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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q/A
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarter ended March 31, 2003
|_| Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Commission file number 1-9819
Virginia 52-1549373
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4551 Cox Road, Suite 300, Glen Allen, Virginia 23060-6740
(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.
|_| Yes |X| No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). |_| Yes |X| No
On April 30, 2003, the registrant had 10,873,903 shares of common stock of $.01
value outstanding, which is the registrant's only class of common stock.
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DYNEX CAPITAL, INC.
FORM 10-Q/A
INDEX
This amendment on Form 10-Q/A reflects restatement of the Company's financial
statements as discussed in Note 13 to the condensed consolidated financial
statements.
All of the information in this Form 10-Q/A is as of May 14, 2003, the filing
date of the original Form 10-Q, and has not been updated for events subsequent
to that date other than for the matter discussed above.
Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at March 31, 2003
and December 31, 2002 (as restated) (unaudited)......................1
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2003 and 2002 (as restated) (unaudited)......2
Condensed Consolidated Statements of Cash Flows for
the three months ended March 31, 2003 and 2002 (as restated)
(unaudited)...........................................................3
Notes to Unaudited Condensed Consolidated Financial Statements.......4
Item 2. Management`s Discussion and Analysis of
Financial Condition and Results of Operations.......................13
Item 3. Quantitative and Qualitative Disclosures about Market Risk..........25
Item 4. Controls and Procedures.............................................27
PART II OTHER INFORMATION
Item 1. Legal Proceedings...................................................27
Item 2. Changes in Securities and Use of Proceeds...........................28
Item 3. Defaults Upon Senior Securities.....................................29
Item 4. Submission of Matters to a Vote of Security Holders.................29
Item 5. Other Information...................................................29
Item 6. Exhibits and Reports on Form 8-K....................................29
SIGNATURE .................................................................30
i
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DYNEX CAPITAL, INC.
Condensed CONSOLIDATED BALANCE SHEETS, UNAUDITED
(amounts in thousands except share data)
March 31, December 31,
2003 2002
--------------- ----------------
(As restated, (As restated,
see Note 13) see Note 13)
ASSETS
Cash and cash equivalents $ 6,795 $ 15,076
Other assets 4,440 4,913
------------- --------------
11,235 19,989
Investments:
Collateral for collateralized bonds
Loans 1,749,763 1,818,577
Debt securities, available-for-sale 310,606 329,920
Other investments 53,082 54,322
Other loans 8,559 9,288
Securities 3,333 6,208
--------------- -----------------
2,125,343 2,218,315
--------------- -----------------
$ 2,136,578 $ 2,238,304
=============== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Non-recourse debt - collateralized bonds $ 1,928,973 $ 2,013,271
Recourse debt 32,079 -
Accrued expenses and other liabilities 1,484 1,612
--------------- -----------------
1,962,536 2,014,883
--------------- -----------------
Commitments and Contingencies (Note 11) - -
SHAREHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 50,000,000 shares authorized:
9.75% Cumulative Convertible Series A, 493,595 and 992,038 shares issued and 11,274 22,658
outstanding, respectively ($15,889 and $31,353 aggregate liquidation
preference, respectively)
9.55% Cumulative Convertible Series B, 688,289 and 1,378,807 shares issued 16,109 32,273
and outstanding, respectively ($22,499 and $44,263 aggregate liquidation
preference, respectively)
9.73% Cumulative Convertible Series C, 684,911 and 1,383,532 shares issued 19,630 39,655
and outstanding, respectively ($27,546 and $54,634 aggregate liquidation
preference, respectively)
Common stock, par value $.01 per share, 100,000,000 shares authorized, 109 109
10,873,903 shares issued and outstanding
Additional paid-in capital 360,706 364,743
Accumulated other comprehensive loss (4,646) (4,832)
Accumulated deficit (229,140) (231,185)
--------------- -----------------
174,042 223,421
--------------- -----------------
$ 2,136,578 $ 2,238,304
=============== =================
See notes to unaudited condensed consolidated financial statements.
1
DYNEX CAPITAL, INC.
Condensed CONSOLIDATED STATEMENTS
OF OPERATIONS, UNAUDITED
(amounts in thousands except share data)
Three Months Ended
March 31,
-----------------------------------------------
2003 2002
---------------------- --------------------
(As restated, (As restated,
see Note 13) see Note 13)
Interest income:
Collateral for collateralized bonds $ 37,756 $ 42,714
Other investments 1,341 1,454
Other loans 125 95
Securities 271 122
---------------------- --------------------
39,493 44,385
---------------------- --------------------
Interest and related expense:
Non-recourse debt 27,760 31,966
Recourse debt 254 1,030
Other 36 444
---------------------- --------------------
28,050 33,440
---------------------- --------------------
Net interest margin before provision for losses 11,443 10,945
Provision for losses (5,844) (5,643)
---------------------- --------------------
Net interest margin 5,599 5,302
Impairment charges (2,078) (2,111)
Gain on sale of investments, net 527 77
Other 17 551
General and administrative expenses (2,021) (1,894)
---------------------- --------------------
Net income 2,044 1,925
Preferred stock benefit (charge) 10,444 (2,396)
---------------------- --------------------
Net income (loss) to common shareholders 12,488 (471)
Change in net unrealized gain/(loss) on:
Investments classified as available for sale during the period 626 (146)
Hedge instruments (440) -
---------------------- --------------------
Comprehensive income $ 2,230 $ 1,779
====================== ====================
Net income (loss) per common share:
Basic $ 1.15 $ (0.04)
Diluted $ 1.13 $ (0.04)
====================== ====================
Weighted average number of common shares outstanding:
Basic 10,873,903 10,873,853
Diluted 12,443,785 10,873,853
See notes to unaudited condensed consolidated financial statements.
2
DYNEX CAPITAL, INC.
CONDENSED CONSOLIDATED STATEMENTS
OF CASH FLOWS, UNAUDITED
(amounts in thousands)
Three Months Ended
March 31,
----------------------------------------
2003 2002
------------------ ------------------
(As restated, (As restated,
see Note 13) see Note 13)
------------------ ------------------
Operating activities:
Net income $ 2,044 $ 1,925
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for losses 5,844 5,643
Impairment charges 2,078 2,111
Gain on sale of investments (527) (77)
Amortization and depreciation 832 5,625
Net change in other assets, accrued expenses and other liabilities (247) (14,235)
------------------ ------------------
Net cash and cash equivalents provided by operating activities 10,024 992
------------------ ------------------
Investing activities:
Principal payments on collateral 79,275 151,283
Principal payments on loans 789 1,621
Payments received on securities and other investments 5,334 2,995
Proceeds from sales of securities and other investments 1,405 -
Other (1,228) (1,636)
------------------ ------------------
Net cash and cash equivalents provided by investing activities 85,575 154,263
------------------ ------------------
Financing activities:
Principal payments on collateralized bonds (84,349) (147,090)
Retirement of preferred stock (19,531) -
Repayment of senior notes - (10,828)
------------------ ------------------
Net cash and cash equivalent used for financing activities (103,880) (157,918)
------------------ ------------------
Net decrease in cash and cash equivalents (8,281) (2,663)
Cash and cash equivalents at beginning of period 15,076 7,129
------------------ ------------------
Cash and cash equivalents at end of period $ 6,795 $ 4,466
================== ==================
Supplement disclosures of cash flow information:
Cash paid for interest $ 27,403 $ 34,968
================== ==================
See notes to unaudited condensed consolidated financial statements.
3
NOTES TO UNAUDITED Condensed CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
March 31, 2003
(amounts in thousands except share and per share data)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying condensed 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 accounting principles generally accepted in
the United States of America, hereinafter referred to as "generally accepted
accounting principles," for complete financial statements. The condensed
consolidated financial statements include the accounts of Dynex Capital, Inc.
and its qualified real estate investment trust ("REIT") subsidiaries and taxable
REIT subsidiary ("Dynex" or the "Company"). All inter-company balances and
transactions have been eliminated in consolidation.
The Company believes it has complied with the requirements for qualification as
a REIT under the Internal Revenue Code (the "Code"). To the extent the Company
qualifies as a REIT for federal income tax purposes, it generally will not be
subject to federal income tax on the amount of its income or gain that is
distributed as dividends to shareholders.
In the opinion of management, all significant adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation of the
condensed consolidated financial statements have been included. The financial
statements presented are unaudited. Operating results for the three months ended
March 31, 2003 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2003. For further information, refer
to the audited consolidated financial statements and footnotes included in the
Company's Form 10-K/A for the year ended December 31, 2002.
The preparation of financial statements, in conformity with generally accepted
accounting principles, requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates. The primary estimates inherent in the
accompanying consolidated financial statements are discussed below.
The Company uses estimates in establishing fair value for its financial
instruments as discussed in Note 2.
The Company also has credit risk on certain investments in its portfolio. An
allowance for loan losses has been estimated and established for current
expected losses based on management's judgment. The allowance for losses is
evaluated and adjusted periodically by management based on the actual and
projected timing and amount of probable credit losses. Provisions made to
increase the allowance related to credit risk are presented as provision for
losses in the accompanying consolidated statements of operations. The Company's
actual credit losses may differ from those estimates used to establish the
allowance.
Certain reclassifications have been made to the financial statements for 2002 to
conform to presentation for 2003,including reclassification of extraordinary
gain pursuant to the adoption of SFAS No. 145, "Recission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
NOTE 2 -- FAIR VALUE
Securities classified as available-for-sale are carried in the accompanying
financial statements at estimated fair value. The Company uses estimates in
establishing fair value for its available-for-sale securities. Estimates of fair
value for securities may be based on market prices provided by certain dealers.
Estimates of fair value for certain other securities are determined by
calculating the present value of the projected cash flows of the instruments
4
using market-based discount rates, prepayment rates and credit loss assumptions.
The estimate of fair value for securities pledged as collateral for
collateralized bonds is determined by calculating the present value of the
projected cash flows of the instruments using prepayment rate assumptions and
credit loss assumptions based on historical experience and estimated future
activity, and using discount rates commensurate with those the Company believes
would be used by third parties. Such discount rate used in the determination of
fair value of securities pledged as collateral for collateralized bonds was 16%
at March 31, 2003 and December 31, 2002. Prepayment rate assumptions at March
31, 2003, and December 31, 2002, were generally at a "constant prepayment rate,"
or CPR ranging from 30%-45% for both 2003 and 2002, for collateral for
collateralized bonds consisting of securities backed by single-family mortgage
loans, and a CPR equivalent of 8% for 2003 and 11% for 2002 for collateral for
collateralized bonds consisting of securities backed by manufactured housing
loans. CPR assumptions for each year are based in part on the actual prepayment
rates experienced for the prior six-month period and in part on management's
estimate of future prepayment activity. The credit loss assumptions utilized
vary depending on the collateral pledged.
