DYNEX CAPITAL INC - Annual Report: 2005 (Form 10-K)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM
10-K
(Mark
One)
þ
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the
fiscal year ended December 31, 2005
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT
OF 1934
Commission
file number 1-9819
DYNEX
CAPITAL, INC.
(Exact
name of registrant as specified in its charter)
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Virginia
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52-1549373
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(State
or other jurisdiction of incorporation or organization)
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(I.R.S.
Employer Identification No.)
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4551
Cox Road, Suite 300, Glen Allen, Virginia
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23060-6740
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(Address
of principal executive offices)
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(Zip
Code)
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Registrant’s
telephone number, including area code (804) 217-5800
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Securities
registered pursuant to Section 12(b) of the Act:
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Title
of each class
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Name
of each exchange on which registered
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Common
Stock, $.01 par value
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New
York Stock Exchange
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Series
D 9.50% Cumulative Convertible Preferred Stock,
$.01
par value
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New
York Stock Exchange
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Securities
registered pursuant to Section 12(g) of the
Act:
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None
(Title
of
class)
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act.
Yes o No þ
Indicate
by check mark if the registrant is not required to file reports pursuant
to
Section 13 or 15(d) of the Act.
Yes o No þ
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 90 days.
Yes þ No o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment
to this
Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check
one):
Large
accelerated filer o Accelerated
filer o Non-accelerated
filer þ
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).
Yes o No þ
As
of
June 30, 2005, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $72,038,574 based on a
closing sales price on the New York Stock Exchange of $7.55.
Common
stock outstanding as of February 28, 2006 was 12,163,391 shares.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the Definitive Proxy Statement to be filed pursuant to Regulation 14A
within
120 days from December 31, 2005, are incorporated by reference into Part
III.
DYNEX
CAPITAL, INC.
2005
FORM 10-K ANNUAL REPORT
TABLE
OF CONTENTS
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Page
Number
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PART
I.
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Item
1.
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Business
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1
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Item
1A.
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Risk
Factors
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4
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Item
1B.
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Unresolved
Staff Comments
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8
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Item
2.
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Properties
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8
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Item
3.
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Legal
Proceedings
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8
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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9
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PART
II.
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Item
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
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9
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Item
6.
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Selected
Financial Data
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10
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Item
7.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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11
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Item
7A.
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Quantitative
and Qualitative Disclosures about Market Risk
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28
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Item
8.
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Financial
Statements and Supplementary Data
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29
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Item
9.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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29
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Item
9A.
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Controls
and Procedures
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29
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Item
9B.
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Other
Information
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30
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PART
III.
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Item
10.
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Directors
and Executive Officers of the Registrant
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30
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Item
11.
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Executive
Compensation
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30
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Item
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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30
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Item
13.
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Certain
Relationships and Related Transactions
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30
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Item
14.
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Principal
Accounting Fees and Services
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31
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PART
IV.
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Item
15.
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Exhibits,
Financial Statement Schedules
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31
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SIGNATURES
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33
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i
PART
I
In
this annual report on Form 10-K, we refer to Dynex Capital, Inc. and its
subsidiaries as “we,” “us,” “Dynex,” or “the Company,” unless specifically
indicated otherwise.
Item
1. BUSINESS
GENERAL
Dynex
Capital, Inc., together with its subsidiaries, is a specialty finance company
organized as a real estate investment trust (REIT) that invests in loans
and
securities consisting principally of single-family residential and commercial
mortgage loans. We finance these loans and securities through a combination
of
non-recourse securitization financing, repurchase agreements, and equity.
We
employ financing in order to increase the overall yield on our invested capital.
Our ownership of these investments, and the use of leverage, exposes us to
credit risk, interest-rate risk, margin call risk, and prepayment risk. As
a
REIT, we are required to distribute to stockholders as dividends at least
90% of
our taxable income, which is our income as calculated for tax, after
consideration of any tax net operating loss (NOL) carrryforwards.
We
own
both investment grade and non-investment grade investments. Our ownership
of
non-investment grade securities is generally in the form of the first-loss
or
subordinate classes of securitization trusts, to date most of which we have
sponsored. In securitization trusts, loans and securities are pledged to
a
trust, and the trust issues bonds pursuant to an indenture. We typically
retain
the lowest-rated bond classes in the trust, often referred to as subordinate
bonds or overcollateralization. While the securitization trust is consolidated
in our financial statements, the performance of our investment depends on
the
performance of the subordinate bonds and overcollateralization. The overall
performance of the subordinate bonds and overcollateralization is highly
dependent on the credit performance of the underlying assets.
In
recent
years, we have elected to sell certain non-core assets, including investments
in
manufactured housing loans and delinquent property tax receivable portfolios.
Our emphasis has been on monetizing underperforming assets in anticipation
of
redeploying the invested capital in more compelling investment opportunities.
The investment sales and lack of reinvestment of our capital has resulted
in the
reduction in investments of $1,097 million over the last 24 months, and the
increase in our investable capital to approximately $60 million at the end
of
2005.
Given
the
current flat treasury yield curve, however, and the challenging reinvestment
environment in traditional mortgage REIT investment opportunities, we have
been
compelled to retain capital generated from the sales and from the normal
cash
flows of our investment portfolio. In 2004, we completed a recapitalization
of
our equity capital structure through the exchange of our outstanding shares
of
Series A, Series B and Series C preferred stock into shares of new Series
D
preferred stock and common stock. The recapitalization resulted in the
elimination or payment-in-kind of $18.5 million of dividends in arrears and
the
issuance of 1,288,488 shares of common stock. The shares of Series D preferred
stock automatically convert to 9.50% senior notes if the Company fails to
pay
two consecutive quarterly preferred dividends or if the Company fails to
maintain consolidated shareholders’ equity of at least 200% of the aggregate
issue price of the Series D preferred stock. In light of the lack of compelling
investment opportunities, we utilized a portion of our investable capital
to
redeem approximately $14 million, or 25%, of our 9.50% Series D Preferred
Stock
outstanding in January 2006. We have also announced a common stock repurchase
program for up to one million shares of stock. After the redemption of the
Series D Preferred Stock in January, our GAAP shareholders’ equity will decline
to approximately $135.2 million after the completion of the redemption.
Unlike
other mortgage REITs, our required REIT income distributions are likely to
be
limited well into the future due to the reduction of our future taxable income
by our NOL carryforwards, which were approximately $135 million at December
31,
2004. As a result, we anticipate that we will invest our capital and compound
the returns on such invested capital on an essentially tax-free basis for
the
foreseeable future. Over the long-term this will allow us to increase our
book
value per common share while potentially utilizing a lower risk investment
strategy than some of our competitors would have to utilize in order to achieve
similar results.
We
were
incorporated in the Commonwealth of Virginia in 1987, and began operations
in
1988.
1
BUSINESS
MODEL AND
STRATEGY
As
a
REIT, we seek to generate net interest income from our investment portfolio.
We
earn the excess of the interest income on our investment assets over the
costs
of the financing of those assets. The net interest income is directly impacted
by the credit performance of the underlying loans and securities, by the
level
of prepayments of the underlying loans and securities, and, to a lesser extent,
by changes in interest rates. Net interest income is also dependent on our
investment strategy and the reinvestment rate for our investable capital.
We
intend to invest in assets, and structure the financing of these assets,
in such
a way that will generate reasonably stable net interest income in a variety
of
prepayment, interest rate and credit environments. Our business model and
strategy have inherent risk, a discussion of these risks is provided in
Risk
Factors
in Item
1A below.
We
have
an investment policy which governs the allocation of capital amongst short-term,
highly liquid investments, investment grade fixed income investments,
subordinate and credit sensitive investments, and strategic investments.
Strategic investments are investments in equity and equity-like securities
of
other companies, including other mortgage REITs. Strategic investments may
or
may not be qualifying investments for the respective REIT tests described
in
Federal
Income Tax Considerations.
Our
capital allocations are reviewed annually by the Board of Directors, and
are
adjusted for a variety of factors, including, but not limited to, the current
investment climate, the current interest-rate environment, competition, and
our
desire for capital preservation.
We
currently are also seeking joint-venture or other arrangements with other
mortgage REITs, hedge funds, money managers, Wall Street firms, or other
specialty finance companies for purposes of leveraging their expertise and
resources for the reinvestment and management of a portion of our available
capital in accordance with the requirements of our investment policy. We
believe
that utilizing the expertise and resources of third-parties given the current
competitive environment for mortgage and related assets may be a better means
for generating investment opportunities, and managing the various risks
associated with these investments. We are seeking arrangements with credible
third parties which provide complimentary expertise to our expertise in
structured investments. To date we have had numerous discussions with potential
third parties with no firm commitment to enter into a relationship,
joint-venture, or co-investment strategy with these parties.
Because
of our NOL carryforwards, our distribution requirements to maintain our eligible
REIT status are limited. However, our Series D Preferred Stock requires the
payment of a quarterly dividend, and if the dividend is missed for a period
of
two consecutive quarters, the Series D Preferred Stock will automatically
convert into senior notes. While we will continually evaluate whether to
pay
dividends on our common stock, we intend for the foreseeable future to retain
net income to common shareholders for the future growth of the investment
portfolio, offsetting any REIT distribution requirements with our NOL
carryforward. In this way, we intend to retain net income to grow our capital
base, while at the same time growing our common book value and common book
value
per share. At December 31, 2005, common book value was $93.0 million or $7.65
per common share. Considering our NOL carryfoward of approximately $135 million
as of December 31, 2004, we could increase common book value by $135 million,
to
an approximate total of $228 million or approximately $19 per common share,
before we would be required to make a distribution to our common shareholders.
We have not yet completed our tax calculation for 2005, but we anticipate
reporting a net tax loss, primarily related to book-tax differences related
to
the sale of certain securitization finance receivables during 2005. Although
we
do not foresee any issues with our ability to use our NOL carryforwards to
offset future taxable income, there are circumstances that could restrict
our
ability to do so, which include restrictions based on changes in the ownership
of the Company. While we are retaining amounts that otherwise would be
distributed to shareholders, we believe that this enhances overall shareholder
value in the Company.
COMPETITION
The
financial services industry is a highly competitive industry in which we
compete
with a number of institutions with greater financial resources. In purchasing
portfolio investments, financing such purchases, and in issuing securities,
we
compete with other mortgage REITs, investment banking firms, savings and
loan
associations, commercial banks, mortgage bankers, insurance companies, federal
agencies, foreign investors, and other entities, many of which have greater
financial resources and a lower cost of capital than we do. Increased
competition in the market and our competitors’ greater financial resources have
driven down returns on investments and has adversely impacted our ability
to
invest our capital on an acceptable risk-adjusted basis, and may continue
to do
so for the foreseeable future.
2
AVAILABLE
INFORMATION
Our
website address is www.dynexcapital.com.
Our
annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current
reports on Form 8-K, and amendments to those reports, filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934
are
made available as soon as reasonably practicable after such material is
electronically filed with or furnished to the Securities and Exchange
Commission, free of charge, through our website.
We
have
adopted a Code of Conduct that applies to all of our employees, officers
and
directors. Our Code of Conduct is also available, free of charge, on our
website, along with our Audit Committee Charter, our Nominating and Corporate
Governance Committee Charter, and our Compensation Committee Charter. We
will
post on our website any amendments to the Code of Conduct or waivers from
its
provisions, if any, which are applicable to any of our directors or executive
officers.
FEDERAL
INCOME TAX CONSIDERATIONS
We
believe that we have complied with the requirements for qualification as
a REIT
under the Internal Revenue Code (the “Code”). The REIT rules generally require
that a REIT invest primarily in real estate-related assets, that our activities
be passive rather than active and that we distribute annually to our
shareholders substantially all of our taxable income. In addition, a REIT
is
required to distribute 90% of its taxable income, after certain deductions,
including deductions for NOL carryforwards. We could be subject to income
tax if
we failed to satisfy those requirements or if we acquired certain types of
income-producing real property. For the foreseeable future, we intend to
offset
taxable income with our NOL carryforwards, enabling us to retain taxable
net
income generated for reinvestment opportunities and our future growth.
We
use
the calendar year for both tax and financial reporting purposes. There may
be
differences between taxable income and income computed in accordance with
GAAP.
These differences primarily arise from timing differences in the recognition
of
revenue and expense for tax and GAAP purposes. We currently have tax operating
loss carryforwards of approximately $135 million, which expire between 2019
and
2024. We also had excess inclusion income of $1.4 million from our ownership
of
certain investments. Excess inclusion income cannot be offset by NOL
carryforwards, and therefore, in order to meet REIT distribution requirements,
we must distribute all of our excess inclusion income.
Failure
to satisfy certain Code requirements could cause us to lose our status as
a
REIT. If we failed to qualify as a REIT for any taxable year, we may be subject
to federal income tax (including any applicable alternative minimum tax)
at
regular corporate rates and would not receive deductions for dividends paid
to
shareholders. We could, however, utilize our NOL carryforward to offset any
taxable income. In addition, given the size of our NOL carryfoward, we could
pursue a business plan in the future in which we would voluntarily forego
our
REIT status. If we lost our status as a REIT, we could not elect REIT
status again for five years. Several of our investments in securitization
finance receivables are have ownership restrictions limited to ownership
by a
REIT. Therefore, if we chose to forego our REIT status, we would have to
sell
these investments, or otherwise provide for REIT ownership of these investments.
We
also
have a taxable REIT subsidiary (TRS), which has a NOL carryforward of
approximately $4 million. The TRS has limited operations, and, accordingly,
we
have established a full valuation allowance for the related deferred tax
asset.
Qualification
as a REIT
Qualification
as a REIT requires that we satisfy a variety of tests relating to our income,
assets, distributions and ownership. The significant tests are summarized
below.
Sources
of Income.
To
continue qualifying as a REIT, we must satisfy two distinct tests with respect
to the sources of our income: the “75% income test” and the “95% income test.”
The 75% income test requires that we derive at least 75% of our gross income
(excluding gross income from prohibited transactions) from certain real
estate-related sources. In order to satisfy the 95% income test, 95% of our
gross income for the taxable year must consist either of income that qualifies
under the 75% income test or certain other types of passive income.
3
If
we
fail to meet either the 75% income test or the 95% income test, or both,
in a
taxable year, we might nonetheless continue to qualify as a REIT, if our
failure
was due to reasonable cause and not willful neglect and the nature and amounts
of our items of gross income were properly disclosed to the Internal Revenue
Service. However, in such a case we would be required to pay a tax equal
to 100%
of any excess non-qualifying income.
Nature
and Diversification of Assets.
At the
end of each calendar quarter, three asset tests must be met by us. Under
the 75%
asset test, at least 75% of the value of our total assets must represent
cash or
cash items (including receivables), government securities or real estate
assets.
Under the “10% asset test,” we may not own more than 10% of the outstanding
voting securities of any single non-governmental issuer, provided such
securities do not qualify under the 75% asset test or relate to taxable REIT
subsidiaries. Under the “5% asset test,” ownership of any stocks or securities
that do not qualify under the 75% asset test must be limited, in respect
of any
single non-governmental issuer, to an amount not greater than 5% of the value
of
the total assets of us.
If
we
inadvertently fail to satisfy one or more of the asset tests at the end of
a
calendar quarter, such failure would not cause us to lose our REIT status,
provided that (i) we satisfied all of the asset tests at the close of a
preceding calendar quarter and (ii) the discrepancy between the values of
our assets and the standards imposed by the asset tests either did not exist
immediately after the acquisition of any particular asset or was not wholly
or
partially caused by such an acquisition. If the condition described in clause
(ii) of the preceding sentence was not satisfied, we still could avoid
disqualification by eliminating any discrepancy within 30 days after the
close
of the calendar quarter in which it arose.
Ownership.
