- ------------------------------------------------------------------------------------------- Other Indicies LIBOR Based ARM CMT Based ARM Based Arm Loans Fixed-Rate Loans Loans Loans Total - --------------------------- ------------------------------------------------------------------------------------------- 1998, Quarter 1 $ 2,128.3 $ 656.1 $ 283.3 $ 1,564.2 $ 4,631.9 1998, Quarter 2 2,153.5 1,159.8 240.2 1,467.0 5,020.5 1998, Quarter 3 1,873.7 978.3 208.0 1,351.0 4,411.0 1998, Quarter 4 1,644.0 720.4 195.4 1,704.0 4,263.8 1999, Quarter 1 1,411.6 629.8 159.4 1,927.6 4,128.4 - --------------------------- ------------------------------------------------------------------------------------------- (1) Includes only the principal amount of collateral for collateralized bonds, ARM securities and fixed-rate mortgage securities.
The average asset yield is reduced for the amortization of premiums, net of discounts on the investment portfolio. As indicated in the table below, premiums on the collateral for collateralized bonds, ARM securities and fixed-rate mortgage securities at March 31, 1999 were $65.4 million, or approximately 1.57% of the aggregate investment portfolio. Of this $65.4 million, $37.4 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 declined to 1.46% for the three months ended March 31, 1999, from 1.56% for the same period in 1998 as the investment portfolio mix changed to assets funded at lower premiums, at par, or at a discount. The increase in the amortization expense as a percentage of principal paydowns from the fourth quarter 1998 is due to the multifamily and commercial securitization during the fourth quarter of 1998. The principal repayment rate for the Company (indicated in the table below as "CPR Annualized Rate") was approximately 38% for the three months ended March 31, 1999, which was a decrease from 47% one year ago. 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 securitization, which are carried at a net discount of $3.9 million at March 31, 1999. Premium Basis and Amortization ($ in millions)
- ------------------------------------------------------------------------------------------------------------------------- Amortization CPR Expense as a % of Amortization Annualized Principal Principal Paydowns Net Premium Expense Rate Paydowns - ------------------------------------------------------------------------------------------------------------------------- 1997, Quarter 2 $ 62.7 $ 4.0 30% $ 205.1 1.94% 1997, Quarter 3 57.9 4.8 29% 258.8 1.85% 1997, Quarter 4 56.9 5.8 37% 319.6 1.80% 1998, Quarter 1 49.5 8.5 47% 546.7 1.56% 1998, Quarter 2 45.7 7.0 36% 563.0 1.24% 1998, Quarter 3 39.0 6.3 40% 603.0 1.05% 1998, Quarter 4 77.8 5.7 41% 502.5 1.12% 1999, Quarter 1 65.4 5.9 38% 402.8 1.46% - -------------------------------------------------------------------------------------------------------------------------
Interest Expense and Cost of Funds Dynex REIT's largest expense is the interest cost on borrowed funds. Funds to finance the investment portfolio are borrowed primarily in the form of non-recourse collateralized bonds or repurchase agreements. The interest rates paid on collateralized bonds are either fixed or floating rates; the interest rates on the repurchase agreements are floating rates. Dynex REIT 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 they relate. Average borrowed funds decreased from $4.8 billion for the three months ended March 31, 1998 to $4.6 billion for the same period in 1999. This decrease resulted primarily from the decline in interest-earning assets of $0.3 billion during the twelve months ended March 31, 1999 and the paydown of the related borrowings. For the three months ended March 31, 1999, interest expense decreased to $70.6 million from $76.6 million for the three months ended March 31, 1998, while the average cost of funds decreased to 6.17% for the three months ended March 31, 1999 compared to 6.40% for the same period in 1998. The decreased average cost of funds for the first quarter of 1999 compared to the first quarter of 1998 was mainly a result of a decrease in the one-month LIBOR rate during the latter half of 1998. Cost of Funds ($ in millions)
- ---------------------------------------------------------------------------------------------- Average Interest Cost Borrowed Funds Expense (1)(2) of Funds - ---------------------------------------------------------------------------------------------- 1997, Quarter 2 $ 3,869.7 $ 61.3 6.34% 1997, Quarter 3 4,357.9 68.8 6.31% 1997, Quarter 4 4,570.3 74.1 6.49% 1998, Quarter 1 4,791.1 76.6 6.40% 1998, Quarter 2 5,520.7 88.8 6.44% 1998, Quarter 3 5,377.7 86.0 6.39% 1998, Quarter 4 4,941.6 75.7 6.13% 1999, Quarter 1 4,576.7 70.6 6.17% - ---------------------------------------------------------------------------------------------- 1) Excludes non-interest collateralized bond-related expenses. (2) Includes the net amortization expense of bond discounts and bond premiums.
Interest Rate Agreements As part of the asset/liability management process for its investment portfolio, Dynex REIT may enter into interest rate agreements such as interest rate caps, 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, the funding of fixed interest rates on certain portfolio investments with floating rate borrowings 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 Dynex REIT 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 loan production operations as generally these agreements are used to hedge interest rate risk related to forward commitments to fund loans. 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. 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)
- ----------------------------------------------------------------------------- Interest Interest Notional Amounts Rate Caps Rate Swaps - ----------------------------------------------------------------------------- 1997, Quarter 2 $ 1,599 $ 1,442 1997, Quarter 3 1,599 1,381 1997, Quarter 4 1,599 1,354 1998, Quarter 1 1,599 1,559 1998, Quarter 2 1,599 1,726 1998, Quarter 3 1,599 1,561 1998, Quarter 4 1,599 1,140 1999, Quarter 1 1,364 1,122 - ----------------------------------------------------------------------------- (1) Excludes all interest rate agreements in effect for the Company's loan production operations.