NOTE 3 -- NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is presented on both a basic net income
(loss) per common share and diluted net income (loss) per common share basis.
Diluted net income (loss) per common share assumes the conversion of the
convertible preferred stock into common stock, using the if-converted method,
and stock appreciation rights to the extent that there are rights outstanding,
using the treasury stock method, but only if these items are dilutive. The
preferred stock is convertible into one share of common stock for two shares of
preferred stock. The following table reconciles the numerator and denominator
for both the basic and diluted net income (loss) per common share for the three
months ended March 31, 2003 and 2002.
5
------------------------------------------------- ------------------------------------------------------------------
Three Months Ended March 31,
------------------------------------------------------------------
2003 2002
------------------------------------------------- --------------------------- --- ----------------------------------
Weighted-Average Weighted-
Number of Average
Income Shares Income Number of
(loss) (loss) Shares
------------- ------------- --------------- ------------------
Net income $ 2,044 $ 1,925
Preferred stock benefit (charge) 10,444 (2,396)
------------- ---------------
Net income (loss) to common shareholders
$ 12,488 10,873,903 $ (471) 10,873,853
Effect of dividends and additional shares of
preferred stock 1,593 1,569,882 - -
------------- ------------- --------------- ------------------
Diluted $ 14,081 12,443,785 $ (471) 10,873,853
============= ============= =============== ==================
Net income (loss) per share:
Basic $ 1.15 $ (0.04)
Diluted $ 1.13 $ (0.04)
============= ==================
Reconciliation of shares not included in calculation of earnings per share
due to antidilutive effect:
Conversion of Series A $ - - $ 580 496,019
Conversion of Series B - - 806 689,404
Conversion of Series C - - 1,010 691,766
Expense and incremental shares of stock
appreciation rights - - - -
------------- ------------- --------------- ------------------
$ - - $ 2,396 1,877,189
============= ============= =============== ==================
------------------------------------------------- ------------- ------------- --- --------------- ------------------
NOTE 4 -- COLLATERAL FOR COLLATERALIZED BONDS
The following table summarizes the components of collateral for collateralized
bonds as of March 31, 2003 and December 31, 2002:
---------------------------------- -------------------- -- --------------------
March 31, December 31, 2002
2003
---------------------------------- -------------------- -- --------------------
Loans, at amortized cost $ 1,776,353 $ 1,844,025
Allowance for loan losses (26,590) (25,448)
---------------------------------- -------------------- -- --------------------
Loans, net 1,749,763 1,818,577
Debt securities, at fair value 310,606 329,920
---------------------------------- -------------------- -- --------------------
$ 2,060,369 $ 2,148,497
---------------------------------- -------------------- -- --------------------
6
The following table summarizes the amortized cost basis, gross unrealized gains
and losses and estimated fair value of debt securities pledged as collateral for
collateralized bonds as of March 31, 2003 and December 31, 2002:
------------------------------------- -------------------- -- ------------------
March 31, December 31, 2002
2003
------------------------------------- -------------------- -- ------------------
Debt securities, at amortized cost $ 309,725 $ 329,621
Gross unrealized gains 881 322
Gross unrealized losses - (23)
------------------------------------- -------------------- -- ------------------
Estimated fair value $ 310,606 $ 329,920
------------------------------------- -------------------- -- ------------------
The components of collateral for collateralized bonds at March 31, 2003 and
December 31, 2002 are as follows:
------------------------------ ----------------------------------------- - ----------------------------------------
March 31, 2003 December 31, 2002
----------------------------------------- ----------------------------------------
Loans, Debt Total Loans, Debt Total
net Securities net Securities
------------------------------ -------------- ------------ ------------- ------------- ------------ -------------
Collateral $1,724,483 $306,482 $2,030,965 $1,791,679 $325,819 $2,117,498
Funds held by trustees 130 191 321 140 515 655
Accrued interest receivable 11,194 1,952 13,146 11,741 2,120 13,861
Unamortized premiums and
discounts, net 13,956 1,100 15,056 15,017 1,167 16,184
Unrealized gain, net - 881 881 - 299 299
------------------------------ -------------- ------------ ------------- ------------- ------------ -------------
$1,749,763 $310,606 $2,060,369 $1,818,577 $329,920 $2,148,497
------------------------------ -------------- ------------ ------------- - ------------- ------------ -------------
NOTE 5 -- OTHER INVESTMENTS
The following table summarizes the Company's other investments as of March 31,
2003 and December 31, 2002:
-------------------------------------------------------------------------- ------------------ -- ------------------
March 31, 2003 December 31, 2002
------------------ ------------------
Delinquent property tax receivables and securities, at amortized cost $ 47,935 $ 48,932
Real estate owned 5,125 5,251
Other 22 139
-------------------------------------------------------------------------- ------------------ ------------------
$ 53,082 $ 54,322
-------------------------------------------------------------------------- ------------------ -- ------------------
During the three months ended March 31, 2003 and 2002, the Company collected an
aggregate of $2,703 and $3,868, respectively, including net sales proceeds from
related real estate owned. The Company also accrued interest income of $1,312
and $1,445, respectively, during such periods, on a level-yield basis.
Delinquent property tax securities included in other investments are classified
as held-to-maturity and are carried at amortized cost.
7
NOTE 6 -- SECURITIES
The following table summarizes Dynex's amortized cost basis of securities
classified as held-to-maturity and fair value of securities classified as
available-for-sale, as of March 31, 2003 and December 31, 2002:
---------------------------------------------------- -------------- ------------
March 31, December 31,
2003 2002
---------------------------------------------------- -------------- ------------
Securities:
Asset-backed securities, held-to-maturity $ 1,386 $ 1,644
Fixed-rate mortgage securities, available-for-sale 1,249 1,268
Mortgage-related securities, available-for-sale 1,173 3,770
---------------------------------------------------- -------------- ------------
3,808 6,682
Gross unrealized gains 239 935
Gross unrealized losses (714) (1,409)
---------------------------------------------------- -------------- ------------
$ 3,333 $ 6,208
---------------------------------------------------- -------------- ------------
NOTE 7 -- ALLOWANCE FOR LOAN LOSSES
The Company reserves for credit risk where it has exposure to losses on loans in
its investment portfolio. The following table summarizes the aggregate activity
for the allowance for loan losses on investments for the three months ended
March 31, 2003 and 2002:
--------------------------------- ----------------------------------------------
Three Months Ended March 31,
--------------------------------- ----------------------------------------------
2003 2002
--------------------------------- ----------------------- ----------------------
Allowance at beginning of period $25,472 $22,147
Provision for loan losses 5,844 5,643
Charge-offs (4,702) (4,892)
--------------------------------- ----------------------- ----------------------
Allowance at end of period $26,614 $22,898
--------------------------------- ----------------------- ----------------------
NOTE 8 -- RECOURSE DEBT
The following table summarizes Dynex's recourse debt outstanding at March 31,
2003 and December 31, 2002:
------------------------------------- ----------------- -- ---------------------
March 31, 2003 December 31, 2002
------------------------------------- ----------------- -- ---------------------
9.50% Senior Notes (due 2/28/2005) $ 32,079 $ -
------------------------------------- ----------------- -- ---------------------
$ 32,079 $ -
------------------------------------- ----------------- -- ---------------------
During the quarter ended March 31, 2003, the Company issued $32,079 of 9.50%
senior unsecured notes due February 2005 (the "February 2005 Senior Notes") in
connection with a tender offer on the Company's preferred stock. The February
2005 Senior Notes were issued in exchange for 1,156,891 shares of Series A,
Series B and Series C preferred stock. See Note 9 for further discussion.
Principal payments in the amount of $4,010, along with interest payments at a
rate of 9.50% per annum, are due quarterly beginning May 2003, with final
payment due on February 28, 2005. The Company at its option can prepay the
February 2005 Senior Notes in whole or in part, without penalty, at any time.
The February 2005 Senior Notes prohibit distributions on the Company's capital
stock until they are fully repaid, except distributions necessary for the
Company to maintain REIT status.
NOTE 9 -- PREFERRED STOCK
As of March 31, 2003 and December 31, 2002, the total liquidation preference on
the Preferred Stock was $65,934 and $130,251, respectively, and the total amount
of dividends in arrears on Preferred Stock was $16,677 and $31,157,
respectively. Individually, the amount of dividends in arrears on the Series A,
8
the Series B and the Series C were $4,043 ($8.19 per Series A share), $5,636
($8.19 per Series B share) and $6,999 ($10.22 per Series C share), respectively
at March 31, 2003 and $7,544 ($7.60 per Series A share), $10,485 ($7.60 per
Series B share) and $13,128 ($9.49 per Series C share), respectively at December
31, 2002.
On February 28, 2003, the Company completed a tender offer for shares of its
Series A, Series B and Series C Preferred Stock. The Company purchased for cash
188,940 shares of its Series A Preferred Stock, 272,977 shares of its Series B
Preferred Stock and 268,792 shares of its Series C Preferred Stock for a total
cash payment of $19,286 and incurred $245 of fees and charges to complete the
tender offer. In addition, the Company exchanged $32,079 of February 2005 Senior
Notes for an additional 309,503 shares of Series A Preferred Stock, 417,541
shares of Series B Preferred Stock and 429,847 shares of Series C Preferred
Stock. For purposes of determining net income (loss) to common shareholders used
in the calculation of earnings (loss) per share, the tender offer resulted in a
preferred stock benefit of $12,036 comprised of the elimination of
dividends-in-arrears of $16,073 for the shares tendered, less the premium paid
on the Preferred Stock in excess of the book value of such Preferred Stock, of
$4,037. In addition, until the February 2005 Senior Notes have been fully
repaid, the Company is effectively prohibited from engaging in any future tender
offers for its Preferred Stock and from making any distributions with respect to
the Preferred Stock except as required for the Company to maintain its status as
a REIT.
NOTE 10 -- DERIVATIVE FINANCIAL INSTRUMENTS
Derivative Financial Instruments
In June 2002, the Company entered into an interest rate swap which matures on
June 28, 2005, to mitigate its interest rate risk exposure on $100,000 in
notional value of its variable rate collateralized bonds, which finance a like
amount of fixed rate assets. Under the agreement, the Company will pay interest
at a fixed rate of 3.73% on the notional amount and will receive interest based
on One-Month LIBOR on the same amount. This contract has been treated as a cash
flow hedge with changes in the value of the hedge being reported as a component
of accumulated other comprehensive income. During the three months ended March
31, 2003, the Company recognized an additional $172 in other comprehensive loss
on this position and incurred $577 of additional interest expense. At March 31,
2003, the aggregate accumulated other comprehensive loss was $4,157.