In
order to maintain our REIT status, we must not be deemed to be closely held
and
must have more than 100 shareholders. The closely held prohibition requires
that
not more than 50% of the value of our outstanding shares be owned by five
or
fewer persons at anytime during the last half of our taxable year. The more
than
100 shareholders rule requires that we have at least 100 shareholders for
335
days of a twelve-month taxable year. In the event that we failed to satisfy
the
ownership requirements we would be subject to fines and be required to take
curative action to meet the ownership requirements in order to maintain our
REIT
status.
Taxable
Income
We
use
the calendar year for both tax and financial reporting purposes. However,
there
may be differences between taxable income and income computed in accordance
with
GAAP. These differences primarily arise from timing differences in the
recognition of revenue and expense for tax and GAAP purposes. The principal
difference relates to reserves for loan losses and other-than-temporary
impairment charges provided for GAAP purposes, which are not deductible for
tax
purposes, versus actual charge-offs on loans or realization of a losses on
securities, which are deductible for tax purposes as ordinary
losses.
EMPLOYEES
As
of
December 31, 2005, we had 20 employees. Our relationship with our employees
is
good. None of our employees are covered by any collective bargaining agreements,
and we are not aware of any union organizing activity relating to our
employees.
ITEM
1A. RISK FACTORS
Our business is subject to various risks, including the risks described below.
Our business, operating results and financial condition could be materially
and
adversely affected by any of these risks. Please note that additional risks
not
presently known to us or that we currently deem immaterial may also impair
our
business and operations.
We
may be unable to invest in new assets with attractive yields, and yields
on new
assets in which we do invest may not generate attractive yields, resulting
in a
decline in our earnings per share over time.
Since
2004 we have sold investments or assets have otherwise paid down in the amount
of $1,097 million. Asset yields today are generally lower that those assets
sold
or repaid, due to lower overall interest rates and more competition for these
assets. We have generally been unable to find investments which have acceptable
risk adjusted yields. As a result, our
4
net
interest income has been declining, and may continue to decline in the future,
resulting in lower earnings per share over time. In order to maintain our
investment portfolio size and our earnings, we need to reinvest a portion
of the
cash flows we receive into new interesting earning assets.
Our
ownership of certain subordinate interests in securitization trusts subjects
us
to credit risk on the underlying loans, and we provide for loss reserves
on
these loans as required under GAAP.
As
the
result of our ownership of the overcollateralization portion of the
securitization trust, the predominant risk to us in our investment portfolio
is
credit risk. Credit risk is the risk of loss to us from the failure by a
borrower (or the proceeds from the liquidation of the underlying collateral)
to
fully repay the principal balance and interest due on a loan. A borrower’s
ability to repay and the value of the underlying collateral could be negatively
influenced by economic and market conditions. These conditions could be global,
national, regional or local in nature. Upon securitization of the pool of
loans
or securities backed by loans, the credit risk retained by us from an economic
point of view is generally limited to the overcollateralization tranche of
the
securitization trust. We provide for estimated losses on the gross amount
of
loans pledged to securitization trusts included in our financial statements
as
required by GAAP. In some instances, we may also retain subordinated bonds
from
the securitization trust, which increases our credit risk above the
overcollateralization tranche from an economic perspective. We provide reserves
for existing losses based on the current performance of the respective pool
or
on an individual loan basis. If losses are experienced more rapidly, due
to
declining property performance, market conditions or other factors, than
we have
provided for in our reserves, we may be required to provide for additional
reserves for these losses.
Certain
investments employ internal structural leverage as a result of the
securitization process, and are
in the most subordinate position in the capital structure, which magnifies
the
potential impact of adverse events on our cash flows and reported results.
Many
of
the loans that we own have been pledged to securitization trusts which employ
a
high degree of internal structural leverage and concentrated credit, interest
rate, prepayment, or other risks. We have generally retained the most
subordinate classes of the securitization trust. As a result of these factors,
net interest income and cash flows on our investments will vary based on
the
performance of the assets pledged to the securitization trust. In particular,
should assets meaningfully underperform as to delinquencies, defaults, and
credit losses, it is possible that cash flows which may have otherwise been
paid
to us as a result of our ownership of the subordinate interests, may be retained
within the securitization trust. No amount of risk management or mitigation
can
change the variable nature of the cash flows and financial results generated
by
concentrated risks in our investments. None of our existing securities at
December 31, 2005 have reached these predetermined levels, but such levels
could
be reached in the future.
Our
efforts to manage credit risk may not be successful in limiting delinquencies
and defaults in underlying loans or losses on our
investments.
Despite
our efforts to manage credit risk, there are many aspects of credit that
we
cannot control. Third party servicers provide for the primary and special
servicing of our loans. We have a risk management function, which oversees
the
performance of these services and provides limited asset management
capabilities. Our risk management operations may not be successful in limiting
future delinquencies, defaults, and losses. The securitizations in which
we have
invested may not receive funds that we believe are due from mortgage insurance
companies and other counter-parties. Loan servicing companies may not cooperate
with our risk management efforts, or such efforts may be ineffective. Service
providers to securitizations, such as trustees, bond insurance providers,
and
custodians, may not perform in a manner that promotes our interests. The
value
of the properties collateralizing residential loans may decline. The value
of
properties collateralizing commercial mortgage loans may decline. The frequency
of default, and the loss severity on loans upon default, may be greater than
we
anticipated. If loans become “real estate owned” (REO), servicing companies will
have to manage these properties and may not be able to sell them. Changes
in
consumer behavior, bankruptcy laws, tax laws, and other laws may exacerbate
loan
losses. In some states and circumstances, the securitizations in which we
invest
have recourse as owner of the loan against the borrower’s other assets and
income in the event of loan default; however, in most cases, the value of
the
underlying property will be the sole source of funds for any recoveries.
5
Prepayments
of principal on our investments, and the timing of prepayments, may impact
our
reported earnings and our cash flows.
We
own
many of our securitization finance receivables at premiums to their principal
balances, and have issued associated securitization financing bonds at
discounts. Prepayments of principal on loans and the associated bonds, whether
voluntary or involuntary, impact the amortization of premiums and discounts
under the effective yield method of accounting that we use for GAAP accounting.
Under the effective yield method of accounting, we recognize yields on our
assets and effective costs of our liabilities based on assumptions regarding
future cash flows. Variations in actual cash flows from those assumed as
a
result of prepayments, and subsequent changes in future cash flow expectations,
will cause adjustments in yields on assets and costs of liabilities as a
corresponding charge to earnings.
In
a
period of declining interest rates, loans and securities in the investment
portfolio will generally prepay more rapidly (to the extent that such loans
are
not prohibited from prepayment), which may result in additional amortization
of
asset premium. In a flat yield curve environment (i.e.,
when
the spread between the yield on the one-year Treasury security and the yield
on
the ten-year Treasury security is less than 1.0%), adjustable rate mortgage
loans and securities tend to rapidly prepay, causing additional amortization
of
asset premium. In addition, the spread between our funding costs and asset
yields may compress, causing a further reduction in our net interest
income.
We
finance a portion of our investment portfolio with short-term recourse
repurchase agreements which subjects us to margin calls if the assets pledged
subsequently decline in value.
We
finance a portion of our investments, primarily high credit-quality, liquid
securities, with recourse repurchase agreements. These arrangements require
us
to maintain a certain level of collateral for the related borrowings. If
the
collateral should fall below the required level, the repurchase agreement
lender
could initiate a margin call. This would require that we either pledge
additional collateral acceptable to the lender or repay a portion of the
debt in
order to meet the margin requirement. Should we be unable to meet a margin
call,
we may have to liquidate the collateral or other assets quickly. Because
a
margin call and quick sale could result in a lower than otherwise expected
and
attainable sale price, we may incur a loss on the sale of the
collateral.
We
may be subject to the risks associated with inadequate or untimely services
from
third-party service providers, which may harm our results of
operations.
Our
loans
and loans underlying securities are serviced by third-party service providers.
As with any external service provider, we are subject to the risks associated
with inadequate or untimely services. Many borrowers require notices and
reminders to keep their loans current and to prevent delinquencies and
foreclosures. A substantial increase in our delinquency rate that results
from
improper servicing or loan performance in general could harm our ability
to
securitize our real estate loans in the future and may have an adverse effect
on
our earnings.
Interest
rate fluctuations can have various negative effects on us, and could lead
to
reduced earnings and/or increased earnings
volatility.
Our
investment portfolio today is substantially match-funded, and overall we
are
largely insulated from material risks related to rising, or declining, interest
rates. In the past however, we have been exposed to material changes in
short-term interest rates, and depending on future investments, may again
be
exposed to these changes. Certain of our current investments and contemplated
future investments are adjustable-rate loans and securities which have interest
rates which reset semi-annually or annually, based on an index such as the
one-year constant maturity treasury or the six-month London Interbank Offered
Rate (LIBOR). These investments may be financed with borrowings which reset
monthly, based upon one-month LIBOR. In a rising rate environment, net interest
income earned on these investments may be reduced, as the interest cost for
the
funding sources could increase more rapidly than the interest earned on the
associated asset financed. In a declining interest-rate environment, net
interest income may be enhanced as the interest cost for the funding sources
decreases more rapidly than the interest earned on the associated assets.
To the
extent that assets and liabilities are both fixed-rate or adjustable rate
with
corresponding payment dates, interest-rate risk may be mitigated.
6
Our
reported income depends on accounting conventions and assumptions about the
future that may change.
Accounting
rules for our assets, and for the various aspects of our current and future
business change from time to time. Changes in GAAP, or the accepted
interpretation of these accounting principles, can affect our reported income,
earnings, and shareholders’ equity. Interest income on our assets, and interest
expense on our liabilities, may in part be based on estimates of future events.
These estimates can change in a manner that harms our results or can
demonstrate, in retrospect, that revenue recognition in prior periods was
too
high or too low. We use the effective yield method of GAAP accounting for
many
of our investments. We calculate projected cash flows for each of these assets
incorporating assumptions about the amount and timing of credit losses, loan
prepayment rates, and other factors. The yield we recognize for GAAP purposes
generally equals the discount rate that produces a net present value for
actual
and projected cash flows that equals our GAAP basis in that asset. We change
the
yield recognized on these assets based on actual performance and as we change
our estimates of future cash flows. The assumptions that underlie our projected
cash flows and effective yield analysis may prove to be overly optimistic,
or
conversely, overly conservative. In these cases, our GAAP yield on the asset,
or
cost of the liability may change, leading to changes in our reported GAAP
results.
Failure
to qualify as a REIT would adversely affect our dividend distributions and
could
adversely affect the value of our securities.
We
believe that we have met all requirements for qualification as a REIT for
federal income tax purposes and we intend to continue to operate so as to
qualify as a REIT in the future. However, many of the requirements for
qualification as a REIT are highly technical and complex and require an analysis
of factual matters and an application of the legal requirements to such factual
matters in situations where there is only limited judicial and administrative
guidance. Thus, no assurance can be given that the Internal Revenue Service
or a
court would agree with our conclusion that we have qualified as a REIT or
that
future changes in our factual situation or the law will allow us to remain
qualified as a REIT. If we failed to qualify as a REIT for federal income
tax
purposes and did not meet the requirements for statutory relief, we could
be
subject to federal income tax at regular corporate rates on our income and
we
could possibly be disqualified as a REIT for four years thereafter. Failure
to
qualify as a REIT could force us to sell certain of our investments, possibly
at
a loss, and could adversely affect the value of our common stock.
Maintaining
REIT status may reduce our flexibility to manage our
operations.
To
maintain REIT status, we must follow certain rules and meet certain tests.
In
doing so, our flexibility to manage our operations may be reduced. For
instance:
|
· If
we make frequent asset sales from our REIT entities to persons
deemed
customers, we could be viewed as a “dealer,” and thus subject to 100%
prohibited transaction taxes or other entity level taxes on income
from
such transactions.
|
|
· Compliance
with the REIT income and asset rules may limit the type or extent
of
hedging that we can undertake.
|
|
· Our
ability to own non-real estate related assets and earn non-real
estate
related income is limited. Our ability to own equity interests
in other
entities is limited. If we fail to comply with these limits, we
may be
forced to liquidate attractive assets on short notice on unfavorable
terms
in order to maintain our REIT status.
|
|
· Our
ability to invest in taxable subsidiaries is limited under the
REIT rules.
Maintaining compliance with this limit could require us to constrain
the
growth of our taxable REIT affiliates in the future.
|
|
· Meeting
minimum REIT dividend distribution requirements could reduce our
liquidity. Earning non-cash REIT taxable income could necessitate
our
selling assets, incurring debt, or raising new equity in order
to fund
dividend distributions.
|
|
· Stock
ownership tests may limit our ability to raise significant amounts
of
equity capital from one source.
|
7
We
may fail to properly conduct our operations so as to avoid falling under
the
definition of an investment company pursuant to the Investment Company Act
of
1940.
We
also
conduct our operations so as to avoid falling under the definition of an
investment company pursuant to the Investment Company Act of 1940. If we
were
determined to be an investment company, our ability to use leverage would
be
substantially reduced, and our ability to conduct business may be impaired.
Under the current interpretation of the staff of the Securities and Exchange
Commission (“SEC”), in order to be exempted from regulation as an investment
company, a REIT must, among other things, maintain at least 55% of its assets
directly in qualifying real estate interests. In satisfying this 55%
requirement, a REIT may treat mortgage-backed securities issued with respect
to
an underlying pool to which it holds all issued certificates as qualifying
real
estate interests. If the SEC or its staff adopts a contrary interpretation
of
such treatment, the REIT could be required to sell a substantial amount of
these
securities or other non-qualified assets under potentially adverse market
conditions.
We
are dependent on certain key personnel.
We
have
only one Executive Officer, Stephen J. Benedetti, who serves as our Executive
Vice President and Chief Operating Officer. We currently do not have a Chief
Executive Officer, President, or Chief Financial Officer. Mr. Benedetti
previously served as our Chief Financial Officer. Mr. Benedetti has been
with us
since 1994 and has extensive knowledge of us, our operations, and our current
investment portfolio. He also has extensive experience in managing a portfolio
of mortgage-related investments, and as an executive officer of a
publicly-traded mortgage REIT. The loss of Mr. Benedetti could have an adverse
effect on our operations.
ITEM
1B. UNRESOLVED STAFF COMMENTS
There
are
no unresolved comments from the SEC Staff.
ITEM
2. PROPERTIES
Our
executive and administrative offices and operations offices are both located
in
Glen Allen, Virginia, on properties leased by us. The address is 4551 Cox
Road,
Suite 300, Glen Allen, Virginia 23060. As of December 31, 2005, we leased
8,244
square feet. The term of the lease runs to May 2008.
We
believe that our property is maintained in good operating condition and is
suitable and adequate for our purposes.
ITEM
3. LEGAL
PROCEEDINGS
We
and
our subsidiaries may be involved in certain litigation matters arising in
the
ordinary course of businesses. Although the ultimate outcome of these matters
cannot be ascertained at this time, and the results of legal proceedings
cannot
be predicted with certainty, we believe, based on current knowledge, that
the
resolution of these matters will not have a material adverse effect on our
financial position or results of operations. Information on litigation arising
out of the ordinary course of business is described below.
We,
and
one of our subsidiaries, GLS Capital, Inc. (“GLS”), together with the County of
Allegheny, Pennsylvania (“Allegheny County”), are defendants in a lawsuit in the
Court of Common Pleas, in Allegheny County, Pennsylvania. Plaintiffs are
two
local businesses seeking status to represent, as a class, delinquent taxpayers
in Allegheny County whose delinquent tax liens had been purchased by, and
subsequently assigned to, GLS. This lawsuit relates to the purchase by GLS
of
delinquent property tax receivables from Allegheny County in 1997, 1998,
and
1999, and subsequent collection of certain amounts related to the property
tax
receivables purchased. The suit was initially filed in 1997, and challenges
GLS’
right to charge certain
attorney fees, costs and expenses, and interest in the collection of delinquent
property tax receivables owned by GLS. During 2005, the Court held hearings
in
this matter, and has not yet ruled on whether it will grant class action
status
8
in
the
litigation. Plaintiffs have not enumerated its damages in this
matter. We believe the claims are without merit and we intend to
vigorously defend ourselves in this matter. We believe that the ultimate
outcome
of this litigation will not have a material impact on our financial condition,
but may have a material impact on reported results for the particular period
presented.