Net Interest Rate Agreement Expense The net interest rate agreement expense, or hedging expense, equals the cost of the agreements presented in the previous table, net of any benefits received from these agreements. For the quarter ended March 31, 1999, net hedging expense amounted to $1.12 million compared to $1.72 million and $1.23 million for the quarters ended December 31, 1998 and March 31 1998, 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. The net interest rate agreement expense decreased for the three months ended March 31, 1999 compared to the same period in 1998, primarily due to the expiration of $235 million of interest rate caps during January 1999. In addition, the Company terminated $34.2 million of interest rate swap agreements for a total loss of $0.1 million during the first quarter of 1999 as the collateral which the interest rate swap was hedging was amortizing at a faster rate than the original swap. This loss is being amortized into interest income over the estimated remaining life of the collateral as a yield adjustment. Net Interest Rate Agreement Expense ($ in millions)
- ---------------------------------------------------------------------------------------------------------------- Net Expense Net Expense as Net Interest as Percentage Percentage of Average Rate Agreement Expense of Average Borrowings (annualized) Assets (annualized) - ---------------------------------------------------------------------------------------------------------------- 1997, Quarter 2 $ 1.23 0.09% 0.13% 1997, Quarter 3 1.35 0.11% 0.12% 1997, Quarter 4 1.39 0.11% 0.12% 1998, Quarter 1 1.23 0.10% 0.10% 1998, Quarter 2 1.83 0.13% 0.13% 1998, Quarter 3 1.92 0.14% 0.14% 1998, Quarter 4 1.72 0.13% 0.14% 1999, Quarter 1 1.12 0.09% 0.10% - ----------------------------------------------------------------------------------------------------------------
Fair Value The fair value of the available-for-sale portion of the investment portfolio as of March 31, 1999, as measured by the net unrealized loss on investments available-for-sale, was $4.0 million below its cost basis, which represents a $0.9 million decrease from December 31, 1998. At December 31, 1998, the fair value of the investment portfolio was $3.1 million below its amortized cost basis. This decrease in the portfolio's value is primarily attributable to the prepayment activity in the investment portfolio during the first quarter of 1999. Credit Exposures The Company securitizes its loan production into collateralized bonds or pass-through securitization structures. With either structure, the Company may use overcollateralization, subordination, reserve funds, bond insurance, mortgage pool insurance or any combination of the foregoing as a form of credit enhancement. With all forms of credit enhancement, the Company may retain a limited portion of the direct credit risk after securitization. The following table summarizes the aggregate principal amount of collateral for collateralized bonds and pass-through securities outstanding; the maximum direct credit exposure retained by the Company (represented by the amount of overcollateralization pledged and subordinated securities rated below BBB owned by the Company), net of the credit reserves maintained by the Company for such exposure; and the actual credit losses incurred for each quarter. The table excludes any risks related to representations and warranties made on loans funded by the Company and securitized in mortgage pass-through securities generally funded prior to 1995. This table also excludes any credit exposure on loans held for securitization (which will be included as the loans are securitized), funding notes and other investments. The increase in net credit exposure as a percentage of the outstanding loan principal balance from 2.22% at March 31, 1998 to 3.72% at March 31, 1999 is related primarily to the credit exposure retained by the Company on its commercial securitization issued during December 1998 and its single family and manufactured housing securitizations issued during May 1998 and March 1999. Credit Reserves and Actual Credit Losses ($ in millions)
- ----------------------------------------------------------------------------------------------------------------- Maximum Credit Exposure, Net Outstanding Loan Maximum Credit Actual Credit of Credit Reserves to Principal Balance Exposure, Net Losses Outstanding Loan Balance of Credit Reserves - ----------------------------------------------------------------------------------------------------------------- 1997, Quarter 2 $ 4,305.5 $ 50.3 $ 4.9 1.17% 1997, Quarter 3 3,975.7 50.2 5.8 1.26% 1997, Quarter 4 5,153.1 86.6 6.5 1.68% 1998, Quarter 1 4,209.5 93.6 6.3 2.22% 1998, Quarter 2 5,098.8 120.1 3.8 2.36% 1998, Quarter 3 4,440.2 132.4 6.4 2.98% 1998, Quarter 4 4,389.7 159.7 3.8 3.64% 1999, Quarter 1 4,340.8 161.6 4.3 3.72% - -----------------------------------------------------------------------------------------------------------------
The following table summarizes single family mortgage loan, manufactured housing loan and commercial mortgage loan delinquencies as a percentage of the outstanding collateral balance for those securities in which Dynex REIT has retained a portion of the direct credit risk. The decrease in delinquencies as a percentage of the outstanding collateral balance from 3.09% at March 31, 1998 to 2.69% at March 31, 1999 is primarily related to the fact that the single family loans related to the Company's single family operations that were sold in 1996 are a smaller portion of the outstanding collateral at March 31, 1999, and that the aggregate delinquency rate on the other single family loans, the manufactured housing loans and the commercial mortgage loans were only 0.9%. 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 March 31, 1999, management believes the credit reserves are sufficient to cover any losses which may occur as a result of current delinquencies presented in the table below. Delinquency Statistics (1)
- ------------------------------------------------------------------------------------------------------------------------- 90 days and over delinquent 60 to 90 days delinquent (2) Total - ------------------------------------------------------------------------------------------------------------------------- 1997, Quarter 2 0.60% 3.25% 3.85% 1997, Quarter 3 0.89% 3.39% 4.28% 1997, Quarter 4 0.51% 2.82% 3.33% 1998, Quarter 1 0.44% 2.65% 3.09% 1998, Quarter 2 0.24% 1.82% 2.06% 1998, Quarter 3 0.39% 1.73% 2.12% 1998, Quarter 4 0.25% 2.11% 2.36% 1999, Quarter 1 0.45% 2.24% 2.69% - ------------------------------------------------------------------------------------------------------------------------- (1) Excludes funding notes. (2) Includes foreclosures, repossessions and REO.