In October 2002, the Company entered into a synthetic three-year amortizing
interest-rate swap with an initial notional balance of approximately $80,000 to
mitigate its exposure to rising interest rates on a portion of its variable rate
collateralized bonds, which finance a like amount of fixed rate assets. This
contract is accounted for as a cash flow hedge with gains and losses associated
with the change in the value of the hedge being reported as a component of
accumulated other comprehensive income. At March 31, 2003, the current notional
balance of the amortizing synthetic swap was $60,000, and the remaining
weighted-average fixed-rate payable by the Company under the terms of the
synthetic swap was 2.68%. During the three months ended March 31, 2003, the
Company recognized an additional $268 in other comprehensive loss for the
synthetic interest-rate swap and incurred $40 of interest expense. At March 31,
2003, the aggregate accumulated other comprehensive loss was $745.
NOTE 11 -- COMMITMENTS AND CONTINGENCIES
GLS Capital, Inc. ("GLS"), a subsidiary of the Company, together with the County
of Allegheny, Pennsylvania ("Allegheny County"), were defendants in a lawsuit in
the Commonwealth Court of Pennsylvania (the "Commonwealth Court"), the appellate
court of the state of Pennsylvania. Plaintiffs were two local businesses seeking
status to represent as a class, delinquent taxpayers in Allegheny County whose
delinquent tax liens had been assigned to GLS. Plaintiffs challenged the right
of Allegheny County and GLS to collect certain interest, costs and expenses
related to delinquent property tax receivables in Allegheny County, and whether
the County had the right to assign the delinquent property tax receivables to
GLS and therefore employ procedures for collection enjoyed by Allegheny County
under state statute. This lawsuit was related to the purchase by GLS of
delinquent property tax receivables from Allegheny County in 1997, 1998, and
1999. In July 2001, the Commonwealth Court issued a ruling that addressed, among
other things, (i) the right of GLS to charge to the delinquent taxpayer a rate
of interest of 12% per annum versus 10% per annum on the collection of its
delinquent property tax receivables, (ii) the charging of a full month's
9
interest on a partial month's delinquency; (iii) the charging of attorney's fees
to the delinquent taxpayer for the collection of such tax receivables, and (iv)
the charging to the delinquent taxpayer of certain other fees and costs. The
Commonwealth Court in its opinion remanded for further consideration to the
lower trial court items (i), (ii) and (iv) above, and ruled that neither
Allegheny County nor GLS had the right to charge attorney's fees to the
delinquent taxpayer related to the collection of such tax receivables. The
Commonwealth Court further ruled that Allegheny County could assign its rights
in the delinquent property tax receivables to GLS, and that plaintiffs could
maintain equitable class in the action. In October 2001, GLS, along with
Allegheny County, filed an Application for Extraordinary Jurisdiction with the
Supreme Court of Pennsylvania, Western District appealing certain aspects of the
Commonwealth Court's ruling. In March 2003, the Supreme Court issued its opinion
as follows: (i) the Supreme Court determined that GLS can charge delinquent
taxpayers a rate of 12% per annum; (ii) the Supreme Court remanded back to the
lower trial court the charging of a full month's interest on a partial month's
delinquency; (iii) the Supreme Court revised the Commonwealth Court's ruling
regarding recouping attorney fees for collection of the receivables indicating
that the recoupment of fees requires a judicial review of collection procedures
used in each case; and (iv) the Supreme Court upheld the Commonwealth Court's
ruling that GLS can charge certain fees and costs, while remanding back to the
lower trial court for consideration the facts of each individual case. Finally,
the Supreme Court remanded to the lower trial court to determine if the
remaining claims can be resolved as a class action. No hearing date has been set
for the issues remanded back to the lower trial court.
The Company and Dynex Commercial, Inc. ("DCI"), formerly an affiliate of the
Company and now known as DCI Commercial, Inc., are defendants in state court in
Dallas County, Texas in the matter of Basic Capital Management et al ("BCM")
versus Dynex Commercial, Inc. et al. The suit was filed in April 1999 originally
against DCI, and in March 2000, BCM amended the complaint and added the Company
as a defendant. The current complaint alleges that, among other things, DCI and
the Company failed to fund tenant improvement or other advances allegedly
required on various loans made by DCI to BCM, which loans were subsequently
acquired by the Company; that DCI breached an alleged $160,000 "master" loan
commitment entered into in February 1998 and a second alleged loan commitment of
approximately $9,000; that DCI and the Company made negligent misrepresentations
in connection with the alleged $160,000 commitment; and that DCI and the Company
fraudulently induced BCM into canceling the alleged $160,000 master loan
commitment in January 1999. Plaintiff BCM is seeking damages approximating
$40,000, including approximately $36,500 for DCI's breach of the alleged
$160,000 master loan commitment, approximately $1,600 for alleged failure to
make additional tenant improvement advances, and approximately $1,900 for DCI's
not funding the alleged $9,000 commitment. DCI and the Company are vigorously
defending the claims on several grounds. The Company was not a party to the
alleged $160,000 master commitment or the alleged $9,000 commitment. The Company
has filed a counterclaim for damages approximating $11,000 against BCM.
Commencement of the trial of the case in Dallas, Texas is anticipated in
September 2003.
In November 2002, the Company received notice of a Second Amended Complaint
filed in the First Judicial District, Jefferson County, Mississippi in the
matter of Barbara Buie and Elizabeth Thompson versus East Automotive Group,
World Rental Car Sales of Mississippi, AutoBond Acceptance Corporation, Dynex
Capital, Inc. and John Does # 1-5. The Second Amended Complaint represents a
re-filing of the First Amended Complaint against the Company, which was
dismissed by the Court without prejudice in August 2001. The Second Amended
Complaint in reference to the Company alleges that Plaintiffs were the
beneficiaries of a contract entered into between AutoBond Acceptance Corporation
and the Company, and alleges that the Company breached such contract and that
such breach caused them to suffer economic loss. The Plaintiffs are seeking
compensatory damages of $1,000 and punitive damages of $1,000. Defendants East
Automotive Group and World Rental Car Sales of Mississippi have also filed cross
complaints against the Company. In February 2003, both the Second Amended
Complaint and the cross complaint were dismissed with prejudice by the
Mississippi Court.
Although no assurance can be given with respect to the ultimate outcome of the
above litigation, the Company believes the resolution of these lawsuits will not
have a material effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
10
NOTE 12 -- RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 145, "Recission of FASB Statements
No. 4, 44 and 64, Amendment of SFAS No. 13 and Technical Corrections". Effective
January 1, 2003, SFAS No. 145 requires gains and losses from the extinguishment
or repurchase of debt to be classified as extraordinary items only if they meet
the criteria for such classification in APB Opinion No. 30. Until January 1,
2003, gains and losses from the extinguishment or repurchase of debt must be
classified as extraordinary items. After January 1, 2003, any gain or loss
resulting from the extinguishment or repurchase of debt classified as an
extraordinary item in a prior period that does not meet the criteria for such
classification under APB Opinion No. 30 must be reclassified. The Company
adopted SFAS No. 145 on January 1, 2003 and has reclassified extraordinary items
to other income. The adoption of SFAS No. 145 has not had a material impact on
its financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." Effective January 1, 2003, SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. This statement applies to activities that are initiated
after December 31, 2002. The Company has adopted SFAS No. 146, which adoption
did not have a significant impact on the financial position, results of
operations or cash flows of the Company.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure." Effective after December 15, 2002,
this Statement amends SFAS No. 123, "Accounting for Stock-Based Compensation",
to provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The adoption of SFAS No. 148 has
not had a significant impact on its financial position, results of operations or
cash flows.
On November 25, 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34." FIN
No. 45 clarifies the requirements of SFAS No. 5, "Accounting for Contingencies,"
relating to the guarantor's accounting for, and disclosure of, the issuance of
certain types of guarantees. The disclosure requirements of FIN No. 45 are
effective for financial statements of interim or annual periods that end after
December 15, 2002. The Company had no guarantees that require disclosure at
year-end 2002 and the three-month period ended March 31, 2003. The provisions
for initial recognition and measurement are effective on a prospective basis for
guarantees that are issued or modified after December 31, 2002, irrespective of
the guarantor's year-end. FIN No. 45 requires that upon issuance of a guarantee,
the entity must recognize a liability for the fair value of the obligation it
assumes under that guarantee. The Company's adoption of FIN No. 45 in 2003 is
not expected to have a material effect on the Company's results of operations,
cash flows or financial position.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities - an interpretation of ARB No. 51," which addresses consolidation of
variable interest entities. FIN No. 46 expands the criteria for consideration in
determining whether a variable interest entity should be consolidated by a
business entity, and requires existing unconsolidated variable interest entities
(which include, but are not limited to, special purpose entities, or SPEs) to be
consolidated by their primary beneficiaries if the entities do not effectively
disperse risks among parties involved. This interpretation applies immediately
to variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date. It
applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The adoption of FIN No. 46
did not have a material effect on the Company's results of operations, cash
flows or financial position.
11
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." Effective after June 30, 2003,
this Statement amends SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", to provide clarification of financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts. In particular, this Statement (1) clarifies under
what circumstances a contract with an initial net investment meets the
characteristic of a derivative discussed in paragraph 6(b) of Statement 133, (2)
clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying to conform it to language used in FIN No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others," and (4) amends certain other
existing pronouncements. Those changes are intended to result in more consistent
reporting of contracts as either derivatives or hybrid instruments. The Company
is reviewing the implications of SFAS No. 149 but does not believe that its
adoption will have a significant impact on its financial position, results of
operations or cash flows.
NOTE 13 - RESTATEMENT OF FINANCIAL STATEMENTS
Subsequent to the issuance of its financial statements for the three months
ended March 31, 2003, the Company determined that declines in the fair value of
its delinquent property tax receivable debt security upon the reclassification
from available-for-sale to held-to-maturity in the fourth quarter of 2001 were
not accounted for correctly. As a result, the accompanying condensed
consolidated financial statements for the three months ended March 31, 2003 and
2002 and the condensed consolidated balance sheet as of December 31, 2002 have
been restated from the amounts previously reported to correct the accounting for
these impairment charges.