We
and
Dynex Commercial, Inc. (“DCI”), formerly our affiliate and now known as DCI
Commercial, Inc., are appellees (or “respondents”) in the Court of Appeals for
the Fifth Judicial District of Texas at Dallas, related to the matter of
Basic
Capital Management et al (collectively, “BCM” or “the Plaintiffs”) versus
Dynex Commercial, Inc. et al. The appeal seeks to overturn a judgment from
a lower court in favor of the Company and DCI which denied recovery to
Plaintiffs, as discussed further below, and to have a judgment entered in
favor
of Plaintiffs based on a jury award for damages against the Company of $0.3
million, and against DCI for $2.2 million or $25.6 million, all of which
was set
aside by the trial court. In the alternative, Plaintiffs are seeking a new
trial. The appeal relates to a suit filed against us and DCI in 1999, alleging,
among
other things, that DCI and we failed to fund tenant improvement or other
advances allegedly required on various loans made by DCI to BCM, which loans
were subsequently acquired by us; that DCI breached an alleged $160 million
“master” loan commitment entered into in February 1998; and that DCI breached
another alleged loan commitment of approximately $9 million. The original
trial
commenced in January 2004, and, in February 2004, the jury in the case rendered
a verdict in favor of one of the Plaintiffs and against us on the alleged
breach
of the loan agreements for tenant improvements and awarded that Plaintiff
damages in the amount of $0.25 million. The jury entered a separate verdict
against DCI in favor of BCM under two mutually exclusive damage models, for
$2.2
million and $25.6 million, respectively. The jury found in favor of DCI on
the
alleged $9 million loan commitment, but did not find in favor of DCI for
counterclaims made against BCM. The jury also awarded the Plaintiffs attorneys’
fees in the amount of $2.1 million. After considering post-trial motions,
the
presiding judge entered judgment in favor of us and DCI, effectively overturning
the verdicts of the jury and dismissing damages awarded by the jury. DCI
is a
former affiliate of ours, and we believe that we will have no obligation
for
amounts, if any, awarded to the Plaintiffs as a result of the actions of
DCI.
The
Court
of Appeals has scheduled an oral argument on the matter for April 18, 2006.
On
February 11, 2005, a putative class action complaint alleging violations
of the
federal securities laws and various state common law claims was filed against
us, our subsidiary MERIT Securities Corporation, Stephen J. Benedetti, the
Company's Executive Vice President, and Thomas H. Potts, the Company's former
President and a former Director, in United States District Court for the
Southern District of New York (“District Court”) by the Teamsters Local 445
Freight Division Pension Fund ("Teamsters"). The lawsuit purported to be a
class action on behalf of purchasers of MERIT Series 13 securitization financing
bonds, which are collateralized by manufactured housing loans. On May 31,
2005, the Teamsters filed an amended class action complaint. The amended
complaint dropped all state common law claims but added federal securities
claims related to the MERIT Series 12 securitization financing bonds. In
February 2006, based on a motion to dismiss filed by us, the District Court
dismissed Messrs. Benedetti and Potts from the suit, but did not dismiss
the
claims against us or MERIT. The Company has appealed the District Court’s
decision not to dismiss us or MERIT. The Company has evaluated the
allegations and believes them to be without merit and intends to vigorously
defend itself against them.
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 our consolidated balance sheet but could materially
affect
our consolidated results of operations in a given year.
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
No
matters were submitted to a vote of our shareholders during the fourth quarter
of 2005.
PART
II
ITEM
5. MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Our
common stock is traded on the New York Stock Exchange under the trading symbol
“DX”. The common stock was held by approximately [1,810] holders of record and
beneficial holders who hold common stock in street name as of
9
December
31, 2005. During the last two years, the high and low closing stock prices
and
cash dividends declared on common stock were as follows:
|
High
|
Low
|
Cash
Dividends Declared
|
||||||||
|
2005:
|
||||||||||
|
First
quarter
|
$
|
8.08
|
$
|
7.12
|
$
|
-
|
||||
|
Second
quarter
|
7.69
|
7.10
|
-
|
|||||||
|
Third
quarter
|
7.75
|
6.85
|
-
|
|||||||
|
Fourth
quarter
|
7.24
|
6.70
|
-
|
|||||||
|
2004:
|
||||||||||
|
First
quarter
|
$
|
7.65
|
$
|
6.15
|
$
|
-
|
||||
|
Second
quarter
|
7.71
|
6.35
|
-
|
|||||||
|
Third
quarter
|
7.24
|
6.48
|
-
|
|||||||
|
Fourth
quarter
|
7.83
|
6.70
|
-
|
|||||||
Dividends
declared by the Board of Directors have generally been for the purpose of
maintaining our REIT status, and in compliance with requirements set forth
at
the time of the issuance of the Series D Preferred Shares. The quarterly
dividend on Series D Preferred Shares is $0.2375 per share. In accordance
with
the terms of the Series D Preferred Shares, if we fail to pay two consecutive
quarterly preferred dividends or if we fail to maintain consolidated
shareholders’ equity of at least 200% of the aggregate issue price of the Series
D preferred stock, then these shares automatically convert into a new series
of
9.50% senior notes. Dividends for the preferred stock must be fully paid
before
dividends can be paid on common stock. No common dividends have been paid
since
1998.
We
did
not repurchase any of our equity securities during the fourth quarter of
2005.
Item
6. Selected
Financial Data
|
Years
ended December 31,
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||
|
(amounts
in thousands except share and per share data)
|
||||||||||||||||
|
Net
interest income(1)
|
$
|
11,889
|
$
|
23,281
|
$
|
38,971
|
$
|
49,153
|
$
|
48,082
|
||||||
|
Net
interest income after provision for loan losses(2)
|
6,109
|
4,818
|
1,889
|
20,670
|
28,410
|
|||||||||||
|
Impairment
charges(3)
|
(2,474
|
)
|
(14,756
|
)
|
(16,355
|
)
|
(18,477
|
)
|
(43,439
|
)
|
||||||
|
Other
income (expense) and trading losses
|
2,022
|
(179
|
)
|
436
|
1,397
|
7,876
|
||||||||||
|
General
and administrative expenses
|
(5,681
|
)
|
(7,748
|
)
|
(8,632
|
)
|
(9,493
|
)
|
(10,526
|
)
|
||||||
|
Net
income (loss)
|
$
|
9,585
|
$
|
(3,375
|
)
|
$
|
(21,107
|
)
|
$
|
(9,360
|
)
|
$
|
(21,209
|
)
|
||
|
Net
income (loss) to common shareholders
|
$
|
4,238
|
$
|
(5,194
|
)
|
$
|
(14,260
|
)
|
$
|
(18,946
|
)
|
$
|
(13,492
|
)
|
||
|
Net
income (loss) per common share:
|
||||||||||||||||
|
Basic
& diluted
|
$
|
0.35
|
$
|
(0.46
|
)
|
$
|
(1.31
|
)
|
$
|
(1.74
|
)
|
$
|
(1.18
|
)
|
||
|
Dividends
declared per share:
|
||||||||||||||||
|
Common
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
-
|
||||||
|
Series
A and B Preferred
|
-
|
-
|
0.8775
|
0.2925
|
0.2925
|
|||||||||||
|
Series
C Preferred
|
-
|
-
|
1.0950
|
0.3651
|
0.3649
|
|||||||||||
|
Series
D Preferred
|
0.9500
|
0.6993
|
-
|
-
|
-
|
|||||||||||
10
|
December
31,
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||
|
Investments(4)
|
$
|
756,409
|
$
|
1,343,448
|
$
|
1,853,675
|
$
|
2,185,746
|
$
|
2,511,229
|
||||||
|
Total
assets(4)
|
805,976
|
1,400,934
|
1,865,235
|
2,205,735
|
2,531,509
|
|||||||||||
|
Non-recourse
securitization financing(4)
|
516,578
|
1,177,280
|
1,679,830
|
1,980,702
|
2,225,863
|
|||||||||||
|
Recourse
debt
|
133,315
|
70,468
|
33,933
|
-
|
58,134
|
|||||||||||
|
Total
liabilities(4)
|
656,642
|
1,252,168
|
1,715,389
|
1,982,314
|
2,289,399
|
|||||||||||
|
Shareholders’
equity
|
149,334
|
148,766
|
149,846
|
223,421
|
242,110
|
|||||||||||
|
Number
of common shares outstanding
|
12,163,391
|
12,162,391
|
10,873,903
|
10,873,903
|
10,873,853
|
|||||||||||
|
Average
number of common shares
|
12,163,062
|
11,272,259
|
10,873,903
|
10,873,871
|
11,430,471
|
|||||||||||
|
Book
value per common share(5)
|
$
|
7.65
|
$
|
7.60
|
$
|
7.55
|
$
|
8.57
|
$
|
11.06
|
||||||
(1) Net
interest income has declined due to a reduction in investments, declining
yields
on our interest-earning assets and an increase in our cost of funds.
(2) Net
interest income after provision for loan losses has increased due to a reduction
in the manufactured housing loan loss provision associated with the
derecognition of the MERIT Series 12 securitization.
(3) Impairment
charges have declined as a result of the sale of certain underperforming
securities.
(4) Certain
deferred hedging gains and losses for 2002 and prior years were reclassified
from securitized finance receivables to non-recourse securitization
financing.
(5) Inclusive
of the effects of the liquidation preference on our preferred
stock.
Item
7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
SUMMARY
Dynex
Capital, Inc., together with its subsidiaries, is a specialty finance company
organized as a real estate investment trust (REIT) that invests in loans
and
securities consisting principally of single-family residential and commercial
mortgage loans. We finance these loans and securities through a combination
of
non-recourse securitization financing, repurchase agreements, and equity.
We
employ leverage in order to increase the overall yield on our invested capital.
We seek to generate net interest income (i.e., interest income on investments
in
excess of the cost of financing these assets), which provide acceptable returns
on our invested capital on a risk adjusted basis.
In
recent
years, we have elected to sell certain non-core assets, including investments
in
manufactured housing loans and delinquent property tax receivable portfolios.
Our emphasis has been on monetizing underperforming assets in anticipation
of
redeploying the invested capital in more compelling investment opportunities.
Given the flat treasury yield curve, however, and the challenging reinvestment
environment in traditional mortgage REIT investment opportunities, we have
retained our capital in anticipation of more compelling investment opportunities
in the future. We believe our strategy of retaining capital in the face of
increases in interest-rates by the Federal Reserve of 3.50% since June 2004
has
protected shareholder value.
We
have
an investment policy which governs the allocation of capital amongst short-term,
highly liquid investments, investment grade fixed income investments,
subordinate and credit sensitive investments, and strategic investments.
Strategic investments are investments in equity and equity-like securities
of
other companies, including other mortgage REITs. We anticipate in 2006 making
additional strategic investments while using our capital in the interim to
pay
down recourse debt or to invest only in short-term, highly liquid
investments.
During
2005, we earned net income of $9.6 million, and net income to our common
shareholders of $4.2 million. Because of differences in GAAP income and taxable
income, we expect to report a tax loss but have not completed our tax
calculation. Accordingly, we did not pay a dividend on the common shares
outstanding and will increase our NOL carryforward, which was $135 million
as of
December 31, 2004.
During
2005, we continued the process of monetizing under-performing and non-core
investments. These investments sold had a carrying value of $373.3 million
, and
we recorded net gains of $9.6 million , while derecognizing or repaying
associated financing liabilities of $363.8 million. We also had paydowns
of
investments of $151.0 million which were utilized to repay the associated
financing liabilities of $140.1 million. During 2005, we redeemed all of
the
bonds
11
issued
by
one of our securitization trusts, financing the acquisition of these bonds
with
repurchase agreements. We have kept the securitization financing bonds
outstanding and pledged as collateral for repurchase agreements. At December
31,
2005, the bonds had an outstanding principal balance of $153.5 million, and
the
associated repurchase agreement financing had an outstanding balance of $133.1
million .
FINANCIAL
CONDITION
Comparative
balance sheet information is set forth in the tables below:
|
December
31,
|
|||||||
|
(amounts
in thousands except per share data)
|
2005
|
2004
|
|||||
|
Investments:
|
|||||||
|
Securitized
finance receivables:
|
|||||||
|
Loans,
net
|
$
|
722,152
|
$
|
1,036,123
|
|||
|
Debt
securities
|
-
|
206,434
|
|||||
|
Securities
|
24,908
|
87,706
|
|||||
|
Other
investments
|
4,067
|
7,596
|
|||||
|
Other
loans
|
5,282
|
5,589
|
|||||
|
Non-recourse
securitization financing
|
516,578
|
1,177,280
|
|||||
|
Repurchase
agreements secured by securitization financing bonds
|
133,104
|
-
|
|||||
|
Repurchase
agreements secured by securities
|
211
|
70,468
|
|||||
|
Shareholders’
equity
|
149,334
|
148,766
|
|||||
|
Book
value per common share (inclusive of preferred stock liquidation
preference)
|
$
|
7.65
|
$
|
7.60
|
|||
Securitized
Finance Receivables
Securitized
finance receivables include loans and securities consisting
of or secured by principally single-family residential and commercial mortgage
loans. Securitized
finance receivables decreased to $722.2 million at December 31, 2005
from
$1,242.6 million at December 31, 2004. This decrease of $520.4 million is
primarily the result of sales and derecognition of $370.1 million of
receivables, and principal repayments of $151.0 million. Principal repayments
resulted from normal principal amortization of the underlying loan or security,
and higher than anticipated prepayments on these assets due to the favorable
interest rate and real estate environment, leading to refinances of the
underlying mortgages or sales of the underlying properties. In addition to
the
above, allowance for loan losses, primarily on delinquent commercial mortgage
loans was increased by a net $5.7 million during the year.
Securities
Securities
are predominantly investment grade single-family residential mortgage
securities. Securities at December 31, 2005 include investment-grade rated
securities of $23.0 million, and non-investment grade rated securities of
$1.9
million, including equity securities. Securities decreased to $24.9 million
at
December 31, 2005
compared
to $87.7 million at December 31, 2004,
primarily as a result of principal payments of $58.8 million on investment-grade
securities during the year, net sales of $5.8 million of equity securities
and a
$0.7 million net decrease in market value of available-for-sale securities.
These increases were partially offset by the purchase of $2.6 million of
investment grade single-family residential securities.
Other
Investments
Other
investments at December 31, 2005
and 2004
consist primarily of delinquent property tax receivables, a security
collateralized by delinquent property tax receivables, and the associated
real
estate owned. Other investments
12
decreased
to $4.1 million at December 31, 2005
compared
to $7.6 million at December 31, 2004. This decrease of $3.5 million resulted
from payments of $2.2 million collected in 2005 and applied against the carrying
value of the investment, $0.8 million in net proceeds from sales of related
real
estate owned, a $1.7 million other-than-temporary impairment charge and losses
on sales of REO properties of $0.2 million. These decreases were partially
offset by increases related to advances made in the foreclosure of property
tax
receivables of $0.7 million and interest accretion of $0.6 million.