The following table summarizes the credit ratings for collateral for collateralized bonds and securities held in the investment portfolio. This table excludes $15.5 million of other derivative and residual securities (as the risk on such securities is primarily prepayment-related, not credit-related), other investments and loans held for securitization. This table also excludes the funding notes, aggregating $131.8 million which are not rated. The balance of the investments rated below A are net of credit reserves and discounts. All balances exclude the related mark-to-market adjustment on such assets. At March 31, 1999, securities with a credit rating of AA or better were $3.6 billion, or 90.9% of the total. Investments by Credit Rating (1) ($ in millions)
- ------------------------------------------------------------------------------------------------------------- Below Below AAA/AA A BBB BBB AAA /AA A BBB BBB Carrying Carrying Carrying Carrying Percent of Percent Percent Percent Value Value Value Value Total of Total of Total of Total - ------------------------------------------------------------------------------------------------------------- 1998, Quarter 1 $4,369.9 $ 72.0 $ 50.0 $ 3.6 97.2% 1.6% 1.1% 0.1% 1998, Quarter 2 4,729.1 138.5 72.7 7.7 95.6% 2.8% 1.5% 0.1% 1998, Quarter 3 4,126.6 139.3 73.3 5.4 95.0% 3.2% 1.7% 0.1% 1998, Quarter 4 3,815.6 206.2 97.6 14.4 92.3% 5.0% 2.4% 0.3% 1999, Quarter 1 3,614.8 219.2 118.8 24.0 90.9% 5.5% 3.0% 0.6% - ------------------------------------------------------------------------------------------------------------- (1) Carrying value does not include funding notes, derivative and residual securities, other investments and loans held for securitization. Balances also exclude the mark-to-market adjustment. Carrying value also excludes $231.1 million of overcollateralization at March 31, 1999.
General and Administrative Expenses General and administrative expenses and net administrative fees and expenses to DHI ("collectively, G&A expense") consist of expenses incurred in conducting the production activities and managing the investment portfolio, as well as various other corporate expenses. G&A expense remained relatively flat for the three month period ended March 31, 1999 as compared to the same period in 1998. The Company expects overall G&A expense levels to remain relatively constant for the remainder of 1999. The following table summarizes the ratio of G&A expense to average interest-earning assets and the ratios of G&A expense to average total equity. Operating Expense Ratios
- ----------------------------------------------------------------------------------- G&A Expense/Average G&A Expense/Average Interest-Earning Assets Total Equity (Annualized) (Annualized) (1) - ----------------------------------------------------------------------------------- 1997, Quarter 2 0.39% 3.73% 1997, Quarter 3 0.43% 4.37% 1997, Quarter 4 0.62% 6.61% 1998, Quarter 1 0.62% 6.59% 1998, Quarter 2 0.50% 5.93% 1998, Quarter 3 0.56% 6.43% 1998, Quarter 4 0.66% 7.23% 1999, Quarter 1 0.66% 6.96% - ----------------------------------------------------------------------------------- (1) Average total equity excludes net unrealized gain (loss) on investments available-for-sale.
Net Income and Return on Equity Net income decreased from $14.4 million for the three months ended March 31, 1998 to $2.3 million for the three months ended March 31, 1999. Net income available to common shareholders decreased from $11.1 million to a $1.0 million loss for the same periods, respectively. Return on common equity (excluding the impact of the net unrealized gain on investments available-for-sale) decreased from 12.5% for the three months ended March 31, 1998 to a negative 1.2% for the three months ended March 31, 1999. The decrease in the return on common equity is a result primarily of the decline in net income available to common shareholders from the quarter ended March 31, 1998 to the same period in 1999 and the issuance of new common shares during 1998. Components of Return on Equity ($ in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------ Equity in Earnings (Loss), Net Interest Provision Permanent Gains (Losses) G&A Preferred Margin/ for Losses Impairment / and Other Expense/ Dividend/ Return on Average /Average Average Income Average Average Average Net Income Common Equity Common Common /Average Common Common Common Equity Common Available to (annualized) Equity Equity Equity Equity (annualized) Equity Common (annualized) (annualized) (annualized) (annualized) (annualized) Shareholders - ------------------------------------------------------------------------------------------------------------------------------------ 1997, Quarter 2 27.7% 1.5% - 2.0% 5.3% 4.6% 18.3% $ 14,668 1997, Quarter 3 25.9% 1.3% - 4.8% 6.1% 4.5% 18.8% 15,784 1997, Quarter 4 26.2% 1.9% - 4.9% 9.0% 4.2% 16.0% 14,103 1998, Quarter 1 20.9% 1.6% - 5.9% 9.0% 3.7% 12.5% 11,145 1998, Quarter 2 21.1% 1.9% - 6.3% 8.0% 3.7% 13.8% 12,323 1998, Quarter 3 19.0% 2.4% - (0.5%) 8.7% 3.7% 3.7% 3,257 1998, Quarter 4 21.9% 1.2% (20.8%) (10.0%) 9.9% 3.8% (23.8%) (20,167) 1999, Quarter 1 18.3% 4.6% - (1.3%) 9.7% 3.9% (1.2%) (969) - ------------------------------------------------------------------------------------------------------------------------------------
Dividends and Taxable Income Dynex REIT has 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. Dynex REIT may issue additional common stock, preferred stock or other securities in the future in order to fund growth in its operations, growth in its investment portfolio or for other purposes. Dynex REIT intends to declare and pay out as dividends 100% of its taxable income over time. Dynex REIT's current practice is to declare quarterly dividends; however, no dividends on its common stock had been declared since September 1998. Generally, Dynex REIT strives to declare a quarterly dividend which will result in the distribution of most or all of the taxable income earned during the applicable year. At the time of the dividend announcement, however, the total level of taxable income for the quarter is unknown. Additionally, Dynex REIT 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)
- ------------------------------------------------------------------------------------------------------------------------- Estimated Taxable Net Estimated Income (Loss) Estimated Taxable Cumulative Available to Common Net Income (Loss) Dividend Declared Dividend Undistributed Shareholders Per Common Share Per Common Share Pay-out Ratio Taxable Income (Loss) - ------------------------------------------------------------------------------------------------------------------------- 1997, Quarter 2 $ 12,016 $ 0.283 $ 0.335 118% $ 13,524 1997, Quarter 3 10,531 0.248 0.345 139% 9,392 1997, Quarter 4 10,132 0.228 0.350 154% 3,949 1998, Quarter 1 21,970 0.484 0.300 62% 12,293 1998, Quarter 2 11,339 0.245 0.300 122% 9,746 1998, Quarter 3 3,852 0.083 0.250 301% 2,045 1998, Quarter 4 (2,698) (0.059) - - (653) 1999, Quarter 1 (6,618) (0.144) - - (7,271) - -------------------------------------------------------------------------------------------------------------------------