In 2001, the Company recorded other-than-temporary impairment charges of $6.3
million in the statement of operations and a reduction in the carrying value of
the delinquent property tax receivable security of $18.1 million as an
adjustment to accumulated other comprehensive loss included in shareholders'
equity. The Company subsequently amortized a portion of this $18.1 million in
2002 and 2003 on a level-yield basis as a reduction in accumulated other
comprehensive loss and as an increase in the carrying value of the tax
receivable security. As a result of the continued decline of the fair value of
this security, in the third quarter of 2003, the Company reconsidered the
accounting treatment afforded to the security in 2001, and determined that the
$18.1 million previously recorded as an adjustment to accumulated other
comprehensive loss should have been recorded as an other-than-temporary
impairment charge in the statement of operations in 2001. The Company has
further determined that interest income should have then been recorded in 2002
and 2003 based on estimated collections on a level-yield basis.
A summary of the significant effects of the restatement is as follows:
Condensed Consolidated Balance Sheet Data
(amounts in thousands)
---------------------------------------------- --------------------------------- -- --------------------------------
March 31, 2003 December 31, 2002
--------------------------------- --------------------------------
(As (As Restated) (As (As Restated)
Previously Previously
Reported) Reported)
-------------- --- -------------- ------------- --- --------------
Accumulated other comprehensive loss $ (15,973) $ (4,646) $ (17,472) $ (4,832)
Accumulated deficit (217,813) (229,140) (218,545) (231,185)
Total stockholders' equity 174,042 174,042 223,421 223,421
---------------------------------------------- -------------- --- -------------- -- ------------- --- --------------
12
Condensed Consolidated Statements of Operations Data
(amounts in thousands, except share data)
-------------------------------------------- --------------------------------- --- ---------------------------------
Three Months Ended March 31, Three Months Ended March 31,
2003 2002
--------------------------------- ---------------------------------
(As (As
Previously (As Previously
Reported) Restated) Reported) (As Restated)
-------------------------------------------- --------------- -- -------------- --- -------------- -- ---------------
Interest income - other investments $ 28 $ 1,341 $ 10 $ 1,454
Total interest income 38,181 39,493 42,940 44,385
Net interest margin before provision for
loan losses 10,131 11,443 9,500 10,945
Net interest margin 4,287 5,599 3,857 5,302
Net income 732 2,044 481 1,925
Net income (loss) to common shareholders
$ 11,176 $ 12,488 $ (1,915) $ (471)
Change in net unrealized gain/(loss) during
period on:
Investments classified as available-
for-sale 1,939 626 1,299 (146)
Comprehensive income (loss) 12,675 2,230 (616) 1,779
Net income (loss) per common share
Basic $ 1.03 $ 1.15 $ (0.18) $ (0.04)
Diluted $ 1.03 $ 1.13 $ (0.18) $ (0.04)
-------------------------------------------- --------------- -- -------------- --- -------------- -- ---------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
As discussed in Note 13 to the condensed consolidated financial statements, the
Company has restated its condensed consolidated financial statements for the
three months ended March 31, 2003 and 2002 and the condensed consolidated
balance sheet for the year ended December 31, 2002. The following MD&A takes
into account the effects of the restatement.
Dynex Capital, Inc. was incorporated in the Commonwealth of Virginia in 1987.
References to "Dynex", or "the Company" contained herein refer to Dynex Capital,
Inc. together with its qualified real estate investment trust (REIT)
subsidiaries and taxable REIT subsidiary. Dynex is a financial services company,
which invests in loans and securities consisting of or secured by, principally
single family mortgage loans, commercial mortgage loans, manufactured housing
installment loans and delinquent property tax receivables. The loans and
securities in which the Company invests have generally been pooled and pledged
(i.e. securitized) as collateral for non-recourse bonds ("collateralized
bonds"), which provides long-term financing for such loans while limiting
credit, interest rate and liquidity risk. The Company has elected to be treated
as a REIT for federal income tax purposes under the Internal Revenue Code of
1986, as amended, and, as such, must distribute substantially all of its taxable
income to shareholders. Provided that the Company meets all of the prescribed
Internal Revenue Code requirements for a REIT, the Company will generally not be
subject to federal income tax. The Company owns the right to call
adjustable-rate and fixed-rate mortgage pass-through securities previously
issued and sold by the Company once the outstanding balance of such securities
reaches a call trigger, generally either 10% or less of the original amount
issued or a specified date. During the quarter ended March 31, 2003, the Company
called approximately $8.2 million of securities, and subsequently sold the
underlying seasoned single-family mortgage loan collateral at a gain of $0.4
million. The Company has also initiated a call which is expected to result in
the acquisition and subsequent sale of approximately $17 million in seasoned
single-family loans. At March 31, 2003, the aggregate callable balance of such
securities at the time of the projected call is approximately $122 million,
relating to 8 securities. The Company may or may not elect to call one or more
of these securities when eligible to call.
13
The Company's primary focus today is on maximizing cash flows from its
investment portfolio and opportunistically calling securities pursuant to
clean-up calls if the underlying collateral has value for the Company. Longer
term, the Board of Directors will continue to evaluate alternatives for the use
of the Company's cash flow in an effort to improve overall shareholder value.
Such evaluation may include a number of alternatives, including the acquisition
of a new business. The Company has considered the possible acquisition of a
depository institution, but it is the Board of Directors' view that the Company
would likely attempt to resolve the remaining preferred stock
dividends-in-arrears before the Company would move forward with an acquisition.
In addition, given the availability of tax net operating loss carryforwards, the
Company could forego its REIT status in connection with the introduction of a
new business plan, if such business plan included activities not traditionally
associated with REITs, or that are prohibited or otherwise restricted for REITs.
FINANCIAL CONDITION
(amounts in thousands)
---------------------------------------- ----------------- ---------------------
March 31, 2003 December 31, 2002
---------------------------------------- ----------------- ---------------------
Investments:
Collateral for collateralized bonds $ 2,060,369 $ 2,148,497
Other investments 53,082 54,322
Other loans 8,559 9,288
Securities 3,333 6,208
Non-recourse debt - collateralized bonds 1,928,973 2,013,271
Recourse debt 32,079 -
Shareholders' equity 174,042 223,421
---------------------------------------- ------------ ------------------------
Collateral for collateralized bonds As of March 31, 2003, the Company had 21
series of collateralized bonds outstanding. The collateral for collateralized
bonds decreased to $2.06 billion at March 31, 2003 compared to $2.15 billion at
December 31, 2002. This decrease of $88.1 million is primarily the result of
$79.3 million in paydowns on the collateral, $5.8 million of additions to
allowance for loan losses, $1.5 million of impairment charges and $1.1 million
of net premium amortization.
Other investments. Other investments at March 31, 2003 consist primarily of
delinquent property tax receivables. Other investments decreased from $54.3
million at December 31, 2002 to $53.1 million at March 31, 2003. This decrease
is primarily the result of pay-downs of delinquent property tax receivables
which totaled $2.6 million, and sales of real estate owned properties of $0.2
million during the quarter. These decreases were partially offset by $1.3
million of interest income recorded during the period and additional advances
for collections of $0.3 million.
Other loans. Other loans decreased by $0.7 million from $9.3 million at December
31, 2002 to $8.6 million at March 31, 2003 as the result of paydowns during the
quarter.
Securities. Securities decreased during the three months ended March 31, 2003 by
$2.9 million, to $3.3 million at March 31, 2003 from $6.2 million at December
31, 2002 due to principal payments of $2.7 million, the sale of six securities
with a book value of $1.2 million, partially offset by $1.0 million of net
discount amortization.
Non-recourse debt. Collateralized bonds decreased $84.3 million, from $2.0
billion at December 31, 2002 to $1.9 billion at March 31, 2003. This decrease
was primarily a result of principal payments received of $79.3 million on the
associated collateral pledged which were used to pay down the collateralized
bonds in accordance with the respective indentures. Additionally, for certain
securitizations, surplus cash in the amount of $4.49 million was retained within
the security structure and used to repay collateralized bonds outstanding,
instead of being released to the Company, as certain performance triggers were
not met in such securitizations.
Recourse debt. Recourse debt increased to $32.1 million at March 31, 2003 from
December 31, 2002 as the result of the issuance of the February 2005 Senior
Notes issued in exchange for Preferred Stock in February 2003.
14
Shareholders' equity. Shareholders' equity decreased to $174.0 million at March
31, 2003 from $223.4 million at December 31, 2002. This decrease was primarily
the result of a $51.6 million retirement of preferred shares in connection with
the tender offer completed in February 2003, a net increase in accumulated other
comprehensive loss due to a decline in unrealized gain on investments
available-for-sale of $0.6 million and $0.4 million of deferred losses on
hedging instruments. This decrease was partially offset by net income of $2.0
million.
RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------------------
(amounts in thousands except per share information) 2003 2002
--------------------------------------------------------------------------------
Net interest margin $ 5,599 $ 5,302
Impairment charges (2,078) (2,111)
Gain on sales of investments 527 77
General and administrative expenses (2,021) (1,894)
Net income 2,044 1,925
Net income (loss) per common share:
Basic $ 1.15 $ (0.04)
Diluted $ 1.13 $ (0.04)
--------------------------------------------------------------------------------
Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002.
The increase in net income and net income per common share during the three
months ended March 31, 2003 as compared to the same period in 2002 is primarily
the result of an increase in net interest margin of $0.3 million, and an
increase in gain on sales of investments of $0.4 million, partially offset by a
decrease of $0.4 million in gain on extinguishment of debt.
Net interest margin for the three months ended March 31, 2003 increased to $5.6
million from $5.3 million for the same period for 2002. Net interest spread
increased from 1.49% to 1.66% for the three month periods ended March 31, 2002
and 2003, respectively. The improvement in the Company's net interest spread can
be attributed to a decline in the cost of interest-bearing liabilities from the
respective 2002 period, which have declined as a result in the decline of
One-Month LIBOR. The majority of the Company's variable-rate interest-bearing
liabilities are priced relative to One-Month LIBOR. Interest-bearing liability
costs declined by 19 basis points for the three month period ended March 31,
2003, compared to the same period in 2002. For the three month period ended
March 31, 2003, there has been a lesser decline in the effective
interest-earning yield on the collateral for collateralized bonds due to the
`reset' lag and `floors' (the loans generally adjust or `reset' every six or
twelve months and are generally limited to maximum adjustments upwards or
downwards of 1% each six months) on the approximate $472 million in
single-family ARM loans that comprise a portion of the collateral for
collateralized bonds. The average One-Month LIBOR rate declined to 1.34% for the
three-month period ended March 31, 2003 from 1.85% for the three-month period
ended March 31, 2002. Average interest-earning assets declined from $2.4 billion
for the three months ended March 31, 2002 to $2.1 billion for the three months
ended March 31, 2003. In addition, net interest margin was impacted by a
negative non-recurring item in 2002 related to the call of certain securities.