Non-recourse
Securitization Financing
Non-recourse
securitization financing decreased to $516.6 million at December 31,
2005
from
$1,177 million at December 31, 2004. This decrease was primarily a result
of
principal payments received of $102.5 million on the associated collateral
pledged which were used to pay down the securitization financing in accordance
with the respective indentures, the derecognition of $363.9 million of
non-recourse securitization financing as a result of the sale of the associated
securitized finance receivables as described above, and a redemption of $195.7
million of certain outstanding bonds issued by us. The decrease also reflects
a
$0.6 million decline in accrued interest payable and an increase of $2.1
million
related to the amortization of bond discounts and issuance costs during the
year.
Repurchase
Agreements Secured by Securitization Financing Bonds
In
April
2005, we redeemed $195.7 million of outstanding securitization financing
bonds
as discussed above, utilizing cash on hand of $25.0 million and $170.7 million
in repurchase agreements to finance the purchase. The bonds continue to remain
outstanding and serve as collateral for the repurchase agreement borrowings.
During 2005, payments of $37.6 million received on the bonds were used to
paydown the repurchase agreement borrowings to their current balance of $133.1
million at December 31, 2005.
Repurchase
Agreements Secured by Securities
Repurchase
agreements decreased from $70.4 million at December 31, 2004 to $0.2 million
at
December 31, 2005 resulting from $70.3 million of repayments.
Shareholders’
Equity
Shareholders’
equity increased from $148.8 million at December 31, 2004 to $149.4 million
at
December 31, 2005.
This
increase of $0.6 million resulted from net income of $9.6 million, offset
by a
change in accumulated other comprehensive income of $3.7 million consisting
of
$4.3 million from the sale of certain available-for-sale investments, an
increase of $0.6 million on interest-rate swap and synthetic interest-rate
swap
contracts from the realization of losses on settled contracts and deferred
gains
on the remaining hedge contracts, and by dividends declared and paid on shares
of Series D Preferred Stock of $5.3 million.
Supplemental
Discussion of Investments
We
also
manage our investment portfolio based on a net basis. Below is the net basis
of
our investments as of December 31, 2005 and 2004. Excluded from this table
are
cash and cash equivalents, other assets, and other liabilities.
As
the
cash flows received on our investments is generally subordinate to the
obligations under the associated financing of the investment, we evaluate
and
manage our investment portfolio based on our net capital invested in that
particular investment. Net capital invested is generally defined as the cost
basis of the investment net of the associated financing for that investment.
For
securitized finance receivables, because the securitization financing is
recourse only to the finance receivables pledged and is, therefore, not our
general obligation, the risk on our investment in securitized finance
receivables from an economic point of view is limited to our net retained
investment in the securitization trust. Below is the net basis of our
investments as of December 31, 2005 and 2004. Included in the table is an
estimate of the fair value of the our net investment. The fair value of our
net
investment in securitized finance receivables is based on the present value
of
the projected cash flow from the collateral, adjusted for the impact and
assumed
level of future prepayments and credit losses, less the projected principal
and
interest due on the securitization financing bonds owned by third parties.
The
fair value of securities is based on quotes obtained from third-party dealers,
or from management estimates.
13
|
(amounts
in thousands)
|
December
31, 2005
|
||||||||||||
|
Amortized
cost basis
|
Financing
|
Net
basis
|
Fair
value of net basis (1)
|
||||||||||
|
Securitized
finance receivables:
|
|||||||||||||
|
Single
family mortgage loans
|
$
|
163,892
|
$
|
133,104
|
$
|
30,788
|
$
|
31,888
|
|||||
|
Commercial
mortgage loans
|
577,295
|
516,578
|
60,717
|
39,685
|
|||||||||
|
Manufactured
housing loans
|
-
|
-
|
-
|
-
|
|||||||||
|
Allowance
for loan losses
|
(19,035
|
)
|
-
|
(19,035
|
)
|
-
|
|||||||
|
722,152
|
649,682
|
72,470
|
71,573
|
||||||||||
|
Securities:
|
|||||||||||||
|
Investment
grade single-family
|
22,702
|
211
|
22,491
|
22,491
|
|||||||||
|
Non-investment
grade single-family
|
469
|
-
|
469
|
469
|
|||||||||
|
Equity
and other
|
1,737
|
-
|
1,737
|
1,737
|
|||||||||
|
24,908
|
211
|
24,697
|
24,697
|
||||||||||
|
Other
loans and investments
|
9,349
|
-
|
9,349
|
10,107
|
|||||||||
|
Total
|
$
|
756,409
|
$
|
649,893
|
$
|
106,516
|
$
|
106,377
|
|||||
|
(1)
|
Fair
values are based on dealer quotes, where dealer quotes are not
available
fair values are calculated as the net present value of expected
future
cash flows, discounted at 16%. Fair value also includes our capital
invested in redeemed securitization financing bonds. Expected cash
flows
were based on the forward LIBOR curve as of December 31, 2005,
and
incorporate 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.
|
|
(amounts
in thousands)
|
December
31, 2004
|
||||||||||||
|
Carrying
value
|
Financing
|
Net
basis
|
Fair
value of net basis(1)
|
||||||||||
|
Securitized
finance receivables:
|
|||||||||||||
|
Single
family mortgage loans
|
$
|
284,786
|
$
|
263,506
|
$
|
21,280
|
$
|
22,438
|
|||||
|
Commercial
mortgage loans
|
639,677
|
577,419
|
62,258
|
36,852
|
|||||||||
|
Manufactured
housing loans
|
346,108
|
336,355
|
9,753
|
706
|
|||||||||
|
Allowance
for loan losses
|
(28,014
|
)
|
-
|
(28,014
|
)
|
-
|
|||||||
|
1,242,557
|
1,177,280
|
65,277
|
59,996
|
||||||||||
|
Securities:
|
|||||||||||||
|
Investment
grade single-family
|
78,478
|
70,468
|
8,010
|
8,010
|
|||||||||
|
Non-investment
grade single-family
|
712
|
-
|
712
|
712
|
|||||||||
|
Other
loans and investments
|
21,701
|
-
|
21,701
|
23,984
|
|||||||||
|
Total
|
$
|
1,343,448
|
$
|
1,247,748
|
$
|
95,700
|
$
|
92,702
|
|||||
|
(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
December
31, 2004, and incorporate 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.
|
Our
net
investment for 2005 increased versus 2004 as a result of the sale and
derecognition of securitized finance receivables, the redemption of the
securitization financing associated with the single-family mortgage loans
(which
was
14
financed
with a combination of investable capital and repurchase financing), the
repayment of repurchase agreement financing on our securities portfolio,
and the
sale of certain equity investments. The repayment of repurchase agreement
financing was for liquidity management purposes, and we expect to be able
to
borrow these amounts in the future if necessary.
The
following table summarizes the assumptions used in estimating fair value
for our
net investment in securitized finance receivables and the cash flow related
to
those net investments during 2005.
|
Fair
Value Assumptions
|
($
in thousands)
|
||||
|
Loan
type
|
Weighted-average
prepayment speeds
|
Losses
|
Weighted-Average
Discount
Rate
|
Projected
cash flow termination date
|
Cash
flows received in 2005
(1)
|
|
Single-family
mortgage loans
|
30%
CPR
|
0.2%
annually
|
16%
|
Anticipated
final maturity 2024
|
$
4,692.3
|
|
Commercial
mortgage loans(2)
|
(3)
|
0.8%
annually
|
13%
|
(4)
|
$
3,199.8
|
(1) Represents
the excess of the cash flows received on the collateral pledged over the
cash
flow requirements of the securitization financing bond
security.
(2) Includes
loans pledged to three different securitization trusts.
(3
Assumed CPR speeds generally are governed by underlying pool characteristics,
prepayment lock-out provisions, and yield maintenance provisions. Loans
currently delinquent in excess of 30 days are assumed liquidated in month
six.
(4) Cash
flow termination dates are modeled based on the repayment dates of the loans
or
optional redemption dates of the underlying securitization financing
bonds.
Comparative
information on our results of operations is provided in the tables
below:
|
For
the Year Ended December 31,
|
||||||||||
|
(amounts
in thousands except per share information)
|
2005
|
2004
|
2003
|
|||||||
|
Net
interest income
|
$
|
11,889
|
$
|
23,281
|
$
|
38,971
|
||||
|
Provision
for loan losses
|
(5,780
|
)
|
(18,463
|
)
|
(37,082
|
)
|
||||
|
Net
interest income after provision for loan losses
|
6,109
|
4,818
|
1,889
|
|||||||
|
Impairment
charges
|
(2,474
|
)
|
(14,756
|
)
|
(16,355
|
)
|
||||
|
Gain
on sales of investments
|
9,609
|
14,490
|
1,555
|
|||||||
|
Other
income (expense)
|
2,022
|
(179
|
)
|
436
|
||||||
|
General
and administrative expenses
|
(5,681
|
)
|
(7,748
|
)
|
(8,632
|
)
|
||||
|
Net
income (loss)
|
9,585
|
(3,375
|
)
|
(21,107
|
)
|
|||||
|
Preferred
stock (charge) benefit
|
(5,347
|
)
|
(1,819
|
)
|
6,847
|
|||||
|
Net
income (loss) to common shareholders
|
$
|
4,238
|
$
|
(5,194
|
)
|
$
|
(14,260
|
)
|
||
|
Basic
& diluted net income (loss) per common share
|
$
|
0.35
|
$
|
(0.46
|
)
|
$
|
(1.31
|
)
|
||
|
Dividends
declared per share:
|
||||||||||
|
Common
|
$
|
-
|
$
|
-
|
$
|
-
|
||||
|
Series
A and B Preferred
|
-
|
-
|
0.8775
|
|||||||
|
Series
C Preferred
|
-
|
-
|
1.0950
|
|||||||
|
Series
D Preferred
|
0.9500
|
0.6993
|
-
|
|||||||
15
2005
Compared to 2004
Net
income increased in 2005 by $13.0 million, to $9.6 million in 2005 from a
loss
of $3.4 million in 2004, as a result of a decrease in provision for loan
losses
of $12.7 million, decreased impairment charges of $12.3 million, decreased
general and administrative expenses of $2.1 million and $2.0 million of other
income. These increases in income were partially offset by a decrease of
net
interest income of $11.4 million and a decrease in gain on sales of investments
of $4.9 million. Net income to common shareholders increased by $9.4 million
in
2005, from a loss of $5.2 million in 2004 to income of $4.2 million in 2005.
The
increase in net income to common shareholders was due to increased net income
of
$9.6 million, offset by an increase in preferred stock charges of $3.5 million.
Net
interest income for the year ended December 31, 2005 decreased to $11.9 million,
from $23.3 million for the same period in 2004. Net interest income decreased
$11.4 million, or 48.9%, as a result of a decline in average interest-earning
assets and a decrease in the net interest spread on interest-earning assets.
Average interest earning assets decreased in 2005 due to the sale of
investments, including $370.1 million of securitized finance receivables,
$7.3
million of equity securities and $1.7 million of other loans. Net interest
spread was 0.26% in 2005 versus 1.00% in 2004, and decreased in 2005 as a
result
of sales and prepayments of higher coupon assets, the proceeds of which have
been reinvested in lower-yielding cash equivalents, and also decreased due
in
part to increasing borrowing costs from both increasing LIBOR rates and
repayment of lower-cost securitization financing bonds pursuant to the terms
of
the securitization trust. See further discussion below as to changes in the
net
interest spread on our investment portfolio during 2005.
Net
interest income after provision for loan losses increased as a result of
the
decline of the provision for loan losses in 2005 compared to 2004 of $12.7
million. Provision for loan losses decreased to $5.8 million in 2005, from
$18.5
million in 2004. The decrease of $12.7 million from 2004 was primarily due
to
the sale in late 2004 and early 2005 of our investment in manufactured housing
loans. Provision for manufactured housing loan losses decreased by $15.4
million
in 2005 while commercial and single family loan loss reserve provisions
increased by $2.1 million and $0.7 million, respectively.
Impairment
charges decreased from $14.8 million in 2004 to $2.5 million in 2005. Impairment
charges for 2004 included $9.1 million on manufactured housing loan securities
and $4.9 million on delinquent property tax receivable securities. No impairment
charges were recorded on manufactured housing securities as a result of their
sale in 2005. Impairment charges in 2005 included $1.7 million on a debt
security collateralized by delinquent property tax receivables.
Gain
on
sale of investments for 2005 resulted primarily from a net gain of $8.2 million
recognized on the sale of our interests in securitization trusts collateralized
primarily by manufactured housing loans and securities backed by manufactured
housing loans, for cash proceeds of $8.0 million. The sale of our
interests in those securitizations resulted in the derecognition of
approximately $367.2 million of securitized finance receivables and $363.9
million of related securitization financing. We also recorded a gain of
$1.4 million on the sale of approximately $2.0 million in mezzanine loans
for
net proceeds of $3.4 million.
General
and administrative expense decreased by $2.0 million from $7.7 million to
$5.7
million for the twelve months ended December 31, 2004 and 2005, respectively.
General and administrative expenses decreased during 2005 with the sale in
October 2004 of the Ohio delinquent property tax receivable servicing operation
and through continued downsizing in the operation. General and Administrative
expenses in 2004 included $1.0 million of litigation related expenses versus
$0.8 million in 2005. General and Administrative expenses in 2005 included
approximately $291 increase in professional fees related to the audit of
our
2004 financial statements and the subsequent termination of our independent
accounting firm.
We
reported a preferred stock charge of $5.3 million for the year ended December
31, 2005, which represents an increase of $3.5 million from the $1.8 million
reported for the year ended December 31, 2004. Preferred stock charge for
2005
includes a full year’s dividend on the Series D preferred stock. In 2004,
dividends on the preferred stock outstanding was partially offset by the
preferred stock benefit resulting from the recapitalization completed in
2004.
2004
Compared to 2003
Net
loss
decreased in 2004 by $17.7 million, to $3.4 million in 2004 from a loss of
$21.1
million in 2003, as a result of an increase in net interest income after
provision for loan losses of $2.9 million and an increase in gain on sales
of
investments of $12.9 million. Net loss to common shareholders decreased by
$9.1
million in 2004, from $14.3 million in 2003 to $5.2 million in 2004. The
improvement in net loss to common shareholders was due to reduced net loss
of
$17.7
16
million,
offset by the reduction in preferred stock benefit of $8.7 million. The
preferred stock benefit in 2003 resulted from the effects of a tender offer
on
the outstanding preferred stock completed in 2003 as compared to the net
effect
of the recapitalization of the preferred stock in 2004 and 2004 preferred
stock
dividends.
Net
interest income for the year ended December 31, 2004 decreased to $23.3 million,
from $39.0 million for the same period in 2003. Net interest income decreased
$15.7 million, or 40.3%, as a result of a decline in average interest-earning
assets and a decrease in the net interest spread on interest-earning assets.
Net
interest spread decreased in 2003 as a result of prepayments of higher coupon
assets, the proceeds of which have been reinvested in lower-yielding cash
equivalents, and also decreased due in part to increasing borrowing costs
from
both increasing LIBOR rates and repayment of lower-cost securitization financing
bonds pursuant to the terms of the securitization trust. See further discussion
below as to changes in the net interest spread on our investment portfolio
during 2004.
Net
interest income after provision for loan losses increased as a result of
the
decline of the provision for loan losses in 2004 compared to 2003 of $18.6
million. Provision for loan losses decreased to $18.5 million in 2004, from
$37.1 million in 2003. The decrease of $18.6 million from 2003 was primarily
due
to $14.4 million of provision for loan losses recorded during the second
quarter
of 2003 specifically for currently existing credit losses within outstanding
manufactured housing loans that were current as to payment but which we had
determined to be impaired. The remaining $4.2 million of the decrease was
primarily due to a decrease in the estimated losses on commercial and
manufactured housing loans.
Impairment
charges decreased from $16.4 million in 2003 to $14.8 million in 2004.