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 March 31, 1999, taxable net loss per common share exceeded GAAP loss per common share principally due to the preferred dividend paid in January 1999. The fourth quarter 1998 dividends were included in the first quarter 1999 taxable income as a result of a January 1, 1999 record date. 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 Dynex REIT files its federal income tax returns for each year. 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. FAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company is in the process of determining the impact of adopting FAS No. 133. Year 2000 The Company is dependent upon purchased, leased, and internally-developed software to conduct certain operations. In addition, the Company relies upon certain counterparties such as banks and loan servicers who are also highly dependent upon computer systems. The Company recognizes that some computer software may incorrectly recognize dates beyond December 31, 1999. The ability of the Company and its counterparties to correctly operate computer software in the Year 2000 is critical to the Company's operations. The Company uses several major and minor computer systems to conduct its business operations. The computer systems deemed most important to the Company's ability to continue operations are as follows: - The internally-developed loan origination system for manufactured housing operations - The internally-developed loan origination and asset management system for commercial loans - The internally-developed investment portfolio analytics, securitization, and securities administration software - The purchased servicing system for commercial loans - The purchased servicing system for single family and manufactured housing loans - The purchased general ledger accounting system In addition, the Company is involved in data interchange with a number of counterparties in the normal course of business. Each system or interface that the Company relies on is being tested and evaluated for Year 2000 compliance. The Company has contacted all of its key software vendors to determine their Year 2000 readiness. The Company has received documentation from each of the vendors providing assurances of Year 2000 compliance: - Baan/CODA, vendor of the general ledger accounting system, has provided confirmation that their current software release is fully Year 2000 compliant. The Company plans to apply this release by June 30, 1999. - Synergy Software, vendor of the commercial loan servicing system, has provided confirmation that the current release of their software is fully Year 2000 compliant. The Company has installed and performed initial testing on this version with no issues discovered. - Interlinq Software, vendor of the single-family and manufactured housing loan servicing software, has provided assurance that their software is Year 2000 compliant. The Company has begun Year 2000 assurance testing on this product with no issues discovered to date. All software developed internally by the Company was designed to be Year 2000 compliant. Nevertheless, the Company established a Year 2000 test-bed to ensure that there were no design or development oversights that could lead to a Year 2000 problem. Initial testing of all key applications was completed in January of 1999, with only minor issues discovered and subsequently remedied. Continued testing of certain applications will continue through June of 1999. The Company has reviewed or is reviewing the Year 2000 progress of its primary financial counterparties. Based on initial reviews, these counterparties are expected to be in compliance. The Company, as master servicer of certain securities, is in the process of assessing the Year 2000 readiness of its external servicers, to ensure that these parties will be able to correctly remit loan information and payments after December 31, 1999. The Company believes that, other than its exposure to financial counterparties, its most significant risk with respect to internal or purchased software is the software systems used to service manufactured housing loans. The Company will not be able to service these loans without the automated system. Should these loans go unattended for a period greater than three months, the result could have a material adverse impact on the Company. The Company is also at significant risk if the systems of the financial institutions that provide the Company financing and software for cash management services should fail. In a worst case scenario, the Company would be unable to fund its operations or pay on its obligations for an unknown period of failure. This would have a material adverse impact on the Company. The Company is also at significant risk if the voice and data communications network supplied by its provider should fail. In such an instance the Company would be unable to originate or efficiently service its manufactured housing loans until the problem is remedied. The Company is closely monitoring the Year 2000 efforts of its telecommunications provider and is developing contingency plans in the event that the provider does not give sufficient assurance of compliance by June 30, 1999. The Company is also at significant risk should the electric utility company for the Company's offices in Glen Allen, Virginia, fail to provide power for several business days. In such an instance, the Company would be unable (i) to communicate over its telecommunication systems, (ii) would be unable to process data, and (iii) would be unable to originate or service loans until the problem is remedied. The Company continues to monitor the Year 2000 status of its utility provider, whose plan is scheduled to be completed in the fall of 1999. The Company uses many other systems (including systems that are not information technology oriented), both purchased and developed internally, that could fail to perform accurately after December 31, 1999. Management believes that the functions performed by these systems are either non-critical or could be performed manually in the event of failure. The Company will complete its Year 2000 test plan and remediation efforts in the second quarter of 1999. Management believes that there is little possibility of a significant disruption in business. The major risks are those related to the ability of vendors and business partners to complete Year 2000 plans. The Company expects that those vendors and counterparties will complete their Year 2000 compliance programs before January 1, 2000. The Company has incurred less than $50,000 in costs to date in carrying out its Year 2000 compliance program. The Company estimates that it will spend less than $100,000 to complete the plan. Costs could increase in the event that the Company determines that a counterparty will not be Year 2000 compliant. The Company is still developing contingency plans in the event that a system or counterparty is not Year 2000 compliant. These plans will be developed by June 30, 1999. LIQUIDITY AND CAPITAL RESOURCES The Company finances its operations from a variety of sources. These sources include cash flow generated from the investment portfolio, including net interest income and principal payments and prepayments, common stock offerings through the dividend reinvestment plan, short-term warehouse lines of credit with commercial and investment banks, repurchase agreements