Impairment charges consist of losses on certain debt securities and costs
associated with foreclosed properties formerly included in the Company's
property tax receivables portfolio. Impairment charges for the three month
periods ended March 31, 2002 and 2003 were $2.1 million each year. Gain on sales
of investments increased by $0.4 from $0.1 million in 2002 to $0.5 million for
2003. Gain on sales of investments in 2003 includes the call of $8.2 million of
previously issued securities, and the subsequent sale of the underlying seasoned
single-family mortgage collateral.
Other income in 2002 includes income from the extinguishment of debt associated
with the early retirement of the Company's Senior Notes due in July 2002 that
resulted in a $0.4 million gain during the three month period ended March 31,
15
2002. Due to the adoption of SFAS No. 145, this gain has been reclassified from
extraordinary to other income.
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. Assets that are on non-accrual status are excluded from the
table below for each period presented.
Average Balances and Effective Interest Rates
-------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------------------------------------
2003 2002
----------------------------------------------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------------------------- ----------------------------
Interest-earning assets: (1)
Collateral for collateralized bonds (2) $ 2,100,177 7.19% $ 2,365,993 7.22%
Securities 5,668 19.13% 5,340 9.16%
Loans 8,755 5.76% 2,967 12.75%
Cash and other investments 63,824 8.40% 68,448 8.55%
----------------------------- ----------------------------
Total interest-earning assets $ 2,178,424 7.25% $ 2,442,748 7.27%
============================= ============================
Interest-bearing liabilities:
Non-recourse debt (3) $ 1,962,979 5.57% $ 2,192,492 5.72%
Other recourse debt - secured 10,693 9.50% 50,589 8.13%
----------------------------- ----------------------------
Total interest-bearing liabilities $ 1,973,672 5.59% $ 2,243,081 5.78%
============================= ============================
Net interest spread on all investments (3) 1.66% 1.49%
============ ============
Net yield on average interest-earning assets (3) 2.19% 1.96%
============ ============
-------------------------------------------------------------------------------------------------------------------
(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 $501 and $534 for the
three months ended March 31, 2003 and 2002, respectively.
(3) Effective rates are calculated excluding non-interest related
collateralized bond expenses and provision for credit losses. If
included, the net yield on average interest-earning assets would be 0.81%
and 0.65% for the three months ended March 31, 2003 and 2002,
respectively.
The net interest spread increased 17 basis points, to 1.66% for the three months
ended March 31, 2003 from 1.49% for the same period in 2002. The net yield on
average interest earning assets for the three months ended March 31, 2003 also
improved relative to the same period in 2002, to 2.19% from 1.96%. The
improvement in the Company's net interest spread can be attributed to a decline
in the cost of interest-bearing liabilities from the respective 2002 period,
which have declined as a result in the decline of One-Month LIBOR. The majority
of the Company's variable-rate interest-bearing liabilities are priced relative
to One-Month LIBOR. Interest-bearing liability costs declined by 19 basis points
for the three month period ended March 31, 2003, compared to the same period in
2002. For the three month period ended March 31, 2003, there has been a lesser
decline in the effective interest-earning yield on the collateral for
collateralized bonds due to the `reset' lag and `floors' (the loans generally
adjust or `reset' every six or twelve months and are generally limited to
maximum adjustments upwards or downwards of 1% each six months) on the
approximate $472 million in single-family ARM loans that comprise a portion of
the collateral for collateralized bonds. The average One-Month LIBOR rate
declined to 1.34% for the three-month period ended March 31, 2003 from 1.85% for
the three-month period ended March 31, 2002.
From March 31, 2002 to March 31, 2003, average interest-earning assets declined
$264 million, or approximately 11%. A large portion of such reduction relates to
paydowns on the Company's adjustable-rate single-family mortgage loans. The
Company's portfolio as of March 31, 2003 consists of $471.6 million of
16
adjustable rate assets and $1.6 billion of fixed-rate assets. The Company
currently finances approximately $227.0 million of the fixed-rate assets with
non-recourse LIBOR based floating-rate liabilities. Assuming short-term interest
rates stay at or about current levels, the single-family ARM loans should
continue to reset downwards in rate (subject to the floors) which will have the
impact of reducing net interest spread in future periods. In June 2002, the
Company entered into a $100 million notional pay fixed/receive variable interest
rate swap agreement to hedge part of this fixed-rate/floating-rate interest
mismatch. In October 2002, the company short sold a series of 3-month Eurodollar
futures contracts with decreasing notional amounts to hedge an additional
portion of this mismatch. At March 31, 2003, the notional amount of this
synthetic amortizing swap was $60 million.
Interest Income and Interest-Earning Assets. At March 31, 2003, $1.6 billion of
the investment portfolio consists of loans and securities which pay a fixed-rate
of interest, and approximately $471.6 million of the investment portfolio is
comprised of loans and securities that have coupon rates which adjust over time
(subject to certain periodic and lifetime limitations) in conjunction with
changes in short-term interest rates. Approximately 73% of the ARM loans
underlying the ARM securities and collateral for collateralized bonds are
indexed to and reset based upon the level of six-month LIBOR; approximately 14%
of the ARM loans are indexed to and reset based upon the level of the one-year
Constant Maturity Treasury (CMT) index. The following table presents a
breakdown, by principal balance, of the Company's collateral for collateralized
bonds and securities by type of underlying loan. This table excludes
mortgage-related securities, other investments and unsecuritized loans.
Investment Portfolio Composition (1)
($ in millions)
---------------- ------------------ ------------------ ------------------ ------------------ ------------------
LIBOR Based ARM CMT Based ARM Other Indices
Loans Loans Based ARM Loans Fixed-Rate Loans Total
---------------- ------------------ ------------------ ------------------ ------------------ ------------------
2002, Quarter 1 $ 410.2 $ 100.2 $ 65.7 $ 1,725.1 $ 2,301.2
2002, Quarter 2 452.6 90.1 63.8 1,740.2 2,346.7
2002, Quarter 3 414.4 80.8 59.9 1,698.4 2,253.5
2002, Quarter 4 384.6 73.2 57.0 1,650.9 2,165.7
2003, Quarter 1 352.5 66.3 52.8 1,605.3 2,076.9
---------------- ------------------ ------------------ ------------------ ------------------ ------------------
(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, net
premium on the collateral for collateralized bonds and securities at March 31,
2003 was $15.1 million, or approximately 0.73% of the aggregate balance of
collateral for collateralized bonds and securities. The $15.1 million net
premium consists of gross collateral premiums of $37.1 million, less gross
collateral discounts of $22.1 million. Of the $37.1 million in gross premiums on
collateral, $22.1 million relates to the premium on multifamily and commercial
mortgage loans with a principal balance of $774.6 million at March 31, 2003, and
that have prepayment lockouts and yield maintenance provisions generally
extending to at least 2008. Net premium on such multifamily and commercial loans
is $22.1 million. Amortization expense as a percentage of principal paydowns has
decreased to 1.32% for the three months ended March 31, 2003 from 1.53% for the
same period in 2002. The principal prepayment rate for the Company (indicated in
the table below as "CPR Annualized Rate") was approximately 24% for the three
months ended March 31, 2003. CPR or "constant prepayment rate" is a measure of
the annual prepayment rate on a pool of loans.
17
Premium Basis and Amortization
($ in millions)
--------------------------------------------------------------------------------
CPR Amortization Expense
Net Amortization Annualized as a % of Principal
Premium Expense Rate Paydowns
--------------------------------------------------------------------------------
2002, Quarter 1 $ 20.0 $ 2.4 $ 157.4 1.53%
2002, Quarter 2 18.3 1.5 108.3 1.39%
2002, Quarter 3 16.7 1.6 94.5 1.70%
2002, Quarter 4 16.2 0.5 95.5 0.57%
2003, Quarter 1 15.1 1.1 85.4 1.32%
--------------------------------------------------------------------------------
(1) Represents total principal reduction for the period consistent with the
basis for the calculation of the annualized CPR rate..
Credit Exposures. The Company invests in collateralized bonds or pass-through
securitization structures. Generally these securitization structures use
over-collateralization, subordination, third-party guarantees, reserve funds,
bond insurance, mortgage pool insurance or any combination of the foregoing as a
form of credit enhancement. The Company generally has retained a limited portion
of the direct credit risk in these securities. In most instances, the Company
retained the "first-loss" credit risk on pools of loans that it has securitized.
The following table summarizes the aggregate principal amount of collateral for
collateralized bonds and securities outstanding; the direct credit exposure
retained by the Company (represented by the amount of over-collateralization
pledged and subordinated securities owned by the Company), net of the credit
reserves and discounts maintained by the Company for such exposure; and the
actual credit losses incurred for each year.
The table excludes other forms of credit enhancement from which the Company
benefits, and based upon the performance of the underlying loans, may provide
additional protection against losses as discussed in the Company's Annual Report
on Form 10-K/A for the year ended December 31, 2002. These additional
protections include loss reimbursement guarantees with a remaining balance of
$30.2 million and a remaining deductible aggregating $1.4 million on $72.1
million of securitized single family mortgage loans which are subject to such
reimbursement agreements; guarantees aggregating $28.7 million on $302.4 million
of securitized commercial mortgage loans, whereby losses on such loans would
need to exceed the respective guarantee amount before the Company would incur
credit losses; and $241.4 million of securitized single family mortgage loans
which are subject to various mortgage pool insurance policies whereby losses
would need to exceed the remaining stop loss of at least 53% on such policies
before the Company would incur losses. This table excludes any credit exposure
on unsecuritized loans and other investments.
Credit Reserves and Actual Credit Losses
($ in millions)
------------------------------------------------------------------------------
Credit Exposure, Net
Outstanding Credit Exposure, Actual of Credit Reserves to
Loan Principal Net of Credit Outstanding Loan
Balance Credit Reserves Losses Balance
---------------------------------------------------------------------------
2002, Quarter 1 $ 2,423.0 $ 141.8 $ 6.0 5.85%
2002, Quarter 2 2,437.8 114.6 8.4 4.70%
2002, Quarter 3 2,340.5 110.2 8.3 4.71%
2002, Quarter 4 2,246.9 91.9 7.7 4.09%
2003, Quarter 1 2,082.3 90.1 6.2 4.33%
---------------------------------------------------------------------------
The following table summarizes single family mortgage loan, manufactured housing
loan and commercial mortgage loan delinquencies as a percentage of the
outstanding collateral balance for those securities in which Dynex has retained
a portion of the direct credit risk. The delinquencies as a percentage of the
outstanding collateral balance have increased to 2.71% at March 31, 2003 from
2.59% at March 31, 2002. The Company monitors and evaluates its exposure to
credit losses and has established reserves based upon anticipated losses,
18
general economic conditions and trends in the investment portfolio. As of March
31, 2003, management believes the level of credit reserves is appropriate for
currently existing losses.