Impairment charges in 2004 included $9.1 million on a debt security
collateralized by manufactured housing loans and $4.9 million on a debt security
collateralized by delinquent property tax receivables. Other-than-temporary
impairment charges were recorded as a result of the carrying value of the
debt
securities referenced above exceeded their estimated fair value and we
determined that the carrying value would likely exceed the fair value for
the
foreseeable future. Impairment charges for 2003 included $5.5 million on
manufactured housing loan securities and $10.4 million on delinquent property
tax receivable securities.
Gain
on
sale of investments for 2004 included a $17.6 million gain from the sale
of
securitized finance receivables with a carrying value of $219.2 million,
net of
allowance for loan losses of $16.2 million, and the de-recognition of the
associated securitization financing bonds with a carrying amount of $226.7
million. We received a net $11.9 million in proceeds from the sale of these
receivables. This gain was partially offset by a $3.2 million loss on the
sale
of our Ohio delinquent property tax receivable investment.
We
reported a preferred stock charge of $1.8 million for the year ended December
31, 2004, which represents a decline of $8.6 million from the preferred stock
benefit of $6.8 million reported for the year ended December 31, 2003. This
decrease in the preferred stock (charge) benefit was due to the recapitalization
completed in 2004 and the tender offer completed in 2003 described in more
detail above.
17
Average
Balances and Effective Interest
Rates
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.
|
Year
ended December 31,
|
|||||||||||||||||||
|
2005
|
2004
|
2003
|
|||||||||||||||||
|
(amounts
in thousands)
|
Average
Balance
|
Effective
Rate
|
Average
Balance
|
Effective
Rate
|
Average
Balance
|
Effective
Rate
|
|||||||||||||
|
Interest-earning
assets(1):
|
|||||||||||||||||||
|
Securitized
finance receivables(2)(3)
|
$
|
925,172
|
7.25
|
%
|
$
|
1,601,553
|
7.41
|
%
|
$
|
1,948,204
|
7.56
|
%
|
|||||||
|
Other
interest-bearing assets
|
113,729
|
5.12
|
%
|
56,833
|
5.30
|
%
|
72,807
|
6.76
|
%
|
||||||||||
|
Total
interest-earning assets
|
$
|
1,038,901
|
7.01
|
%
|
$
|
1,658,386
|
7.34
|
%
|
$
|
2,021,011
|
7.53
|
%
|
|||||||
|
Interest-bearing
liabilities:
|
|||||||||||||||||||
|
Non-recourse securitization
financing(3)
|
$
|
735,910
|
7.40
|
%
|
$
|
1,499,772
|
6.40
|
%
|
$
|
1,826,827
|
5.85
|
%
|
|||||||
|
Recourse
debt secured by securitized finance receivables
|
106,927
|
3.74
|
%
|
-
|
-
|
%
|
-
|
-
|
%
|
||||||||||
|
Repurchase
agreements
|
44,401
|
3.22
|
%
|
21,040
|
1.75
|
%
|
398
|
1.79
|
%
|
||||||||||
|
Senior
notes
|
-
|
-
|
%
|
2,020
|
9.90
|
%
|
19,330
|
9.53
|
%
|
||||||||||
|
Total
interest-bearing liabilities
|
$
|
887,238
|
6.75
|
%
|
$
|
1,522,832
|
6.34
|
%
|
$
|
1,846,555
|
5.88
|
%
|
|||||||
|
Net
interest spread(3)
|
0.26
|
%
|
1.00
|
%
|
1.65
|
%
|
|||||||||||||
|
Net
yield on average interest-earning assets(3)
|
1.24
|
%
|
1.51
|
%
|
2.15
|
%
|
|||||||||||||
(1) Average
balances exclude adjustments made in accordance with SFAS 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 $2,149, $342,and $374 for the
years
ended December 31, 2005, 2004, and 2003, respectively.
(3) Effective
rates are calculated excluding non-interest related non-recourse securitization
financing expenses and provision for credit losses.
2005
compared to 2004
The
net
interest spread for the year ended December 31, 2005 decreased to 26 basis
points from 100 basis points for the year ended December 31, 2004. This decrease
in the net interest spread is due to declining yields on interest-earning
assets, due principally to decreased interest income as a result of the sale
of
approximately $370.1 million of securitized finance receivables during the
second quarter of 2005 and the sale of approximately $219.2 million in
receivables during the fourth quarter of 2004. The net interest spread
contribution for the receivables sold was 2 basis points and 18 basis points
for
the three and twelve month periods ended December 31, 2005 and 18 basis points
and 37 basis points, respectively during the three and twelve month periods
ended December 31, 2004. The proceeds from the sale of these investments
have
generally been invested in cash and short-term securities. In addition during
2005, the securitization financing that backed variable-rate single family
loans
was replaced with LIBOR-based repurchase agreement financing, which is recourse
to us, and which carries a weighted average spread to LIBOR of 10 basis points.
The securitization financing had an effective spread to LIBOR of 32 basis
points. The
net
interest spread reflects the reduce yield on increased investments in cash
and
cash equivalents and also reflects the amortization of premiums and discounts
on
both the assets and the liabilities.
The
overall yield on interest-earnings assets, decreased to 7.01% for the year
ended
December 31, 2005 from 7.34% for the same period in 2004. The overall yield
declined by 33 basis points as higher rate loans continued to be prepaid
during
the period. In addition to declining asset yields, interest-bearing liability
costs increased from 6.34% to 6.75% as a result of the overall increase in
market interest rates, including LIBOR rates, and the repayment of lower-cost
securitization financing bonds pursuant to the terms of the securitization
trust. Approximately 20% of our interest-bearing liabilities re-price monthly
and are indexed to one-month LIBOR, which averaged 3.39% for 2005, compared
to
1.50% for 2004.
2004
compared to 2003
The
net
interest spread for the year ended December 31, 2004 decreased to 1.00% from
1.65% for the year ended December 31, 2003. This decrease can be generally
attributed to the prepayment of higher coupon investments,
principally
18
securitized
finance receivables, and the resulting reinvestment of net proceeds available
as
a result of these prepayments into lower yielding cash and cash equivalents.
In
addition, net interest spread declined approximately 0.17% from the non-accrual
status of a delinquent property tax receivable in 2004 compared to 2003,
and
declined approximately 0.07% as a result of net asset premium and bond discount
amortization expense from the unexpected prepayment of approximately $98.0
million in commercial mortgage loans during 2004. The overall yield on
interest-earnings assets, decreased to 7.34% for the year ended December
31,
2004 from 7.53% for the same period in 2003. The overall yield declined by
0.17%
as a result of the non-accrual status in 2004 of a delinquent property tax
receivable security, with the balance of the decline due to the prepayment
of
higher coupon investments. In addition to declining asset yields,
interest-bearing liability costs increased from 5.88% to 6.34% as a result
of
the overall increase in market interest rates, including LIBOR rates, and
the
repayment of lower-cost securitization financing bonds pursuant to the terms
of
the securitization trust. Approximately 38% of our interest-bearing liabilities
re-price monthly and are indexed to one-month LIBOR, which averaged 1.50%
for
2004, compared to 1.21% for 2003. In addition, interest bearing liability
costs
increased by approximately a net 0.04% for bond discount amortization resulting
from the prepayment of approximately $98.0 million of securitization financing
related to commercial loans which prepaid during the year.
The
following table summarizes the amount of change in interest income and interest
expense due to changes in interest rates versus changes in volume:
|
2005
to 2004
|
2004
to 2003
|
||||||||||||||||||
|
(amounts
in thousands)
|
Rate
|
Volume
|
Total
|
Rate
|
Volume
|
Total
|
|||||||||||||
|
Securitized
finance receivables
|
$
|
(2,548
|
)
|
$
|
(49,063
|
)
|
$
|
(51,611
|
)
|
$
|
(2,915
|
)
|
$
|
(25,735
|
)
|
$
|
(28,650
|
)
|
|
|
Other
interest-bearing assets
|
95
|
2,712
|
2,807
|
(2,032
|
)
|
125
|
(1,907
|
)
|
|||||||||||
|
Total
interest income
|
(2,453
|
)
|
(46,351
|
)
|
(48,804
|
)
|
(4,947
|
)
|
(25,610
|
)
|
(30,557
|
)
|
|||||||
|
Securitization
financing
|
7,448
|
(45,031
|
)
|
(37,583
|
)
|
9,527
|
(20,321
|
)
|
(10,794
|
)
|
|||||||||
|
Senior
notes
|
(100
|
)
|
(100
|
)
|
(200
|
)
|
69
|
(1,711
|
)
|
(1,642
|
)
|
||||||||
|
Repurchase
agreements
|
460
|
603
|
1,063
|
(3
|
)
|
361
|
358
|
||||||||||||
|
Total
interest expense
|
7,808
|
(44,528
|
)
|
(36,720
|
)
|
9,593
|
(21,671
|
)
|
(12,078
|
)
|
|||||||||
|
Net
interest income
|
$
|
(10,261
|
)
|
$
|
(1,823
|
)
|
$
|
(12,084
|
)
|
$
|
(14,540
|
)
|
$
|
(3,939
|
)
|
$
|
(18,479
|
)
|
|
Note: The
change in interest income and interest expense due to changes in both volume
and
rate, which cannot be segregated, has been allocated proportionately to the
change due to volume and the change due to rate. This table excludes
non-interest related securitization financing expense, other interest expense
and provision for credit losses.
Credit
Exposures
As
discussed in Item 1 above, our predominate securitization structure is
non-recourse securitization financing, whereby loans and securities are pledged
to a trust, and the trust issues bonds pursuant to an indenture. 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. From
an
economic point of view, we generally have retained a limited portion of the
direct credit risk in these structures. In many instances, we retained the
“first-loss” credit risk on pools of loans and securities that we have
securitized. Apart from these investments, we have not otherwise retained
material amounts of credit risk.
The
following table summarizes the aggregate principal amount of our investments
in
securitized finance receivables and subordinate securities; the direct credit
exposure retained by us from those investments (represented by the amount
of
over-collateralization pledged and subordinated securities owned by us),
net of
the credit reserves and discounts maintained by us for such exposure; and
the
actual credit losses incurred for each year. Our credit exposure, net of
credit
reserves has sequentially decreased from year-to-year as a result of the
sale
and derecognition of investments, and as a result of additional provisions
for
loan losses on loans where we have credit risk. From 2003 to 2005, we sold
or
assets were otherwise paid down by $1,097 million, resulting in the reduction
of
our credit risk by $37.2 million.
19
Credit
Reserves and Actual Credit Losses
($
in
millions)
|
Outstanding
Loan Principal Balance
|
Credit
Exposure, Net of Credit Reserves
|
Actual
Credit
Losses
|
Credit
Exposure, Net of Credit Reserves to Outstanding Loan
Balance
|
||||||||||
|
2003
|
$
|
1,859.1
|
$
|
66.1
|
$
|
25.5
|
3.56
|
%
|
|||||
|
2004
|
$
|
1,296.5
|
$
|
39.9
|
$
|
25.1
|
3.08
|
%
|
|||||
|
2005
|
$
|
751.1
|
$
|
28.9
|
$
|
3.6
|
3.85
|
%
|
|||||
The
following tables summarize single-family mortgage loan and commercial mortgage
loan delinquencies as a percentage of the outstanding commercial securitized
finance receivables balance for those securities in which we have retained
a
portion of the direct credit risk. The delinquencies as a percentage of all
outstanding securitized finance receivables balance have decreased to 7.0%
at
December 31, 2005 from 8.2% at December 31, 2004 primarily as a result of
certain commercial loans that were delinquent in 2004 being paid-off during
2005
and the continued strong performance of the residential real estate market.
We
monitor and evaluate our exposure to credit losses and have established reserves
based upon anticipated losses, general economic conditions and trends in
the
investment portfolio. At December 31, 2005, management believes the level
of
credit reserves is appropriate for currently existing losses.
Single
family mortgage loan delinquencies as a percentage of the outstanding loan
balance decreased by approximately 1.2% to 7.50% at December 31, 2005 from
8.71%
at December 31, 2004. The decline in delinquencies is primarily due to the
continued strong performance of the residential real estate market during
the
2005. The following table provides the percentage of delinquent single family
loans at December 31, 2003, 2004 and 2005, respectively.
Single-Family
Loan Delinquency Statistics
|
December
31,
|
30
to 59 days delinquent
|
60
to 89 days
delinquent
|
90
days and over delinquent (1)
|
Total
|
|
2003
|
4.84%
|
1.09%
|
4.75%
|
10.68%
|
|
2004
|
4.30%
|
1.06%
|
3.35%
|
8.71%
|
|
2005
|
4.28%
|
0.62%
|
2.60%
|
7.50%
|
For
commercial mortgage loans, the delinquencies as a percentage of the outstanding
securitized finance receivables balance have decreased to 6.90% at December
31,
2005 from 7.96% at December 31, 2004 primarily due to five commercial loans
which prepaid during 2005, which was partially offset by two loans that became
delinquent in 2005.
Commercial
Mortgage Loan Delinquency Statistics (1)
|
December
31,
|
30
to 59 days delinquent
|
60
to 89 days
delinquent
|
90
days and over delinquent (1)
|
Total
|
|||||||||
|
2003
|
-
|
%
|
-
|
%
|
1.90
|
%
|
1.90
|
%
|
|||||
|
2004
|
-
|
%
|
-
|
%
|
7.96
|
%
|
7.96
|
%
|
|||||
|
2005
|
-
|
%
|
0.25
|
%
|
6.65
|
%
|
6.90
|
%
|
|||||
(1) Includes
foreclosures and real estate owned.
20
CRITICAL
ACCOUNTING POLICIES
The
discussion and analysis of our financial condition and results of operations
are
based in large part upon our consolidated financial statements, which have
been
prepared in conformity with accounting principles generally accepted in the
United States of America. The preparation of the financial statements 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 reported period. Actual results could differ from those
estimates.
Critical
accounting policies are defined as those that are reflective of significant
judgments or uncertainties, and which may result in materially different
results
under different assumptions and conditions, or the application of which may
have
a material impact on our financial statements. The following are our critical
accounting policies.
Consolidation
of Subsidiaries. The
consolidated financial statements represent our accounts after the elimination
of inter-company transactions. We consolidate entities in which we own more
than
50% of the voting equity and control of the entity does not rest with others.
We
follow the equity method of accounting for investments with greater than
20% and
less than a 50% interest in partnerships and corporate joint ventures or
when we
are able to influence the financial and operating policies of the investee
but
own less than 50% of the voting equity. For all other investments, the cost
method is applied.
Impairments.
We
evaluate all securities in our investment portfolio for other-than-temporary
impairments. A security is generally defined to be other-than-temporarily
impaired if, for a maximum period of three consecutive quarters, the carrying
value of such security exceeds its estimated fair value and we estimate,
based
on projected future cash flows or other fair value determinants, that the
fair
value will remain below the carrying value for the foreseeable future. If
an
other-than-temporary impairment is deemed to exist, we record an impairment
charge to adjust the carrying value of the security down to its estimated
fair
value. In certain instances, as a result of the other-than-temporary impairment
analysis, the recognition or accrual of interest will be discontinued and
the
security will be placed on non-accrual status.
We
consider an investment to be impaired if the fair value of the investment
is
less than its recorded cost basis. Impairments of other investments are
generally considered to be other-than-temporary when the fair value remains
below the carrying value for three consecutive quarters. If the impairment
is
determined to be other-than-temporary, an impairment charge is recorded in
order
to adjust the carrying value of the investment to its estimated
value.
Allowance
for Loan Losses.
We have
credit risk on loans pledged in securitization financing transactions and
classified as securitized finance receivables in our investment portfolio.