and the capital markets via the asset-backed securities market (which provides long-term non-recourse funding of the investment portfolio via the issuance of collateralized bonds). Historically, cash flow generated from the investment portfolio has satisfied its working capital needs, and the Company has had sufficient access to capital to fund its loan production operations, on both a short-term (prior to securitization) and long-term (after securitization) basis. However, if a significant decline in the market value of the investment portfolio that is funded with recourse debt should occur, the 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, Dynex REIT 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 Dynex REIT would likely generate without such offerings. During the first quarter 1999, Dynex REIT issued 3,388 shares of its common stock pursuant to its dividend reinvestment program for preferred stockholders for net proceeds of $18 thousand. Certain aspects of Dynex REIT's funding strategies subject it to liquidity risk. Liquidity risk stems from Dynex REIT's use of repurchase agreements, its use of committed lines of credit with mark-to-market provisions and the reliance on the asset-backed securitization markets for its long-term funding needs. Liquidity risk also stems from hedge positions the Company may take to hedge its commercial and manufactured housing loan production. Repurchase agreements are generally provided by investment banks, and subject Dynex REIT to margin call risk if the market value of assets pledged as collateral for the repurchase agreements declines. Dynex REIT has established 'target equity' requirements for each type of investment pledged as collateral, taking into account the price volatility and liquidity of each such investment. Dynex REIT strives to maintain enough liquidity to meet anticipated margin calls if short-term interest rates increased 300 basis points in a twelve-month period. Dynex REIT has committed lines of credit and uncommitted repurchase facilities to finance the accumulation of assets for securitization. Dynex REIT borrows on these lines of credit on a short-term basis to support the accumulation of assets prior to the issuance of collateralized bonds. 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, Dynex REIT's ability to acquire or fund additional assets may be substantially reduced and it may experience losses. Dynex REIT currently has a total of $925 million of committed lines of credit and $700 million of uncommitted repurchase facilities to finance loans held for securitization and other investments. These borrowings are paid down as Dynex REIT securitizes or sells assets. Generally these borrowings allow for the warehousing of assets for a period of 180-365 days. Dynex REIT generally intends to securitize assets by product type every 120-365 days. If there exists a dislocation or disruption in the asset-backed market, Dynex REIT may be unable to securitize the assets, or may only be able to securitize the assets on unfavorable terms. In such a case, Dynex REIT would be required to repay the lines of credit with either available liquidity or would be required to liquidate the assets or other assets to generate liquidity. In addition, lines of credit with commercial and investment banks may include provisions by such banks to mark the collateral to market on a daily basis. To the extent the market value of the associated asset has declined due to market conditions, Dynex REIT may be required to provide additional collateral or sell the associated asset which may result in losses. As a part of its strategy to hedge exposure to changes in interest rates on commercial mortgage loans funded and commitments to fund commercial mortgage loans, Dynex REIT may enter into forward sales of Treasury futures. Such sales are executed through third parties, which require cash collateral in the event that movements in interest rates adversely impact the value of the futures position. The value of the related loans or loan commitments will generally increase in value as the futures position decreases; however, such value is generally not recognized until the loans are securitized. In order to maintain its hedge positions, Dynex REIT may therefore be exposed to additional cash collateral requirements in adverse interest rate environments. A substantial portion of the assets are pledged to secure indebtedness incurred by Dynex REIT. Accordingly, those assets would not be available for distribution to any general creditors or the stockholders of Dynex REIT in the event of the liquidation, except to the extent that the value 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 March 31, 1999, Dynex REIT had $3.7 billion of collateralized bonds outstanding as compared to $3.7 billion at December 31, 1998. Recourse Debt Secured. At March 31, 1999, Dynex REIT had four committed credit facilities aggregating $925 million, comprised of (i) a $250 million credit line, expiring in April 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 manufactured housing loans, (ii) a $400 million credit line, expiring in November 1999, from an investment bank primarily for the warehousing of permanent loans on multifamily and commercial properties, (iii) a $175 million credit line, expiring in June 1999, from a consortium of commercial banks and finance companies to fund the purchase of model homes, and (iv) a $100 million credit line, expiring in September 1999, from an investment bank for the warehousing of the funding notes. Dynex REIT expects these credit facilities will be renewed or replaced, if necessary, at their respective expiration dates, although there can be no assurance of such renewal or replacement. The lines of credit contain certain financial covenants which Dynex REIT met as of March 31, 1999. However, changes in asset levels or results of operations could result in the violation of one or more covenants in the future. At March 31, 1999, Dynex REIT had $379.2 million outstanding under its committed credit facilities. Dynex REIT also uses repurchase agreements to finance a portion of its investments, which generally have thirty day maturities. 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. Dynex REIT has two uncommitted master repurchase facilities aggregating $700 million for the accumulation of assets for securitization. These agreements expired in April 1999 and are in the process of being renewed. Dynex REIT expects these repurchase facilities will be renewed, although there can be no assurance of such renewal. At March 31, 1999, outstanding obligations under all repurchase agreements totaled $271.7 million compared to $528.3 million at December 31, 1998. The following table summarizes the outstanding balances of repurchase agreements by credit rating of the related assets pledged as collateral to support such repurchase agreements. The table excludes repurchase agreements used to finance loans held for securitization. Repurchase Agreements by Rating of Investments Financed ($ in millions)