Delinquency Statistics (1)
--------------------------------------------------------------------------------
60 to 90 days 90 days and over
delinquent delinquent(2) Total
--------------------------------------------------------------------------------
2002, Quarter 1 0.76% 1.83% 2.59%
2002, Quarter 2 0.59% 2.19% 2.78%
2002, Quarter 3 0.34% 2.14% 2.48%
2002, Quarter 4 0.64% 2.07% 2.71%
2003, Quarter 1 0.51% 2.20% 2.71%
--------------------------------------------------------------------------------
(1) Excludes other investments and unsecuritized loans.
(2) Includes foreclosures, repossessions and REO.
General and Administrative Expense The following tables present a breakdown of
general and administrative expense by category and business unit.
----------------- ---------------- ------------------------ --------------------
Servicing Corporate/Investment Total
Portfolio Management
----------------- ---------------- ------------------------ --------------------
2002, Quarter 1 $ 893.5 $ 1,000.6 $ 1,894.1
2002, Quarter 2 1,036.8 1,587.5 2,624.3
2002, Quarter 3 1,122.2 1,103.7 2,225.9
2002, Quarter 4 1,221.5 1,526.9 2,748.4
2003, Quarter 1 1,146.6 874.2 2,020.8
----------------- ---------------- ------------------------ --------------------
Recent Accounting Pronouncements. In April 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 145, "Recission of FASB Statements No. 4, 44 and 64, Amendment of SFAS No.
13 and Technical Corrections". Effective January 1, 2003, SFAS No. 145 requires
gains and losses from the extinguishment or repurchase of debt to be classified
as extraordinary items only if they meet the criteria for such classification in
APB Opinion No. 30. Until January 1, 2003, gains and losses from the
extinguishment or repurchase of debt must be classified as extraordinary items.
After January 1, 2003, any gain or loss resulting from the extinguishment or
repurchase of debt classified as an extraordinary item in a prior period that
does not meet the criteria for such classification under APB Opinion No. 30 must
be reclassified. The Company adopted SFAS No. 145 on January 1, 2003 and has
reclassified extraordinary items to other income. The adoption of SFAS No. 145
has not had a material impact on its financial position or results of
operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." Effective January 1, 2003, SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. This statement applies to activities that are initiated
after December 31, 2002. The Company has adopted SFAS No. 146, which adoption
did not have a significant impact on the financial position, results of
operations or cash flows of the Company.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure." Effective after December 15, 2002,
this Statement amends SFAS No. 123, "Accounting for Stock-Based Compensation",
to provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The adoption of SFAS No. 148 has
not had a significant impact on its financial position, results of operations or
cash flows.
19
On November 25, 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34." FIN
No. 45 clarifies the requirements of SFAS No. 5, "Accounting for Contingencies,"
relating to the guarantor's accounting for, and disclosure of, the issuance of
certain types of guarantees. The disclosure requirements of FIN No. 45 are
effective for financial statements of interim or annual periods that end after
December 15, 2002. The Company had no guarantees that require disclosure at
year-end 2002 and the three-month period ended March 31, 2003. The provisions
for initial recognition and measurement are effective on a prospective basis for
guarantees that are issued or modified after December 31, 2002, irrespective of
the guarantor's year-end. FIN No. 45 requires that upon issuance of a guarantee,
the entity must recognize a liability for the fair value of the obligation it
assumes under that guarantee. The Company's adoption of FIN No. 45 in 2003 is
not expected to have a material effect on the Company's results of operations,
cash flows or financial position.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities - an interpretation of ARB No. 51", which addresses consolidation of
variable interest entities. FIN No. 46 expands the criteria for consideration in
determining whether a variable interest entity should be consolidated by a
business entity, and requires existing unconsolidated variable interest entities
(which include, but are not limited to, special purpose entities, or SPEs) to be
consolidated by their primary beneficiaries if the entities do not effectively
disperse risks among parties involved. This interpretation applies immediately
to variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date. It
applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The adoption of FIN No. 46
did not have a material effect on the Company's results of operations, cash
flows or financial position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." Effective after June 30, 2003,
this Statement amends SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", to provide clarification of financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts. In particular, this Statement (1) clarifies under
what circumstances a contract with an initial net investment meets the
characteristic of a derivative discussed in paragraph 6(b) of Statement 133, (2)
clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying to conform it to language used in FIN No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others," and (4) amends certain other
existing pronouncements. Those changes are intended to result in more consistent
reporting of contracts as either derivatives or hybrid instruments. The Company
is reviewing the implications of SFAS No. 149 but does not believe that its
adoption will have a significant impact on its financial position, results of
operations or cash flows.
Supplemental Information For Collateralized Bond Securities
The Company, through its subsidiaries, pledges collateral (i.e., single-family
mortgage loans and securities, manufactured housing mortgage loans and
securities, or commercial mortgage loans) for collateralized bond obligations
that are issued based on the pledge of such collateral. These collateralized
bonds are recourse only to the collateral pledged, and not to the Company. The
structure created by the pledge of collateral and sale of the associated
collateralized bonds is referred to hereafter as a "collateralized bond
security". The "principal balance of net investment" in a collateralized bond
security represents the principal balance of the collateral pledged less the
outstanding balance of the associated collateralized bonds owned by third
parties. This net investment is also commonly referred to as
"over-collateralization". The "amortized cost basis of net investment" is the
over-collateralization amount plus or minus collateral and collateralized bond
premiums and discounts and related costs. The Company generally has sold the
investment grade classes of the collateralized bonds to third parties, and has
retained the portion of the collateralized bond security that is below
investment grade.
The Company analyzes and values its investment in collateral for collateralized
bonds on a net investment basis. The Company estimates the fair value of its net
investment in collateralized bond securities as the present value of the
projected cash flow from the collateral, adjusted for the impact of and assumed
20
level of future prepayments and credit losses, less the projected principal and
interest due on the bonds owned by third parties. Below is a summary as of March
31, 2003, by each series where the fair value exceeds $0.5 million of the
Company's net investment in collateralized bond securities. The Company master
services four of its collateral for collateralized bond securities. Structured
Asset Securitization Corporation (SASCO) Series 2002-9 is master-serviced by
Wells Fargo Bank. CCA One Series 2 and Series 3 are master-serviced by Bank of
New York. Monthly payment reports for those securities master-serviced by the
Company may be found on the Company's website at www.dynexcapital.com.
The following tables show the Company's net investment in each of the securities
presented below on both a principal balance and amortized cost basis, as those
terms are defined above. The accompanying consolidated financial statements of
the Company presents the collateral for collateralized bonds as an asset, and
presents the associated collateralized bond obligation as a non-recourse
liability. In addition, the Company carries only its investment in MERIT Series
11 at fair value. As a result, the table below is not meant to present the
Company's investment in collateral for collateralized bonds or collateralized
bonds in accordance with generally accepted accounting principles applicable to
the Company's transactions. See below for a reconciliation of the amounts
included in the table to the Company's consolidated financial statements.
--------------------------------------------------------------------------------------------------------------------
(amounts in thousands Principal
Principal Balance of Principal Amortized
Balance Collateralized Balance Cost Basis
Collateralized Of Bonds Of Of
Bond Collateral Outstanding to Net Net
Series (1) Collateral Type Pledged Third Parties Investment Investment
--------------------------------------------------------------------------------------------------------------------
MERIT Series 11 Securities backed by $ 315,065 $ 275,612 $ 39,453 $ 28,687
single-family mortgage
and manufactured housing
loans
MERIT Series 12 Manufactured housing loans 246,576 223,371 23,205 20,913
MERIT Series 13 Manufactured housing loans 296,500 264,847 31,653 26,256
SASCO 2002-9 Single family loans 434,416 423,029 11,387 21,460
MCA Series 1 Commercial mortgage loans 81,741 77,022 4,719 (175)
CCA One Series 2 Commercial mortgage loans 293,421 271,317 22,104 8,363
CCA One Series 3 Commercial mortgage loans 398,421 354,397 44,024 51,449
--------------------------------------------------------------------------------------------------------------------
$ 2,066,140 $ 1,889,595 $ 176,545 $ 156,953
--------------------------------------------------------------------------------------------------------------------
(1) MERIT stands for MERIT Securities Corporation; MCA stands for Multifamily
Capital Access One, Inc. (now known as Commercial Capital Access One,
Inc.); and CCA stands for Commercial Capital Access One, Inc. Each such
entity is a wholly owned limited purpose subsidiary of the Company. SASCO
stands for Structured Asset Securitization Corporation
The following table reconciles the balances presented in the table above with
the amounts included for collateral for collateralized bonds and collateralized
bonds in the accompanying consolidated financial statements.
--------------------------------------------------------------------------------------------------------------------
(amounts in thousands) Collateral For
Collateralized Collateralized Net
Bonds Bonds Investment
--------------------------------------------------------------------------------------------------------------------
Principal balances per the above table $ 2,066,140 $ 1,889,595 $ 176,545
Principal balance of security excluded from above table 5,148 5,126 22
Premiums and discounts 1,325 26,368 (25,043)
Accrued interest and other 14,346 7,884 6,462
Allowance for loan losses (26,590) - (26,590)
--------------------------------------------------------------------------------------------------------------------
Balance per consolidated financial statements $ 2,060,369 $ 1,928,973 $ 131,396
--------------------------------------------------------------------------------------------------------------------
21
The following table summarizes the fair value of the Company's net investment in
collateralized bond securities, the various assumptions made in estimating
value, and the cash flow received from such net investment during 2003. As the
Company does not present its investment in collateralized bonds on a net
investment basis and carries only its investment in MERIT Series 11 at fair
value, the table below is not meant to present the Company's investment in
collateral for collateralized bonds or collateralized bonds in accordance with
generally accepted accounting principles applicable to the Company's
transactions.