An
allowance for loan losses has been estimated and established for currently
existing probable losses. Factors considered in establishing an allowance
include current loan delinquencies, historical cure rates of delinquent loans,
and historical and anticipated loss severity of the loans as they are
liquidated. The allowance for loan losses is evaluated and adjusted periodically
by management based on the actual and estimated timing and amount of probable
credit losses, using the above factors, as well as industry loss experience.
Where loans are considered homogeneous, the allowance for losses is established
and evaluated on a pool basis. Otherwise, the allowance for losses is
established and evaluated on a loan-specific basis. Provisions made to increase
the allowance are a current period expense to operations. Single-family loans
are considered impaired when they are 60-days past due. Commercial mortgage
loans are evaluated on an individual basis for impairment. Generally, a
commercial loan with a debt service coverage ratio of less than one is
considered impaired. However, based on a commercial loan’s details, commercial
loans with a debt service ratio less than one may not be considered impaired;
conversely, commercial loans with a debt service coverage ratio greater than
one
may be considered impaired. Certain of the commercial mortgage loans are
covered
by loan guarantees that limit our exposure on these loans. The level of
allowance for loan losses required for these loans is reduced by the amount
of
applicable loan guarantees. Our actual credit losses may differ from the
estimates used to establish the allowance.
21
LIQUIDITY
AND CAPITAL RESOURCES
We
have
historically financed our operations from a variety of sources. Our primary
source of funding for our operations today is the cash flow generated from
the
investment portfolio, which includes net interest income and principal payments
and prepayments on these investments. From the cash flow on our investment
portfolio, we fund our operating overhead costs, including the servicing
of our
delinquent property tax receivables, pay the dividend on the Series D preferred
stock and service the remaining recourse debt. Our investment portfolio
continues to provide positive cash flow, which can be utilized by us for
reinvestment or other purposes. We have utilized our cash flow to repay recourse
debt outstanding and to purchase loans and securities for our investment
portfolio.
The
cash
flow from our investment portfolio for the year and quarter ended December
31,
2005 was approximately $31.4 million and $9.4 million, respectively, excluding
proceeds from the sales of investments and the above refunding of repurchase
agreements. Such cash flow is after payment of principal and interest on
the
associated non-recourse securitization financing (i.e.,
non-recourse debt) outstanding. We also sold investments in 2005 which generated
net cash proceeds of $19.8 million.
Excluding
any cash flow derived from the sale or re-securitization of assets, and assuming
that short-term interest rates remain stable, we anticipate that the cash
flow
from our investment portfolio will continue to decline in 2006 compared to
2005
as the investment portfolio continues to pay down absent reinvestment of
our
capital. We anticipate, however, that we will have sufficient cash flow from
our
investment portfolio to meet all of our obligations on both a short-term
and
long-term basis.
Our
cash
flow from our investment portfolio is subject to fluctuation due to changes
in
interest rates, repayment rates and default rates and related losses. We
currently have a substantial portion of our available capital invested in
cash
or highly liquid, short-term instruments. At December 31, 2005, this amount
was
$45.2 million, which represents a significant portion of our overall equity
capital base. We intend to maintain high levels of liquidity for the foreseeable
future given the lack of compelling reinvestment opportunities as a result
of
the absolute low level of interest rates, the flat yield curve, and the
historically tight spreads on fixed income instruments.
We
redeemed 25% of our Series D Preferred Stock in January 2006. This redemption
reduced the Series D Preferred Stock outstanding by approximately $14 million,
saving us approximately $1.3 million in dividends annually. The Board of
Directors of Dynex also approved the redemption of up to one million shares
of
common stock of Dynex upon completion of the redemption of the Series D
Preferred Stock. The redemption of any shares of common stock is likely to
occur
if alternative uses of the capital are not available and if accretive to
book
value per common share. Upon completion of the redemption of the Preferred
Stock, we will have an estimated $46 million in remaining investable
capital.
Through
limited-purpose finance subsidiaries, we have issued non-recourse debt in
the
form of non-recourse securitization financing to fund the majority of our
investment portfolio. The obligations under the securitization financing
are
payable solely from the securitized finance receivables and are otherwise
non-recourse to us. The maturity of each class of securitization financing
is
directly affected by the rate of principal prepayments on the related collateral
and is not subject to margin call risk. 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 December
31, 2005, we have $516.6 million of non-recourse securitization financing
outstanding, all of which carries a fixed rate of interest.
We
redeemed approximately $195.7 million of securitization financing in the
second
quarter of 2005, financing the redemption of the bonds outstanding with cash
of
$25.0 million and repurchase agreement financing of $170.7 million. As a
result
of paydowns on the associated securitized finance receivables, the remaining
balance of the securitization financing bonds at the end of 2005 was $153.5
million. We were financing the remaining $153.5 million with cash of $20.4
million and repurchase agreement financing of approximately $133.1 million.
As
the redeemed bonds have not been legally extinguished, we could reissue these
bonds, generating estimated proceeds in excess of $153.5 million, which would
be
used to repay the repurchase agreement financing, and the balance of which
would
increase our cash and cash equivalents.
22
Contractual
Obligations and
Commitments
The
following table shows expected cash payments on our contractual obligations
as
of December 31, 2005 for the following time periods:
|
Payments
due by period
|
|||||||||||||||
|
Contractual
Obligations(1)
|
Total
|
<
1 year
|
1-3
years
|
3-5
years
|
>
5 years
|
||||||||||
|
Long-Term
Debt Obligations:(2)
|
|||||||||||||||
|
Non-recourse
securitization financing(3)
|
$
|
666,531
|
$
|
84,363
|
$
|
374,771
|
$
|
161,057
|
$
|
46,340
|
|||||
|
Repurchase
agreements
|
133,315
|
133,31
|
-
|
-
|
-
|
||||||||||
|
Operating
lease obligations
|
358
|
146
|
212
|
-
|
-
|
||||||||||
|
Mortgage
servicing obligations
|
4,426
|
401
|
741
|
550
|
2,734
|
||||||||||
|
Total
|
$
|
804,630
|
$
|
218,225
|
$
|
375,724
|
$
|
161,607
|
$
|
49,074
|
|||||
|
(1)
|
As
the master servicer for certain of the series of non-recourse
securitization financing securities which we have issued, and certain
loans which have been securitized but for which we are not the
master
servicer, we have an obligation to advance scheduled principal
and
interest on delinquent loans in accordance with the underlying
servicing
agreements should the primary servicer fail to make such advance.
Such
advance amounts are generally repaid in the same month as they
are made,
or shortly thereafter, and the contractual obligation with respect
to
these advances is excluded from the above
table.
|
|
(2)
|
Amounts
presented for Long-Term Debt Obligations include estimated principal
and
interest on the related
obligations.
|
|
(3)
|
Securitization
financing is non-recourse to us as the bonds are payable solely
from loans
and securities pledged as securitized finance receivables. Payments
due by
period were estimated based on the principal repayments forecast
for the
underlying loans and securities, substantially all of which is
used to
repay the associated securitization financing
outstanding.
|
Off-Balance
Sheet Arrangements
We
do not
believe that any off-balance sheet arrangements exist that are reasonably
likely
to have a material current or future effect on our financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources.
23
Selected
Quarterly Results
The
following tables present our unaudited selected quarterly results for 2005
and
2004.
Summary
of Selected Quarterly Results (unaudited)
(amounts
in thousands except share and per share data)
|
Year
ended December 31, 2005
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
|||||||||
|
Operating
results:
|
|||||||||||||
|
Total
interest income
|
$
|
24,053
|
$
|
18,533
|
$
|
15,717
|
$
|
16,092
|
|||||
|
Net
interest income after provision for loan losses
|
2,196
|
2,068
|
992
|
853
|
|||||||||
|
Net
income (loss)
(2)
|
935
|
9,594
|
(1,899
|
)
|
955
|
||||||||
|
Basic
net (loss) income per common share
|
(0.03
|
)
|
0.68
|
(0.27
|
)
|
(0.03
|
)
|
||||||
|
Diluted
net (loss) income per common share
|
(0.03
|
)
|
0.54
|
(0.27
|
)
|
(0.03
|
)
|
||||||
|
Cash
dividends declared per common share
|
-
|
-
|
-
|
-
|
|||||||||
|
Average
interest-earning assets
|
1,368,346
|
1,064,027
|
890,384
|
819,217
|
|||||||||
|
Average
borrowed funds
|
1,216,729
|
912,383
|
745,776
|
678,966
|
|||||||||
|
Net
interest spread on interest-earning assets
(3)
|
0.73
|
%
|
0.14
|
%
|
0.23
|
%
|
(0.17
|
)%
|
|||||
|
Average
asset yield
|
7.00
|
%
|
6.95
|
%
|
7.05
|
%
|
7.18
|
%
|
|||||
|
Net
yield on average interest-earning assets
|
1.43
|
%
|
1.10
|
%
|
1.31
|
%
|
1.07
|
%
|
|||||
|
Cost
of funds
|
6.27
|
%
|
6.81
|
%
|
6.82
|
%
|
7.35
|
%
|
|||||
|
Year
Ended December
31, 2004
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
|||||||||
|
Operating
results:
|
|||||||||||||
|
Total
interest income
|
$
|
33,631
|
$
|
33,217
|
$
|
30,026
|
$
|
25,349
|
|||||
|
Net
interest income after provision for loan losses
|
(765
|
)
|
(3,428
|
)
|
5,103
|
3,908
|
|||||||
|
Net
(loss) income
|
(5,387
|
)
|
(12,953
|
)
|
(56
|
)
|
15,021
|
||||||
|
Basic
net (loss) income per common share
|
(0.60
|
)
|
(0.95
|
)
|
(0.12
|
)
|
1.13
|
||||||
|
Diluted
net (loss) income per common share
|
(0.60
|
)
|
(0.95
|
)
|
(0.12
|
)
|
0.77
|
||||||
|
Cash
dividends declared per common share
|
-
|
-
|
-
|
-
|
|||||||||
|
Average
interest-earning assets
|
1,813,282
|
1,753,743
|
1,635,146
|
1,431,374
|
|||||||||
|
Average
borrowed funds
|
1,710,843
|
1,622,815
|
1,503,468
|
1,282,657
|
|||||||||
|
Net
interest spread on interest-earning assets
|
1.21
|
%
|
0.92
|
%
|
1.21
|
%
|
0.71
|
%
|
|||||
|
Average
asset yield
|
7.42
|
%
|
7.56
|
%
|
7.32
|
%
|
6.98
|
%
|
|||||
|
Net
yield on average interest-earning assets (1)
|
1.56
|
%
|
1.41
|
%
|
1.69
|
%
|
1.35
|
%
|
|||||
|
Cost
of funds
|
6.21
|
%
|
6.64
|
%
|
6.11
|
%
|
6.27
|
%
|
|||||
(1) Computed
as net interest margin excluding non-interest non-recourse securitization
financing expenses divided by average interest earning assets.
(2) The
increase in net income during the second quarter of 2005 relates primarily
to
the gain of approximately $8.2 million recognized on the sale of $367.2 million
of manufactured housing loans and securities and the derecognition of the
related non-recourse securitization financing of $363.9
million.
(3) The
negative net interest spread on interest-earning assets resulted from the
impact
of certain commercial loans being on non-accrual and an increase in amortization
expense related to deferred costs on our commercial securitizations resulting
from higher than anticipated prepayments on those
securitizations.
24
FORWARD-LOOKING
STATEMENTS
Certain
written statements in this Form 10-K
made by
Dynex 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. All statements
contained in this Item as well as those discussed elsewhere in this Report
addressing the results of operations, our operating performance, events,
or
developments that we expect or anticipate will occur in the future, including
statements relating to investment strategies, net interest income growth,
earnings or earnings per share growth, and market share, as well as statements
expressing optimism or pessimism about future operating results, are
forward-looking statements. The forward-looking statements are based upon
management’s views and assumptions as of the date of this Report, regarding
future events and operating performance and are applicable only as of the
dates
of such statements. Such forward-looking statements may involve factors that
could cause our actual results to differ materially from historical results
or
from any results expressed or implied by such forward-looking statements.
Dynex
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.
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:
Reinvestment. Asset
yields today are generally lower than those assets sold or repaid, due to
lower
overall interest rates and more competition for these assets. We have generally
been unable to find investments which have acceptable risk adjusted yields.
As a
result, our net interest income has been declining, and may continue to decline
in the future, resulting in lower earnings per share over time. In order
to
maintain our investment portfolio size and our earnings, we need to reinvest
a
portion of the cash flows we receive into new interesting earning assets.
If we
are unable to find suitable reinvestment opportunities, the net interest
income
on our investment portfolio and investment cash flows could be negatively
impacted.
Economic
Conditions.
We are
affected by general economic conditions. An increase in the risk of defaults
and
credit risk resulting from an economic slowdown or recession could result
in a
decrease in the value of our investments and the over-collateralization
associated with its securitization transactions. As a result of our being
heavily invested in short-term high quality investments, a worsening economy,
however, could also benefit us by creating opportunities for us to invest
in
assets that become distressed as a result of the worsening conditions. These
changes could have an effect on our financial performance and the performance
on
our securitized loan pools.
Investment
Portfolio Cash Flow.
Cash
flows from the investment portfolio fund our operations, the preferred stock
dividend, and repayments of outstanding debt, and are subject to fluctuation
due
to changes in interest rates, repayment rates and default rates and related
losses, particularly given the high degree of internal structural leverage
inherent in our securitized investments. Based on the performance of the
underlying assets within the securitization structure, cash flows which may
have
otherwise been paid to us as a result of our ownership interest may be retained
within the structure. Cash flows from the investment portfolio are likely
to
sequentially decline until we meaningfully begin to reinvest our capital.
There
can be no assurances that we will be able to find suitable investment
alternatives for our capital, nor can there be assurances that we will meet
our
reinvestment and return hurdles.
Defaults.
Defaults
by borrowers on loans we securitized may have an adverse impact on our financial
performance, if actual credit losses differ materially from our estimates
or
exceed reserves for losses recorded in the financial statements. The allowance
for loan losses is calculated on the basis of historical experience and
management’s best estimates. Actual default rates or loss severity may differ
from our estimate as a result of economic conditions. Actual defaults on
adjustable-rate mortgage loans may increase during a rising interest rate
environment. In addition, commercial mortgage loans are generally large dollar
balance loans, and a significant loan default may have an adverse impact
on our
financial results. Such impact may include higher provisions for loan losses
and
reduced interest income if the loan is placed on non-accrual.
Interest
Rate Fluctuations.
Our
income and cash flow depends on our ability to earn greater interest on our
investments than the interest cost to finance these investments. Interest
rates
in the markets served by us generally rise or fall with interest rates as
a
whole. Approximately $614 million of our investments, including loans and
securities currently pledged as securitized finance receivables and securities,
are fixed-rate and approximately $142 million of our investments are variable
rate. We currently finance these fixed-rate assets through $516.5 million
of
fixed rate securitization financing and $133 million of variable rate repurchase
agreements. The net interest spread for these investments could decrease
during
a
25
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; the related borrowing has no delayed resets or such interest rate caps.
Third-party
Servicers.
Our
loans
and loans underlying securities are serviced by third-party service providers.
As with any external service provider, we are subject to the risks associated
with inadequate or untimely services. Many borrowers require notices and
reminders to keep their loans current and to prevent delinquencies and
foreclosures. A substantial increase in our delinquency rate that results
from
improper servicing or loan performance in general could harm our ability
to
securitize our real estate loans in the future and may have an adverse effect
on
our earnings.
Prepayments.
Prepayments by borrowers on loans we securitized may have an adverse impact
on
our financial performance. Prepayments are expected to increase during a
declining interest rate or flat yield curve environment. Our 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 yielding
investments.
Competition.