- --------------------------- -------------- --------------- --------------- --------------- --------------- -------------- AAA AA A BBB Below BBB Total - --------------------------- -------------- --------------- --------------- --------------- --------------- -------------- 1998, Quarter 3 $ 560.8 $ 91.2 $ 58.7 $ 51.9 $ - $ 762.6 1998, Quarter 4 124.5 109.5 91.4 65.6 - 391.0 1999, Quarter 1 86.3 63.2 64.2 57.9 - 271.7 - --------------------------- -------------- --------------- --------------- --------------- --------------- --------------
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 various 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. 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. The proceeds from these issuances have been used to reduce short-term debt related to financing loans held for securitization during the accumulation period as well as for general corporate purposes. These notes payable have an outstanding balance at March 31, 1999 of $129.3 million. Total recourse debt decreased from $1.0 billion for December 31, 1998 to $0.8 billion for March 31, 1999. This decrease is primarily due to the $190.7 million and $57.5 million reduction on repurchase agreements and notes payable due to the securitization of $277.7 million securities and loans as collateral for collateralized bonds during March 1999. The decrease was partially offset by the addition of $62.6 million of notes payable as a result of the purchase or origination of additional assets. Total Recourse Debt ($ in millions)
- ---------------------------------------------------------------------------------------------------------- Total Recourse Debt to Fixed Charge Coverage Total Recourse Debt Equity Ratio - ---------------------------------------------------------------------------------------------------------- 1997, Quarter 2 $ 1,793.8 3.37% 1.74% 1997, Quarter 3 1,852.4 3.43% 1.87% 1997, Quarter 4 1,133.5 2.02% 1.77% 1998, Quarter 1 2,425.2 4.41% 1.72% 1998, Quarter 2 1,390.3 2.56% 1.48% 1998, Quarter 3 1,614.5 3.21% 1.28% 1998, Quarter 4 1,032.7 2.28% 0.27% 1999, Quarter 1 781.4 1.73% 1.14% - -----------------------------------------------------------------------------------------------------------
Table 1 Components of Collateral for Collateralized Bonds ($ in thousands)
- ------------------------------------------------------------------ ------------------ ------------------ March 31, 1999 December 31, 1998 - ------------------------------------------------------------------ ------------------ ------------------ Collateral for collateralized bonds $ 4,062,722 $ 4,177,592 Allowance for loan losses (15,970) (16,593) Funds held by trustees 2,193 1,104 Accrued interest receivable 24,848 27,834 Unamortized premiums and discounts, net 67,460 81,990 Unrealized gain, net 19,668 21,601 - ------------------------------------------------------------------ ------------------ ------------------ Collateral for collateralized bonds $ 4,160,921 $ 4,293,528 - ------------------------------------------------------------------ ------------------ ------------------
Table 2 Principal Balance of Collateral for Collateralized Bonds by Loan Type ($ in thousands)
- ---------------------------------------------------------------- ------------------- --------------------- March 31, 1999 December 31, 1998 - ---------------------------------------------------------------- ------------------- --------------------- Single family loans ARMS: 1 month LIBOR $ 9,051 $ 9,905 3 month LIBOR 27,055 32,081 6 month LIBOR 1,339,141 1,506,431 Prime 99,110 119,833 6 month CD 50,420 63,649 1 year CMT 636,728 779,960 5 year CMT - 191 - ------------------------------------------------------------------ ------------------ -------------------- Total ARMs 2,161,505 2,512,050 Fixed 290,820 310,827 - ------------------------------------------------------------------ ------------------ -------------------- Total single-family 2,452,325 2,822,877 Manufactured housing loans: ARM 14,557 13,288 Fixed 757,771 500,677 - ------------------------------------------------------------------ ------------------ -------------------- Total manufactured housing 772,328 513,965 Commercial loans 838,069 840,750 - ------------------------------------------------------------------ ------------------ -------------------- Total $ 4,062,722 $ 4,177,592 - ------------------------------------------------------------------ ------------------ --------------------
Table 3 Collateral for Collateralized Bonds by Collateral Type ($ in thousands)
- ------------------------------------------------------------------ ------------------ -------------------- March 31, 1999 December 31, 1998 - ------------------------------------------------------------------ ------------------ -------------------- Single-family loans: Single family detached $ 1,935,132 $ 2,194,304 Condominium 151,085 175,458 Single family attached 174,981 198,089 Planned unit development 117,274 143,293 Cooperative 36,307 41,633 Other 37,546 70,100 - ------------------------------------------------------------------ ------------------- --------------------- Total single family 2,452,325 2,822,877 Manufactured housing loans: Single wide 264,909 157,787 Multi-sectional 507,419 356,178 - ------------------------------------------------------------------ ------------------- --------------------- Total manufactured housing 772,328 513,965 Commercial loans: Multifamily (LIHTC) 530,276 531,233 Office 135,987 136,531 Motel/hotel 59,201 59,414 Industrial 34,072 34,217 Healthcare 30,234 30,342 Mixed use 27,964 28,600 Retail 16,681 16,744 Other 3,654 3,669 - ------------------------------------------------------------------ ------------------- --------------------- Total commercial 838,069 840,750 - ------------------------------------------------------------------ ------------------- --------------------- Total $ 4,062,722 $ 4,177,592 - ------------------------------------------------------------------ ------------------- ---------------------
Table 4 Repricing Period for Adjustable-Rate Single-Family and Manufactured Housing Collateral As of March 31, 1999 ($ in thousands)
- -------------------------------------------- -------------------- -------------------- -------------------- Single- Manufactured Family Housing Total - -------------------------------------------- -------------------- -------------------- -------------------- 2nd Quarter 1999 $ 865,028 $ - $ 865,028 3rd Quarter 1999 751,474 - 751,474 4th Quarter 1999 70,364 - 70,364 1st Quarter 2000 61,448 - 61,448 2nd Quarter 2000 and beyond 413,191 14,557 427,748 - -------------------------------------------- -------------------- -------------------- -------------------- $ 2,161,505 $ 14,557 $ 2,176,062 - -------------------------------------------- -------------------- -------------------- --------------------
Table 5 Commercial Loan Prepayment Protection Periods (1) As of March 31, 1999 ($ in thousands)
- ----------------------------------------------------- -------------------- -------------------- Number of Loans Principal Balance - ----------------------------------------------------- -------------------- -------------------- 0 - 4 years 1 $ 12,750 5 - 10 years 27 112,623 11 - 16 years 200 658,822 Over 16 years 9 53,874 - ----------------------------------------------------- -------------------- -------------------- 237 $ 838,069 - ----------------------------------------------------- -------------------- -------------------- (1) The greater of prepayment lockout period or the yield maintenance period.