--------------------------------------------------------------------------------------------------------------------
Fair Value Assumptions ($ in thousands)
-----------------------------------------------------------------------------------------------
Collateralized Bond Weighted-average Projected cash Fair value of net Cash flows
Series prepayment speeds Losses flow termination investment (1) received in 2003,
date net (2)
--------------------------------------------------------------------------------------------------------------------
MERIT Series 11 30%-45% CPR on SF 3.4% annually on Anticipated final $ 29,308 $ 4,169
securities; 8% MH loans maturity in 2025
CPR on MH
securities
MERIT Series 12 7% CPR 3.6% annually on Anticipated final 1,847 260
MH loans maturity in 2027
MERIT Series 13 8% CPR 4.3% annually Anticipated final 1,048 291
maturity in 2026
SASCO 2002-9 30% CPR 0.2% annually Anticipated call 29,503 2,078
date in 2005
MCA One Series 1 (3) 0.80% annually Anticipated final 2,514 116
maturity in 2018
CCA One Series 2 (4) 0.40% annually Anticipated call 10,188 431
beginning in 2004 date in 2012
CCA One Series 3 (4) 0.60% annually Anticipated call 20,043 596
beginning in 2003 date in 2009
--------------------------------------------------------------------------------------------------------------------
$ 94,451 $ 7,941
--------------------------------------------------------------------------------------------------------------------
(1) Calculated as the net present value of expected future cash flows,
discounted at 16%. Expected cash flows were based on the forward LIBOR
curve as of March 31, 2003, and incorporates the resetting of the interest
rates on the adjustable rate assets to a level consistent with projected
prevailing rates. Increases or decreases in interest rates and index levels
from those used would impact the calculation of fair value, as would
differences in actual prepayment speeds and credit losses versus the
assumptions set forth above.
(2) Cash flows received by the Company during the year, equal to the excess of
the cash flows received on the collateral pledged, over the cash flow
requirements of the collateralized bond security
(3) Computed at 0% CPR
(4) Computed at 0% CPR until the respective call date
The above tables illustrate the Company's estimated fair value of its net
investment in certain collateralized bond securities. In its consolidated
financial statements, the Company carries its investments at amortized cost,
except for its investment in MERIT Series 11, which it carries at estimated fair
value. Including the recorded allowance for loan losses of $26.6 million, the
Company's net investment in collateralized bond securities is approximately
$131.1 million as set forth in the table on page 21. This amount compares to an
estimated fair value, utilizing a discount rate of 16%, of approximately $94.5
million, as set forth in the table above. The difference between the $131.1
million in net investment as included in the consolidated financial statements
and the $94.5 million of estimated fair value, is due to the differences between
the estimated fair value of such net investment and amortized cost.
22
The following table compares the fair value of these investments at various
discount rates, but otherwise using the same assumptions as set forth for the
two immediately preceding tables:
Fair Value of Net Investment
--------------------------------------------------------------------------------
Collateralized 12% 16% 20% 25%
Bond Series
------------------ ------------ ------------ --------------- -------------------
MERIT Series 11A $ 32,154 $ 29,308 $ 27,005 $ 24,682
MERIT Series 12-1 1,731 1,847 1,893 1,891
MERIT Series 13 749 1,048 1,242 1,387
SASCO 2002-9 30,839 29,503 28,252 26,796
MCA One Series 1 3,152 2,514 2,043 1,618
CCA One Series 2 12,606 10,188 8,401 6,785
CCA One Series 3 24,606 20,043 16,818 13,648
------------------ ------------ ------------ --------------- -------------------
$ 105,837 $ 94,451 $ 85,654 $ 76,807
------------------ ------------ ------------ --------------- -------------------
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations from a variety of sources.
These sources have included cash flow generated from the investment portfolio,
including net interest income and principal payments and prepayments. In
addition, while the Company was actively originating loans for its investment
portfolio, the Company funded these operations through 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). The Company's investment portfolio continues to provide
positive cash flow, which can be utilized by the Company for reinvestment or
other purposes. Should the Company's future operations require access to sources
of capital such as lines of credit and repurchase agreements, the Company
believes that it would be able to access such sources.
The Company's cash flow from its investment portfolio for the quarter ended
March 31, 2003 was approximately $14.3 million. Such cash flow is after payment
of principal and interest on the associated collateralized bonds (i.e.,
non-recourse debt) outstanding. From the cash flow on its investment portfolio,
the Company funds its operating overhead costs, including the servicing of its
delinquent property tax receivables, and repays any remaining recourse debt.
Excluding any cash flow derived from the sale or re-securitization of assets,
and assuming that short-term interest rates remain stable, the Company
anticipates that the cash flow from its investment portfolio over 2003 will
decline as assets in the investment portfolio continue to pay down. The Company
anticipates, however, that it will have sufficient cash flow from its investment
portfolio to meet all of its obligations on both a short-term and long-term
basis.
In February 2003, the Company completed a partial tender offer for shares of its
Series A, Series B and Series C Preferred Stock. The Company purchased for cash
188,940 shares of its Series A Preferred Stock, 272,977 shares of its Series B
Preferred Stock and 268,792 shares of its Series C Preferred Stock for a total
cash payment of $19.3 million. In addition, the Company exchanged 9.50% Senior
Notes totaling $32.1 million, due February 28, 2005, for an additional 309,503
shares of Series A Preferred Stock, 417,541 shares of Series B Preferred Stock
and 429,847 shares of Series C Preferred Stock. The Company utilized cash flow
generated from its investment portfolio to fund the cash portion of the tender
offer.
Recourse Debt. During the quarter ended March 31, 2003, the Company issued $32.1
million of 9.50% senior unsecured notes due February 2005 (the "February 2005
Senior Notes") in connection with a tender offer on the Company's preferred
stock. The February 2005 Senior Notes were issued in exchange for 1,156,891
shares of Series A, Series B and Series C preferred stock. Principal payments in
the amount of $4.0 million, along with interest payments at a rate of 9.50% per
annum, are due quarterly beginning May 2003, with final payment due on February
28, 2005. The Company at its option can prepay the February 2005 Senior Notes in
23
whole or in part, without penalty, at any time. The February 2005 Senior Notes
prohibit distributions on the Company's capital stock until they are fully
repaid, except distributions necessary for the Company to maintain REIT status.
Non-recourse Debt. Dynex, 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. Collateral for collateralized bonds is 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 on the earlier of a specified date
or when the remaining balance of the bonds equals 35% or less of the original
principal balance of the bonds. At March 31, 2003, Dynex had $1.9 billion of
collateralized bonds outstanding.
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-Q/A made by the Company, that are not
historical fact constitute "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such forward-looking statements may
involve factors that could cause the actual results of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. The Company cautions the public not to place
undue reliance on forward-looking statements, which may be based on assumptions
and anticipated events that do not materialize. The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.
Factors that may cause actual results to differ from historical results or from
any results expressed or implied by forward-looking statements include the
following:
Economic Conditions. The Company is affected by general economic conditions. The
risk of defaults and credit losses could increase during an economic slowdown or
recession. This could have an adverse effect on the Company's financial
performance and the performance on the Company's securitized loan pools.
Capital Resources. Cash flows from our portfolio are subject to fluctuation due
to changes in interest rates, repayment rates and default rates and related
losses.
Interest Rate Fluctuations. The Company's income depends on its ability to earn
greater interest on its investments than the interest cost to finance these
investments. Interest rates in the markets served by the Company generally rise
or fall with interest rates as a whole. A majority of the loans currently
pledged as collateral for collateralized bonds by the Company are fixed-rate.
The Company currently finances these fixed-rate assets through non-recourse
debt, approximately $227.0 million of which is variable rate. In addition, a
significant amount of the investments held by the Company is adjustable-rate
collateral for collateralized bonds. These investments are financed through
non-recourse long-term collateralized bonds. The net interest spread for these
investments could decrease materially during a period of rapidly rising
short-term interest rates, since the investments generally have interest rates
which reset on a delayed basis and have periodic interest rate caps, whereas the
related borrowing has no delayed resets or 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. The allowance for losses
is calculated on the basis of historical experience and management's best
estimates. Actual default rates or loss severity may differ from the Company's
estimate as a result of economic conditions. In particular, the default rate and
loss severity on the Company's portfolio of manufactured housing loans has been
higher than initially estimated. Actual defaults on ARM loans may increase
during a rising interest rate environment. The Company believes that its
reserves are adequate for such risks on loans that were delinquent as of March
31, 2003.
24
Third-party Servicers. Third-party servicers service the majority of the
Company's investment portfolio. To the extent that these servicers are
financially impaired, the performance of the Company's investment portfolio may
deteriorate, and defaults and credit losses may be greater than estimated.
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.
Depository Institution Strategy. The Company intends to explore the formation or
acquisition of a depository institution. However, the pursuit of this strategy
is subject to the outcome of the Company's investigation. No business plan has
been prepared for such strategy. Therefore, any forward-looking statement made
in the report is subject to the outcome of a variety of factors that are unknown
at this time.
Competition. The financial services industry is a highly competitive market.
Increased competition in the market has adversely affected the Company, and may
continue to do so.
Regulatory Changes. The Company's businesses as of March 31, 2003 are not
subject to any material federal or state regulation or licensing requirements.
However, changes in existing laws and regulations or in the interpretation
thereof, or the introduction of new laws and regulations, could adversely affect
the Company and the performance of the Company's securitized loan pools or its
ability to collect on its delinquent property tax receivables.
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 margin comprises the primary
component of the Company's earnings. Additionally, cash flow from the investment
portfolio represents the primary component of the Company's incoming cash flow.
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 re-price within specified periods. The Company's strategy has been 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 and cash flow in a variety of
interest rate and prepayment environments.
The Company 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.
The Company focuses on the sensitivity of its cash flow, and measures such
sensitivity 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 net interest margin cash flow for
the next twenty-four 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 cash flow.
The following table summarizes the Company's net interest margin cash flow
sensitivity analysis as of March 31, 2003. This analysis represents management's
estimate of the percentage change in net interest margin cash flow given a shift
25
in interest rates as discussed above. Other investments are excluded from this
analysis because they are not interest rate sensitive. The "Base" case
represents the interest rate environment as it existed as of March 31, 2003. At
March 31, 2003, One-Month LIBOR was 1.30% and Six-Month LIBOR was 1.23%. 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 significantly from the
modeled results. In addition, certain financial instruments provide a degree of
"optionality." The most significant option affecting the Company's portfolio is
the borrowers' option to prepay the loans. The model applies prepayment rate
assumptions representing management's estimate of prepayment activity on a
projected basis for each collateral pool in the investment portfolio. The model
applies the same prepayment rate assumptions for all five cases indicated below.
The extent to which borrowers utilize the ability to exercise their option may
cause actual results to significantly differ from the analysis. Furthermore, the
projected results assume no additions or subtractions to the Company's
portfolio, and no change to the Company's liability structure. Historically,
there have been significant changes in the Company's assets and liabilities, and
there are likely to be such changes in the future.