The
financial services industry is a highly competitive market in which we compete
with a number of institutions with greater financial resources. In purchasing
portfolio investments and in issuing securities, we compete with other mortgage
REITs, investment banking firms, savings and loan associations, commercial
banks, mortgage bankers, insurance companies, federal agencies and other
entities, many of which have greater financial resources and a lower cost
of
capital than we do. Increased competition in the market and our competitors
greater financial resources have adversely affected Dynex, and may continue
to
do so. Competition may also continue to keep pressure on spreads resulting
in us
being unable to reinvest our capital on an acceptable risk-adjusted
basis.
Regulatory
Changes.
Our
businesses as of and for the year ended December 31, 2005 were 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 us and
the
performance of our securitized loan pools or our ability to collect on our
delinquent property tax receivables. We are a REIT and are required to meet
certain tests in order to maintain our REIT status as described in the earlier
discussion of “Federal Income Tax Considerations.” If we should fail to maintain
our REIT status, we would not be able to hold certain investments and would
be
subject to income taxes.
Section
404 of the Sarbanes-Oxley Act of 2002.
Based
on our current market capitalization, we do not anticipate that we will be
required to be compliant with the provisions of Section 404 of the
Sarbanes-Oxley Act of 2002 in 2006. However, the measurement date for
determining the compliance deadline is June 30, 2006. Failure to be compliant
may result in doubt in the capital markets about the quality and adequacy
of our
internal disclosure controls. This could result in our having difficulty
in or
being unable to raise additional capital in these markets in order to finance
our operations and future investments.
Other.
The
following risks, which are discussed in more detail in Risk
Factors
in Item
1A above, could also affect our results of operations, financial condition
and
cash flows:
| · |
We
may be unable to invest in new assets with attractive yields, and
yields
on new assets in which we do invest may not generate attractive yields,
resulting in a decline in our earnings per share over
time.
|
| · |
Our
ownership of certain subordinate interests in securitization trusts
subjects us to credit risk on the underlying loans, and we provide
for
loss reserves on these loans as required under GAAP.
|
| · |
Certain
investments employ internal structural leverage as a result of the
securitization process, and are in the most subordinate position
in the
capital structure, which magnifies the potential impact of adverse
events
on our cash flows and reported results.
|
| · |
Our
efforts to manage credit risk may not be successful in limiting
delinquencies and defaults in underlying loans or losses on our
investments.
|
| · |
Prepayments
of principal on our investments, and the timing of prepayments, may
impact
our reported earnings and our cash flows.
|
| · |
We
finance a portion of our investment portfolio with short-term recourse
repurchase agreements which subjects us to margin calls if the assets
pledged subsequently decline in value.
|
| · |
We
may be subject to the risks associated with inadequate or untimely
services from third-party service providers, which may harm our results
of
operations.
|
| · |
Interest
rate fluctuations can have various negative effects on us, and could
lead
to reduced earnings and/or increased earnings
volatility.
|
| · |
Our
reported income depends on accounting conventions and assumptions
about
the future that may change.
|
| · |
Failure
to qualify as a REIT would adversely affect our dividend distributions
and
could adversely affect the value of our
securities.
|
| · |
Maintaining
REIT status may reduce our flexibility to manage our
operations.
|
| · |
We
may fail to properly conduct our operations so as to avoid falling
under
the definition of an investment company pursuant to the Investment
Company
Act of 1940.
|
| · |
We
are dependent on certain key personnel.
|
RECENT
ACCOUNTING PRONOUNCEMENTS
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123 (Revised 2004), Share-Based Payment (FAS 123R). This statement supersedes
APB Opinion No. 25 and its related implementation guidance. The statement
establishes standards for the accounting for transactions in which an entity
exchanges its equity instruments for goods and services. This statement focuses
primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. The most significant change
resulting from this statement is the requirement for public companies to
expense
employee share-based payments under fair value as originally introduced in
SFAS
No. 123. This statement is effective for public companies as of the beginning
of
the first annual reporting period that begins after June 15, 2005, or December
15, 2005 for small business issuers. We will adopt this statement effective
January 1, 2006 and do not expect the adoption of FAS 123R to have a material
impact on our financial statements.
In
May
2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections.”
SFAS 154 changes the requirements for the accounting for and reporting of a
change in accounting principle. Previous guidance required that most voluntary
changes in accounting principle be recognized by including in net income
of the
period of the change the cumulative effect of changing to the new accounting
principle. SFAS 154 requires retrospective application to prior periods’
financial statements of changes in accounting principle, unless it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. We do not believe SFAS 154 will have an impact on our
financial statements.
In
February 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid
Financial Instruments”. Key provisions of SFAS 155 include: (1) a broad
fair value measurement option for certain hybrid financial instruments that
contain an embedded derivative that would otherwise require bifurcation;
(2) clarification that only the simplest separations of interest payments
and principal payments qualify for the exception afforded to interest-only
strips and principal-only strips from derivative accounting under paragraph
14
of FAS 133 (thereby narrowing such exception); (3) a requirement that
beneficial interests in securitized financial assets be analyzed to determine
whether they are freestanding derivatives or whether they are hybrid instruments
that contain embedded derivatives requiring bifurcation; (4) clarification
that concentrations of credit risk in the form of subordination are not embedded
derivatives; and (5) elimination of the prohibition on a QSPE holding
passive derivative financial instruments that pertain to beneficial interests
that are or contain a derivative financial instrument. In general, these
changes
will reduce the operational complexity associated with bifurcating embedded
derivatives, and increase the number of beneficial interests in securitization
transactions, including interest-only strips and principal-only strips, required
to be accounted for in accordance with FAS 133. We do not believe that SFAS
155
will have a material effect on our financial condition, results of operations,
or liquidity.
In
March
2006 the FASB issued SFAS No.156, “Accounting for Servicing of Financial
Assets—an amendment of FASB Statement No. 140” (SFAS 156). This Statement amends
FASB Statement No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. This Statement requires an entity to recognize a
servicing asset or servicing liability each time it undertakes an obligation
to
service a financial asset by entering into a servicing contract in certain
situations and to initially measure those servicing assets and servicing
liabilities at fair value, if practicable. SFAS 156 permits an entity to
measure
each class of separately recognized servicing assets and servicing liabilities
by either amortizing the servicing asset or liability and assessing the mortgage
servicing asset or servicing liability for impairment at each reporting date.
Alternatively, an entity may choose to measure the servicing asset or servicing
liability at fair value at each reporting date and report changes in fair
value
in earnings in the period the changes occur. SFAS 156 permits, at its initial
adoption, a one-time reclassification of available-for-sale securities to
trading securities by entities with recognized servicing rights,
without
26
calling
into question the treatment of other available-for-sale securities under
Statement 115, provided that the available-for-sale securities are identified
in
some manner as offsetting the entity’s exposure to changes in fair value of
servicing assets or servicing liabilities that a servicer elects to subsequently
measure at fair value. This statement is effective as of the beginning of
its
first fiscal year that begins after September 15, 2006. We are currently
evaluating the potential impact this statement may have on our financial
statements.
ITEM
7A. 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 our market risk management extends beyond derivatives
to include all market risk sensitive financial instruments. As a financial
services company, net interest income comprises the primary component of
our
earnings and cash flows. We are subject to risk resulting from interest rate
fluctuations to the extent that there is a gap between the amount of our
interest-earning assets and the amount of interest-bearing liabilities that
are
prepaid, mature or re-price within specified periods.
We
monitor the aggregate cash flow, projected net yield and estimated market
value
of our 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.
We
focus
on the sensitivity of our investment portfolio 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. We estimate our net interest income cash flow for the next
twenty-four months assuming interest rates over such time period follow the
forward LIBOR curve (based on 90-day Eurodollar futures contracts) as of
December 31, 2005. 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. Cash flow changes from interest rate swaps, caps, floors
or
any other derivative instrument are included in this analysis.
The
following table summarizes our net interest income cash flow and market value
sensitivity analyses as of December 31, 2005. These analyses represent
management’s estimate of the percentage change in net interest margin cash flow
and value expressed as a percentage change of shareholders’ equity, given a
parallel shift in interest rates, as discussed above. Other investments are
excluded from this analysis because they are not considered interest rate
sensitive. The “Base” case represents the interest rate environment as it
existed as of December 31, 2005. At December 31, 2005, one-month LIBOR was
4.39% and six-month LIBOR was 4.70%. 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 our 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 our portfolio,
27
and
no
change to our liability structure. Historically, there have been significant
changes in our investment portfolio and the liabilities incurred by us. As
a
result of anticipated prepayments on assets in the investment portfolio,
there
are likely to be such changes in the future.
|
Basis
Point
Increase
(Decrease)
in
Interest Rates
|
Projected
Change in Net
Interest
Margin
Cash
Flow From
Base
Case
|
Projected
Change in Value, Expressed as a Percentage of Shareholders’
Equity
|
|
+200
|
(4.2)%
|
(1.1)%
|
|
+100
|
(1.8)%
|
(0.4)%
|
|
Base
|
|
|
|
-100
|
0.6%
|
0.1%
|
|
-200
|
1.1%
|
0.2%
|
Our
interest rate risk is related both to the rate of change in short term interest
rates and to the level of short-term interest rates. Approximately $614 million
of our investment portfolio is comprised of loans or securities that have
coupon
rates that are fixed. Approximately $142 million of our investment portfolio
as
of December 31, 2005 was 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 65%,
13%
and 12% of the adjustable-rate loans underlying our securitized finance
receivables are indexed to and reset based upon the level of six-month LIBOR,
one-year constant maturity treasury rate (CMT) and prime rate,
respectively.
Generally,
during a period of rising short-term interest rates, our net interest income
earned and the corresponding cash flow on our investment portfolio will
decrease. The decrease of the net interest spread results from
(i) fixed-rate loans and investments financed with variable-rate debt, (ii)
the lag in resets of the adjustable-rate loans underlying the securitized
finance receivables relative to the rate resets on the associated borrowings,
and (iii) rate resets on the adjustable-rate 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 to item
(i),
we have substantially limited our interest rate risk by match funding fixed
rate
assets and variable rate assets. As to items (ii) and (iii), as short-term
interest rates stabilize and the adjustable-rate loans reset, the net interest
margin may be partially restored as the yields on the adjustable-rate loans
adjust to market conditions.
Net
interest income may increase following a fall in short-term interest rates.
This
increase may be temporary as the yields on the adjustable-rate loans adjust
to
the new market conditions after a lag period. 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 we have entered into such
agreements.
ITEM
8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
Our
consolidated financial statements and the related notes, together with the
Report of the Independent Registered Public Accounting Firm thereon, are
set
forth on pages F-1 through F-25 of this Form 10-K.
ITEM
9. CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not
applicable.
ITEM
9A. CONTROLS
AND PROCEDURES
(a) Evaluation
of disclosure controls and procedures.
Disclosure
controls and procedures are controls and other procedures that are designed
to
ensure that information required to be disclosed in our 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
28
limitation,
controls and procedures designed to ensure that information required to be
disclosed in our reports filed under the Exchange Act is accumulated and
communicated to management, including our management, as appropriate, to
allow
timely decisions regarding required disclosures.
As
of the
end of the period covered by this annual report, we carried out an evaluation
of
the effectiveness of the design and operation of our disclosure controls
and
procedures pursuant to Rule 13a-15 under the Exchange Act. This evaluation
was
carried out under the supervision and with the participation of our management,
including our Principal Executive Officer and Principal Financial Officer.
Based
upon that evaluation, our management concluded that our disclosure controls
and
procedures are effective.
In
conducting its review of disclosure controls, management concluded that
sufficient disclosure controls and procedures did exist to ensure that
information required to be disclosed in our 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.
(b) Changes
in internal controls.
Our
management is also responsible for establishing and maintaining adequate
internal control over financial reporting. There were no changes in our internal
controls or in other factors during the fourth quarter of 2005 that materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting. There were also no significant deficiencies or
material weaknesses in such internal controls requiring corrective
actions.
ITEM
9B. OTHER
INFORMATION
None.
PART
III
ITEM
10. DIRECTORS
AND EXECUTIVE OFFICERS OF THE REGISTRANT
The
information required by Item 10 is included in our proxy statement for its
2006
Annual Meeting of Shareholders (the “2006 Proxy Statement”) in the Election of
Directors, Corporate Governance and the Board of Directors, Ownership of
Stock
and Management and Executive Compensation of Dynex sections and is incorporated
herein by reference.
ITEM
11. EXECUTIVE
COMPENSATION
The
information required by Item 11 is included in the 2006 Proxy Statement in
the
Management of Dynex and Executive Compensation section and is incorporated
herein by reference.
ITEM
12. SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
The
information required by Item 12 is included in the 2006 Proxy Statement in
the
Ownership of Stock and Management of Dynex and Executive Compensation sections
and is incorporated herein by reference.
ITEM
13. CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS
The
information required by Item 13 is included in the 2006 Proxy Statement in
Management of Dynex and Executive Compensation section and is incorporated
herein by reference.
29
Item
14. Principal
Accounting Fees and Services
The
information required by Item 14 is included in the 2006 Proxy Statement in
the
Audit Information section and is incorporated herein by reference.
PART
IV
ITEM
15. EXHIBITS,
FINANCIAL STATEMENT SCHEDULES
(a) Documents
filed as part of this report:
1.
and
2. Financial
Statements and Schedules
The
information required by this section of Item 15 is set forth in the Consolidated
Financial Statements and Report of Independent Registered Public Accounting
Firm
beginning at page F-1 of this Form 10-K.
The
index to the Financial Statements is set forth at page F-2 of this Form
10-K.
3. Exhibits
|
Number
|
Exhibit
|
|
3.1
|
Articles
of Incorporation of the Registrant, as amended, effective as of
February
4, 1988. (Incorporated herein by reference to Dynex’s Amendment No. 1 to
the Registration Statement on Form S-3 (No. 333-10783) filed March
21,
1997.)
|
|
3.2
|
Amended
Bylaws of the Registrant. (Incorporated by reference to Dynex’s Annual
Report on Form 10-K for the year ended December 31, 1992, as
amended.)
|
|
3.3
|
Amendment
to Articles of Incorporation, effective December 29, 1989. (Incorporated
herein by reference to Dynex’s Amendment No. 1 to the Registration
Statement on Form S-3 (No. 333-10783) filed March 21,
1997.)
|
|
3.4
|
Amendment
to Articles of Incorporation, effective October 9, 1996. (Incorporated
herein by reference to the Registrant’s Current Report on Form 8-K, filed
October 15, 1996.)
|
|
3.5
|
Amendment
to Articles of Incorporation, effective October 19, 1992. (Incorporated
herein by reference to Dynex’s Amendment No. 1 to the Registration
Statement on Form S-3 (No. 333-10783) filed March 21,
1997.)
|
|
3.6
|
Amendment
to Articles of Incorporation, effective April 25, 1997. (Incorporated
herein by reference to Dynex’s Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997.)
|
|
3.7
|
Amendment
to Articles of Incorporation, effective June 17, 1998 (Incorporated
herein
by reference to Dynex’s Annual Report on Form 10-K for the year ended
December 31, 2004).
|
|
3.8
|
Amendment
to Articles of Incorporation, effective August 2, 1999 (Incorporated
herein by reference to Dynex’s Annual Report on Form 10-K for the year
ended December 31, 2004).
|
30
|
3.9
|
Amendment
to Articles of Incorporation, effective May 19, 2004. (Incorporated
herein
by reference to Dynex’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2004.)
|
|
3.10
|
Amendments
to the Bylaws of Dynex. (Incorporated herein by reference to Dynex’s
Annual Report on Form 10-K for the year ended December 31, 2002,
as
amended.)
|
|
10.1
|
Dynex
Capital, Inc. 2004 Stock Incentive Plan (Incorporated herein by
reference
to Dynex’s Annual Report on Form 10-K for the year ended December 31,
2004).
|
|
10.2
|
Form
of Stock Option Agreement for Non-Employee Directors under the
Dynex
Capital, Inc. 2004 Stock Incentive Plan. (Incorporated herein by
reference
to Dynex’s Quarterly Report on Form 10-Q for the quarter ended June 30,
2005.)
|
|
10.3
|
Form
of Stock Appreciation Rights Agreement for Senior Executives under
the
Dynex Capital, Inc. 2004 Stock Incentive Plan. (Incorporated herein
by
reference to Dynex’s Quarterly Report on Form 10-Q for the quarter ended
June 30, 2005.)
|
|
21.1
|
List
of consolidated entities of Dynex (filed herewith)
|
|
23.1
|
Consent
of BDO Seidman, LLP (filed herewith)
|
|
23.2
|
Consent
of Deloitte & Touche, LLP (filed herewith)
|
|
31.1
|
Certification
of Principal Executive Officer and Principal Financial Officer
pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
|
|
32.1
|
Certification
of Principal Executive Officer and Chief Financial Officer pursuant
to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
|
(b) Exhibits:
See Item
15(a)(3) above.