Table 6 Margin of Single Family Loans over Indices
- ------------------------------------------------------------------ ------------------ -------------------- March 31, 1999 December 31, 1998 - ------------------------------------------------------------------ ------------------ -------------------- Single-family ARM loans 1 month LIBOR 3.27% 3.24% 3 month LIBOR 3.08 2.87 6 month LIBOR 3.07 3.06 Prime (1) 2.47 2.48 6 month CD 2.50 2.50 1 year CMT 2.85 2.85 5 year CMT - 2.88 - ------------------------------------------------------------------ ------------------- --------------------- Total single-family ARM loans (weighted-average) 2.84 2.82 Manufactured housing loans (6-month LIBOR) 5.80 5.80 - ------------------------------------------------------------------ ------------------- --------------------- Weighted average gross margin 2.85% 2.83% - ------------------------------------------------------------------ ------------------- --------------------- (1) Relative to 1-month LIBOR, after giving effect to the Prime/LIBOR swap owned by the Company.
Table 7 Weighted Average Coupon for Collateral for Collateralized Bonds
- ------------------------------------------------------------------ ------------------ -------------------- March 31, 1999 December 31, 1998 - ------------------------------------------------------------------ ------------------ -------------------- Single-family loans: ARM loans 8.16% 8.38% Fixed 9.77 9.82 - ------------------------------------------------------------------ ------------------- --------------------- Total 8.35 8.54 Manufactured housing loans: ARM loans 9.33 9.48 Fixed 8.72 9.07 - ------------------------------------------------------------------ ------------------- --------------------- Total 8.73 9.08 Commercial loans 8.01 8.01 - ------------------------------------------------------------------ ------------------- --------------------- Aggregate weighted average coupon 8.35% 8.50% - ------------------------------------------------------------------ ------------------- ---------------------
Table 8 Net Balance Sheet (1) ($ in thousands)
March 31, December 31, 1999 1998 ---------------- ----------------- ASSETS Investments: Collateral for collateralized bonds $ 4,160,921 $ 4,293,528 Less: Collateralized bonds issued (3,909,874) (4,062,089) ---------------- ----------------- Net investment in collateralized bonds 251,047 231,439 Collateralized bonds retained 254,555 389,842 Securities 238,932 243,984 Other investments 34,653 30,371 Loans held for securitization 238,550 388,782 ---------------- ----------------- 1,017,737 1,284,418 Investment in and advances to Dynex Holding, Inc. 184,118 169,384 Cash 28,716 30,103 Accrued interest receivable 4,861 9,093 Other assets 16,812 18,488 ---------------- ----------------- $ 1,252,244 $ 1,511,486 ================ ================= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Repurchase agreements $ 271,704 $ 528,283 Notes payable 509,717 502,450 Accrued interest payable 4,732 8,403 Other liabilities 11,935 16,318 Dividends payable 3,228 3,228 ---------------- ----------------- 801,316 1,058,682 ---------------- ----------------- Shareholders' Equity: Preferred stock, par value $.01 per share, 50,000,000 shares authorized: 9.75% Cumulative Convertible Series A 1,309,061 and 1,309,061 issued and outstanding, respectively 29,900 29,900 9.55% Cumulative Convertible Series B 1,912,434 and 1,912,434 issued and outstanding, respectively 44,767 44,767 9.73% Cumulative Convertible Series C 1,840,000 and 1,840,000 issued and outstanding, respectively 52,740 52,740 Common stock, par value $.01 per share, 100,000,000 shares authorized, 46,030,814 and 46,027,426 issued and outstanding, respectively 460 460 Additional paid-in capital 352,331 352,382 Accumulated other comprehensive loss (3,953) (3,097) Accumulated deficit (25,317) (24,348) ---------------- ----------------- 450,928 452,804 ---------------- ----------------- $ 1,252,244 $ 1,511,486 ================ ================= (1) This presents the balance sheet where the collateralized bonds are "netted" against the collateral for collateralized bonds. This presentation better illustrates the Company's net investment in the collateralized bonds and the collateralized bonds retained for its investment portfolio.