Basis Point % Change in Net
Increase Interest Margin
(Decrease) In Cash Flow From
Interest Rates Base Case
------------------------------ ---------------------------
+200 (9.5)%
+100 (5.8)%
Base -
-100 7.7%
-200 16.7%
Approximately $471.6 million of the Company's investment portfolio as of March
31, 2003 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 73% and 14% 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, to the extent that the Company has entered into such agreements.
The remaining portion of the Company's investment portfolio as of March 31,
2003, approximately $1.6 billion, is comprised of loans or securities that have
coupon rates that are fixed. The Company has substantially limited its interest
rate risk on such investments through (i) the issuance of fixed-rate
collateralized bonds which approximated $1.2 billion as of March 31, 2003, and
(ii) equity, which was $174.0 million. Overall, the Company's interest rate risk
is primarily related both to the rate of change in short term interest rates,
and to the level of short-term interest rates.
26
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. As required by
Rule 13a-15 under the Exchange Act, as of the end of the period covered by this
quarterly report (the "Evaluation Date"), the Company carried out an evaluation
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures. This evaluation was carried out under the supervision
and with the participation of the Company's management. Based upon that
evaluation, the Company's management concluded that the Company's disclosure
controls and procedures are effective. Disclosure controls and procedures are
controls and other procedures that are designed to ensure that information
required to be disclosed in the Company's reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed in the Company's reports filed
under the Exchange Act is accumulated and communicated to management, including
the Company's management, as appropriate, to allow timely decisions regarding
required disclosures.
(b) Changes in internal controls. There were no significant changes in
the Company's internal controls or in other factors that could materially
affect, or are reasonably likely to materially affect the Company's internal
controls during the most recent quarter and subsequent to March 31, 2003, nor
any significant deficiencies or material weaknesses in such internal controls
requiring corrective actions.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
GLS Capital, Inc. ("GLS"), a subsidiary of the Company, together with the County
of Allegheny, Pennsylvania ("Allegheny County"), were defendants in a lawsuit in
the Commonwealth Court of Pennsylvania (the "Commonwealth Court"), the appellate
court of the state of Pennsylvania. Plaintiffs were two local businesses seeking
status to represent as a class, delinquent taxpayers in Allegheny County whose
delinquent tax liens had been assigned to GLS. Plaintiffs challenged the right
of Allegheny County and GLS to collect certain interest, costs and expenses
related to delinquent property tax receivables in Allegheny County, and whether
the County had the right to assign the delinquent property tax receivables to
GLS and therefore employ procedures for collection enjoyed by Allegheny County
under state statute.. This lawsuit was related to the purchase by GLS of
delinquent property tax receivables from Allegheny County in 1997, 1998, and
1999. In July 2001, the Commonwealth Court issued a ruling that addressed, among
other things, (i) the right of GLS to charge to the delinquent taxpayer a rate
of interest of 12% per annum versus 10% per annum on the collection of its
delinquent property tax receivables, (ii) the charging of a full month's
interest on a partial month's delinquency; (iii) the charging of attorney's fees
to the delinquent taxpayer for the collection of such tax receivables, and (iv)
the charging to the delinquent taxpayer of certain other fees and costs. The
Commonwealth Court in its opinion remanded for further consideration to the
lower trial court items (i), (ii) and (iv) above, and ruled that neither
Allegheny County nor GLS had the right to charge attorney's fees to the
delinquent taxpayer related to the collection of such tax receivables. The
Commonwealth Court further ruled that Allegheny County could assign its rights
in the delinquent property tax receivables to GLS, and that plaintiffs could
maintain equitable class in the action. In October 2001, GLS, along with
Allegheny County, filed an Application for Extraordinary Jurisdiction with the
Supreme Court of Pennsylvania, Western District appealing certain aspects of the
Commonwealth Court's ruling. In March 2003, the Supreme Court issued its opinion
as follows: (i) the Supreme Court determined that GLS can charge delinquent
taxpayers a rate of 12% per annum; (ii) the Supreme Court remanded back to the
lower trial court the charging of a full month's interest on a partial month's
delinquency; (iii) the Supreme Court revised the Commonwealth Court's ruling
regarding recouping attorney fees for collection of the receivables indicating
that the recoupment of fees requires a judicial review of collection procedures
used in each case; and (iv) the Supreme Court upheld the Commonwealth Court's
ruling that GLS can charge certain fees and costs, while remanding back to the
lower trial court for consideration the facts of each individual case. Finally,
the Supreme Court remanded to the lower trial court to determine if the
27
remaining claims can be resolved as a class action. No hearing date has been set
for the issues remanded back to the lower trial court.
The Company and Dynex Commercial, Inc. ("DCI"), formerly an affiliate of the
Company and now known as DCI Commercial, Inc., are defendants in state court in
Dallas County, Texas in the matter of Basic Capital Management et al ("BCM")
versus Dynex Commercial, Inc. et al. The suit was filed in April 1999 originally
against DCI, and in March 2000, BCM amended the complaint and added the Company,
as a defendant. The current complaint alleges that, among other things, DCI and
the Company failed to fund tenant improvement or other advances allegedly
required on various loans made by DCI to BCM, which loans were subsequently
acquired by the Company; that DCI breached an alleged $160 million "master" loan
commitment entered into in February 1998 and a second alleged loan commitment of
approximately $9 million; that DCI and the Company made negligent
misrepresentations in connection with the alleged $160 million commitment; and
that DCI and the Company fraudulently induced BCM into canceling the alleged
$160 million master loan commitment in January 1999. Plaintiff BCM is seeking
damages approximating $40 million, including approximately $37 million for DCI's
breach of the alleged $160 million master loan commitment, approximately $1.6
million for alleged failure to make additional tenant improvement advances, and
approximately $1.9 million for DCI's not funding the alleged $9 million
commitment. DCI and the Company are vigorously defending the claims on several
grounds. The Company was not a party to the alleged $160 million master
commitment or the alleged $9 million commitment. The Company has filed a
counterclaim for damages approximating $11 million against BCM. Commencement of
the trial of the case in Dallas, Texas is anticipated in September 2003.
In November 2002, the Company received notice of a Second Amended Complaint
filed in the First Judicial District, Jefferson County, Mississippi in the
matter of Barbara Buie and Elizabeth Thompson versus East Automotive Group,
World Rental Car Sales of Mississippi, AutoBond Acceptance Corporation, Dynex
Capital, Inc. and John Does # 1-5. The Second Amended Complaint represents a
re-filing of the First Amended Complaint against the Company, which was
dismissed by the Court without prejudice in August 2001. The Second Amended
Complaint in reference to the Company alleges that Plaintiffs were the
beneficiaries of a contract entered into between AutoBond Acceptance Corporation
and the Company, and alleges that the Company breached such contract and that
such breach caused them to suffer economic loss. The Plaintiffs are seeking
compensatory damages of $1 million and punitive damages of $1 million.
Defendants East Automotive Group and World Rental Car Sales of Mississippi have
also filed cross complaints against the Company. In February 2003, both the
Second Amended Complaint and the cross complaint were dismissed with prejudice
by the Mississippi Court.
Although no assurance can be given with respect to the ultimate outcome of the
above litigation, the Company believes the resolution of these lawsuits will not
have a material effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
Item 2. Changes in Securities and Use of Proceeds
On February 28, 2003, the Company completed a tender offer for shares of its
Series A, Series B and Series C Preferred Stock. The Company purchased for cash
188,940 shares of its Series A Preferred Stock, 272,977 shares of its Series B
Preferred Stock and 268,792 shares of its Series C Preferred Stock for a total
cash payment of $19.3 million. In addition, the Company exchanged $32.1 million
of February 2005 Senior Notes for an additional 309,503 shares of Series A
Preferred Stock, 417,541 shares of Series B Preferred Stock and 429,847 shares
of Series C Preferred Stock. The tender offer resulted in a preferred stock
benefit of $12.4 million comprised the elimination of dividends-in-arrears of
$16.5 million for the shares tendered, less the premium paid on the Preferred
Stock in excess the book value of such Preferred Stock, of $4.0 million. In
addition, until the February 2005 Senior Notes have been fully repaid, the
company is effectively prohibited from engaging in any future tender offers for
its Preferred Stock and from making any distributions with respect to the
Preferred Stock except as required for the Company to maintain its status as a
REIT. The Company relied on Section 3(a)(9) of the Securities Act of 1933 for an
exemption from the registration requirements of Section 5.
28
Item 3. Defaults Upon Senior Securities
See Note 9 to accompanying condensed consolidated financial statements in Part I
Item 1.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Principal Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Principal Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
(b) Reports on Form 8-K None.
29
SIGNATURE
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.
Dated: December 23, 2003 By: /s/ Stephen J. Benedetti
----------------------------------------
Stephen J. Benedetti,
Executive Vice President
(Principal Executive Officer)
30
Exhibit 31.1
CERTIFICATION
PURSUANT TO 17 CFR 240.13a-14
PROMULGATED UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Stephen J. Benedetti, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of Dynex
Capital, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in
all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e) for the registrant and have:
(a) designed such disclosure controls and procedures, or caused
such disclosure controls to be designed under our
supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure
controls and procedures as of the end of the period covered
by this report based on such evaluation; and
(c) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the
registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control of
financial reporting; and
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Dated: December 23, 2003 By: /s/ Stephen J. Benedetti
--------------------------------------
Stephen J. Benedetti,
Principal Executive Officer
31
Exhibit 31.2
CERTIFICATION
PURSUANT TO 17 CFR 240.13a-14
PROMULGATED UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Stephen J. Benedetti, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of Dynex Capital,
Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the
registrant and have:
(a) designed such disclosure controls and procedures, or caused such
disclosure controls to be designed under our supervision, to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control of financial reporting;
and
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Dated: December 23, 2003 By: /s/ Stephen J. Benedetti
-----------------------------------
Stephen J. Benedetti,
Chief Financial Officer
32
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Dynex Capital, Inc. (the
"Company") on Form 10-Q/A for the quarter ended March 31, 2003, as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Stephen J. Benedetti, the Principal Executive Officer and the Chief Financial
Officer of the Company, certify, pursuant to and for purposes of 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, that to my knowledge:
(1) The Report fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in
all material respects, the financial condition and results of
operations of the Company.
Dated: December 23, 2003 By: /s/ Stephen J. Benedetti
---------------------------------------
Stephen J. Benedetti,
Principal Executive Officer
Chief Financial Officer
33