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 commercial and 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. Capital Markets. The Company relies on the capital markets for the sale upon securitization of its collateralized bonds or other types of securities. While the Company has historically been able to sell such collateralized bonds and securities into the capital markets, there can be no assurances that circumstances relating either to the Company or the capital markets may limit or preclude the ability of the Company to sell such collateralized bonds or securities in the future. 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 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 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 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. At March 31, 1999, the yield curve was considered flat relative to its normal shape, and as a result, the Company expects a continuation of relatively high prepayment rates during the second quarter in 1999. 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. 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 several tools and risk management strategies to monitor and address interest rate risk, including (i) a quarterly sensitivity analysis using option-adjusted spread ("OAS") methodology to calculate the expected change in net interest margin as well as the change in the market value of various assets within the portfolio under various extreme scenarios; and (ii) a monthly static cash flow and yield projection under 49 different scenarios. Such tools allow the Company to continually monitor and evaluate its exposure to these risks and to manage the risk profile of the investment portfolio in response to changes in the market risk. 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 March 31, 1999 and December 31, 1998. 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 March 31, 1999 and December 31, 1998. 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 (CPR) ranging from 6.0% for fixed-rate manufactured housing loans to 69.1% for single family ARM loans indexed to the six month certificate of deposit rate. The model varies the CPR 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. Therefore, the following estimates should not be viewed as a forecast and no assurance can be given that actual results will not vary significantly from the analysis below.
-------------------- ------------------------------------------------ Basis Point Increase (Decrease) in Interest Rates Over 12 Months % Change in Net Interest Margin from Base Case -------------------- ------------------------------------------------ March 31, 1999 December 31, 1998 -------------------- ----------------------- +200 (13.59)% (11.69)% +100 (6.77)% (9.30)% Base - - -100 6.97% 9.65% -200 14.57% 21.29% -------------------- -------------------- --- -----------------------
The March 31, 1999 analysis illustrates that net interest margin is less sensitive to interest rate changes than it was at December 31, 1998. This change is primarily the result of the securitization of $360.9 million of manufactured housing loans which support $323.3 million of fixed-rate collateralized bonds at March 31, 1999. This fixed rate financing replaced variable rate collateralized bonds, repurchase agreements and bank borrowings and therefore reduced the Company's interest rate risk on this portion of the Company's interest-bearing liabilities. 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. Approximately $2.4 billion of the Company's investment portfolio as of March 31, 1999 is comprised of loans or securities that have coupon rates which adjust over time (subject to certain periodic and lifetime limitations) in conjunction with changes in short-term interest rates. Approximately 63% and 29% 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. 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. To mitigate this potential liquidity risk, the Company strives to maintain excess liquidity to cover any additional margin required in a rapidly increasing interest rate environment, defined as a 3% increase in short-term interest rates over a twelve-month time period. 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 enters 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. To help protect the Company's net interest income in a rising interest rate environment, the Company has purchased interest rate caps with a notional amount of $1.4 billion, which help reduce the Company's exposure to interest rate risk rising above the lifetime interest rate caps on ARM securities and loans. These interest rate caps provide the Company with additional cash flow should the related index increase above the contracted rates. The contracted rates on these interest rate caps are based on one-month LIBOR, six-month LIBOR or one-year CMT. The Company will 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. To date, short term interest rates have not risen at the speed or to the extent such that the protective cashflows provided by the caps and swaps have been realized. The Company may also utilize futures and options on futures to moderate the risks inherent in the financing of a portion of its investment portfolio with floating-rate repurchase agreements. The Company uses these instruments to synthetically lengthen the terms of repurchase agreement financing, generally from one to three or six months. Interest rate futures and option agreements have historically provided the Company a means of essentially locking-in borrowing costs at specified rates for specified period of time. Under these contracts, the Company will receive additional cash flow if the underlying index increases above contracted rates, mitigating the net interest income loss that results from the higher repurchase agreement rates The Company will pay additional cash flow if the underlying index decreases below contracted rates. The Company has not utilized futures or options on futures for this purpose since 1997, as they primarily benefit the Company when expected rates as measured by the forward yield-curve are less than current cash market rates. The remaining portion of the Company's investments portfolio as of March 31, 1999, approximately $2.3 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 $1.6 billion as of the same date. The Company's interest rate risk is primarily related to the rate of change in short term interest rates, not 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 a Credit Agreement, dated June 9, 1998, by and among AutoBond, Funding and the Company. The Plaintiffs also allege that the Defendants conspired to misrepresent and mischaracterize AutoBond's credit underwriting criteria and its compliance with such criteria with the intention of interfering and causing actual damage to AutoBond's business, prospective business and contracts. In addition to actual, punitive and exemplary damages, the Plaintiffs also seek injunctive relief compelling the Company to fund immediately all advances due AutoBond under the Credit Agreement. The Company believes AutoBond's claims are without merit and intends to defend against them vigorously. The Company filed a complaint against the Plaintiffs in the United States District Court for the Eastern District of Virginia (Richmond District) seeking declaratory relief and damages. The Company is subject to various lawsuits as result of its lending activities. The Company does not anticipate that the resolution of such lawsuits will have a material impact on the Company's financial condition. 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 None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None (b) Reports on Form 8-K Current Report on Form 8-K as filed with the Commission on February 26, 1999, relating to certain recent developments. 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: May 17, 1999 EX-27 2 FDS ART. 5 FOR THE QUARTER ENDED MARCH 31, 1999
5 1,000 3-mos Dec-31-1999 Jan-01-1999 Mar-31-1999 28,716 4,434,506 3,293 0 0 0 0 0 4,905,995 0 3,653,751 0 127,407 460 323,061 4,905,995 0 88,477 0 0 13,185 3,793 71,382 117 0 117 0 (1,086) 0 (969) (0.02) (0.02) The Company's balance sheet is unclassified.
-----END PRIVACY-ENHANCED MESSAGE-----