(c) Financial
Statement Schedules:
None.
31
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) 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.
|
||
|
(Registrant)
|
||
|
March
31, 2006
|
/s/
Stephen J. Benedetti
|
|
|
Stephen
J. Benedetti, Executive Vice President
|
||
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report
has been
signed below by the following persons on behalf of the registrant and in
the
capacities and on the dates indicated.
|
Signature
|
Capacity
|
Date
|
|
/s/
Stephen J. Benedetti
|
Principal
Executive Officer
|
March
31, 2006
|
|
Stephen
J. Benedetti
|
Principal
Financial Officer
|
|
|
/s/
Jeffrey L. Childress
|
Principal
Accounting Officer
|
March
31, 2006
|
|
Jeffrey
L. Childress
|
||
|
/s/
Thomas
B. Akin
|
Director
|
March
31, 2006
|
|
Thomas
B. Akin
|
||
|
/s/
J.
Sidney Davenport, IV
|
Director
|
March
31, 2006
|
|
J.
Sidney Davenport, IV
|
||
|
/s/
Leon
A. Felman
|
Director
|
March
31, 2006
|
|
Leon
A. Felman
|
||
|
/s/
Barry Igdaloff
|
Director
|
March
31, 2006
|
|
Barry
Igdaloff
|
||
|
/s/
Daniel K. Osborne
|
Director
|
March
31, 2006
|
|
Daniel
K. Osborne
|
||
|
/s/
Eric
P. Von der Porten
|
Director
|
March
31, 2006
|
|
Eric
P. Von der Porten
|
||
32
DYNEX
CAPITAL, INC.
CONSOLIDATED
FINANCIAL STATEMENTS AND
REPORT
OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
For
Inclusion in Form 10-K
Annual
Report Filed with
Securities
and Exchange Commission
December
31, 2005
F
-
1
DYNEX
CAPITAL, INC.
INDEX
TO FINANCIAL STATEMENTS
Financial
Statements:
|
Page
|
|
|
Report
of Independent Registered Public Accounting Firm for the Year
ended
December 31, 2005
|
F-3
|
|
Report
of Independent Registered Public Accounting Firm for the Years
ended
December 31, 2004 and 2003
|
F-4
|
|
Consolidated
Balance Sheets December 31, 2005 and 2004
|
F-5
|
|
Consolidated
Statements of Operations -- Years ended December 31, 2005, 2004
and
2003
|
F-6
|
|
Consolidated
Statements of Shareholders’ Equity -- Years ended December 31, 2005, 2004
and 2003
|
F-7
|
|
Consolidated
Statements of Cash Flows -- Years ended December 31, 2005, 2004
and
2003
|
F-8
|
|
Notes
to Consolidated Financial Statements December 31, 2005, 2004,
and
2003
|
F-9
|
F
-
2
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors and Stockholders of
Dynex
Capital, Inc.
Glen
Allen, Virginia
We
have
audited the accompanying consolidated balance sheet of Dynex Capital, Inc.
(“Dynex”) as of December 31, 2005 and the related consolidated statements of
operations, shareholders’ equity, and cash flows for the year then ended. These
financial statements are the responsibility of Dynex’s management. Our
responsibility is to express an opinion on these financial statements based
on
our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the
financial
statements are free of material misstatement. Dynex is not required to
have, nor
were we engaged to perform, an audit of its internal control over financial
reporting. Our
audit
included consideration of internal control over financial reporting as
a basis
for designing audit procedures that are appropriate in the circumstances
but not
for the purpose of expressing an opinion on the effectiveness of Dynex’s
internal control over financial reporting. Accordingly, we express no such
opinion. An audit includes examining, on a test basis, evidence supporting
the
amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our
audit provides a reasonable basis for our opinion.
In
our
opinion, the 2005 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Dynex at December
31, 2005, and the results of its operations and its cash flows for the
year then
ended, in conformity with accounting principles generally accepted in the
United
States of America.
BDO
SEIDMAN LLP
Richmond,
Virginia
March
1,
2006
F
-
3
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors and Stockholders of
Dynex
Capital, Inc.
Glen
Allen, Virginia
We
have
audited the accompanying consolidated balance sheets of Dynex Capital, Inc.
and
subsidiaries (the “Company”) as of December 31, 2004, and the related
consolidated statements of operations, shareholders’ equity, and cash flows for
each of the two years in the period ended December 31, 2004. These financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on the financial statements based
on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required
to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our
audit
included consideration of internal control over financial reporting as a
basis
for designing audit procedures that are appropriate in the circumstances
but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such
opinion. An audit includes examining, on a test basis, evidence supporting
the
amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our
audits provide a reasonable basis for our opinion.
In
our
opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2004 and
2003, and the results of their operations and their cash flows for each of
the
three years in the period ended December 31, 2004, in conformity with accounting
principles generally accepted in the United States of America.
DELOITTE
& TOUCHE LLP
Princeton,
New Jersey
April
7,
2005
F
-
4
CONSOLIDATED
BALANCE SHEETS
DYNEX
CAPITAL, INC.
December
31, 2005 and 2004
(amounts
in thousands except share data)
|
2005
|
2004
|
||||||
|
ASSETS
|
|||||||
|
Cash
and cash equivalents
|
$
|
52,522
|
|||||
|
Other
assets
|
4,332
|
4,964
|
|||||
|
49,567
|
57,486
|
||||||
|
Investments:
|
|||||||
|
Securitized
finance receivables:
|
|||||||
|
Loans,
net
|
722,152
|
1,036,123
|
|||||
|
Debt
securities
|
-
|
206,434
|
|||||
|
Securities
|
24,908
|
87,706
|
|||||
|
Other
investments
|
4,067
|
7,596
|
|||||
|
Other
loans
|
5,282
|
5,589
|
|||||
|
756,409
|
1,343,448
|
||||||
|
$
|
805,976
|
$
|
1,400,934
|
||||
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|||||||
|
LIABILITIES
|
|||||||
|
Securitization
financing:
|
|||||||
|
Non-recourse
securitization financing
|
$
|
516,578
|
$
|
1,177,280
|
|||
|
Repurchase
agreements secured by securitization financing
|
133,104
|
-
|
|||||
|
Repurchase
agreements secured by securities
|
211
|
70,468
|
|||||
|
Other
liabilities
|
6,749
|
4,420
|
|||||
|
656,642
|
1,252,168
|
||||||
|
Commitments
and Contingencies (Note 16)
|
|||||||
|
SHAREHOLDERS’
EQUITY
|
|||||||
|
Preferred
stock, par value $.01 per share,
|
|||||||
|
50,000,000
shares authorized:
|
|||||||
|
9.5%
Cumulative Convertible Series D,
|
|||||||
|
5,628,737
shares issued and outstanding
|
55,666
|
55,666
|
|||||
|
($57,624
aggregate liquidation preference)
|
|||||||
|
Common
stock, par value $.01 per share, 100,000,000 shares
authorized,
|
|||||||
|
12,163,391
and 12,162,391 shares issued and outstanding at 2005 and 2004,
respectively
|
122
|
122
|
|||||
|
Additional
paid-in capital
|
366,903
|
366,896
|
|||||
|
Accumulated
other comprehensive income
|
140
|
3,817
|
|||||
|
Accumulated
deficit
|
(273,497
|
)
|
(277,735
|
)
|
|||
|
149,334
|
148,766
|
||||||
|
|
$
|
805,976
|
$
|
1,400,934
|
|||
See
notes to consolidated financial statements.
F
-
5
CONSOLIDATED
STATEMENTS OF OPERATIONS
DYNEX
CAPITAL, INC.
Years
ended December 31, 2005, 2004 and 2003
(amounts
in thousands except share data)
|
2005
|
2004
|
2003
|
||||||||
|
Interest
income:
|
||||||||||
|
Securitized
finance receivables
|
$
|
118,647
|
$
|
147,297
|
||||||
|
Securities
|
3,885
|
2,535
|
773
|
|||||||
|
Other
investments
|
1,369
|
335
|
3,537
|
|||||||
|
Other
loans
|
754
|
706
|
608
|
|||||||
|
74,395
|
122,223
|
152,215
|
||||||||
|
Interest
and related expense:
|
||||||||||
|
Non-recourse
securitization financing
|
57,166
|
98,271
|
111,056
|
|||||||
|
Repurchase
agreements and senior notes
|
5,428
|
567
|
1,849
|
|||||||
|
Other
|
(88
|
)
|
104
|
339
|
||||||
|
62,506
|
98,942
|
113,244
|
||||||||
|
Net
interest income
|
11,889
|
23,281
|
38,971
|
|||||||
|
Provision
for loan losses
|
(5,780
|
)
|
(18,463
|
)
|
(37,082
|
)
|
||||
|
Net
interest income after provision for loan losses
|
6,109
|
4,818
|
1,889
|
|||||||
|
Impairment
charges
|
(2,474
|
)
|
(14,756
|
)
|
(16,355
|
)
|
||||
|
Gain
on sale of investments, net
|
9,609
|
14,490
|
1,555
|
|||||||
|
General
and administrative expenses
|
(5,681
|
)
|
(7,748
|
)
|
(8,632
|
)
|
||||
|
Other
income (expense)
|
2,022
|
(179
|
)
|
436
|
||||||
|
Net
income (loss)
|
9,585
|
(3,375
|
)
|
(21,107
|
)
|
|||||
|
Preferred
stock (charge) benefit
|
(5,347
|
)
|
(1,819
|
)
|
6,847
|
|||||
|
Net
income (loss) to common shareholders
|
$
|
4,238
|
$
|
(5,194
|
)
|
$
|
(14,260
|
)
|
||
|
Net
income (loss) per common share :
|
||||||||||
|
Basic
and diluted
|
$
|
0.35
|
$
|
(0.46
|
)
|
$
|
(1.31
|
)
|
||
See
notes to consolidated financial statements.
F
-
6
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY
DYNEX
CAPITAL, INC.
Years
ended December 31, 2005, 2004, and 2003
(amounts
in thousands except share data)
|
Preferred
Stock
|
Common
Stock
|
Additional
Paid-in
Capital
|
Accumulated
Other
Compre-hen-sive
(Loss) Income
|
Accumulated
Deficit
|
Total
|
||||||||||||||
|
Balance
at January 1, 2003
|
$
|
94,586
|
$
|
109
|
$
|
364,743
|
$
|
(4,832
|
)
|
$
|
(231,185
|
)
|
$
|
223,421
|
|||||
|
Comprehensive
loss:
|
|||||||||||||||||||
|
Net
loss - 2003
|
-
|
-
|
-
|
-
|
(21,107
|
)
|
(21,107
|
)
|
|||||||||||
|
Change
in net unrealized gain on:
|
|||||||||||||||||||
|
Investments
classified as available for sale
|
-
|
-
|
-
|
115
|
-
|
115
|
|||||||||||||
|
Hedge
instruments
|
-
|
-
|
-
|
835
|
-
|
835
|
|||||||||||||
|
Total
comprehensive loss
|
(20,157
|
)
|
|||||||||||||||||
|
Repurchase
of preferred stock
|
(47,572
|
)
|
-
|
(4,059
|
)
|
-
|
-
|
(51,631
|
)
|
||||||||||
|
Dividends
on preferred stock
|
-
|
-
|
-
|
-
|
(1,787
|
)
|
(1,787
|
)
|
|||||||||||
|
Balance
at December 31, 2003
|
47,014
|
109
|
360,684
|
(3,882
|
)
|
(254,079
|
)
|
149,846
|
|||||||||||
|
Comprehensive
income:
|
|||||||||||||||||||
|
Net
loss - 2004
|
-
|
-
|
-
|
-
|
(3,375
|
)
|
(3,375
|
)
|
|||||||||||
|
Change
in net unrealized gain on:
|
|||||||||||||||||||
|
Investments
classified as available for sale
|
-
|
-
|
-
|
4,681
|
-
|
4,681
|
|||||||||||||
|
Hedge
instruments
|
-
|
-
|
-
|
3,018
|
-
|
3,018
|
|||||||||||||
|
Total
comprehensive income
|
4,324
|
||||||||||||||||||
|
Recapitalization
|
8,652
|
13
|
6,212
|
-
|
(16,345
|
)
|
(1,468
|
)
|
|||||||||||
|
Dividends
on preferred stock
|
-
|
-
|
-
|
-
|
(3,936
|
)
|
(3,936
|
)
|
|||||||||||
|
Balance
at December 31, 2004
|
55,666
|
122
|
366,896
|
3,817
|
(277,735
|
)
|
148,766
|
||||||||||||
|
Comprehensive
income:
|
|||||||||||||||||||
|
Net
income - 2005
|
-
|
-
|
-
|
-
|
9,585
|
||||||||||||||
|
Change
in net unrealized gain/(loss) on:
|
|||||||||||||||||||
|
Investments
classified as available for sale
|
-
|
-
|
-
|
(4,286
|
)
|
-
|
(4,286
|
)
|
|||||||||||
|
Hedge
instruments
|
-
|
-
|
-
|
609
|
-
|
609
|
|||||||||||||
|
Total
comprehensive income
|
5,908
|
||||||||||||||||||
|
Issuance
of common stock
|
-
|
-
|
7
|
-
|
-
|
7
|
|||||||||||||
|
Dividends
on preferred stock
|
-
|
-
|
-
|
-
|
(5,347
|
)
|
(5,347
|
)
|
|||||||||||
|
Balance
at December 31, 2005
|
$
|
55,666
|
$
|
122
|
$
|
366,903
|
$
|
140
|
$
|
(273,497
|
)
|
$
|
149,334
|
||||||
See
notes to consolidated financial statements.
F
-
7
CONSOLIDATED
STATEMENTS OF CASH FLOWS
DYNEX
CAPITAL, INC.
Years
ended December 31, 2005, 2004
and
2003
(amounts
in thousands except share data)
|
2005
|
2004
|
2003
|
||||||||
|
Operating
activities:
|
||||||||||
|
Net
income (loss)
|
$
|
(3,375
|
)
|
$
|
(21,107
|
)
|
||||
|
Adjustments
to reconcile net income (loss) to cash provided by
operating
activities:
|
||||||||||
|
Provision
for loan losses
|
5,780
|
18,463
|
37,082
|
|||||||
|
Impairment
charges
|
2,474
|
14,756
|
16,355
|
|||||||
|
Gain
on sale of investments
|
(9,609
|
)
|
(14,490
|
)
|
(1,555
|
)
|
||||
|
Amortization
and depreciation
|
2,607
|
3,726
|
3,072
|
|||||||
|
Net
change in other assets and other liabilities
|
1,500
|
3,953
|
(4,031
|
)
|
||||||
|
Net
cash and cash equivalents provided by operating
activities
|
12,337
|
23,033
|
29,816
|
|||||||
|
Investing
activities:
|
||||||||||
|
Principal
payments received on investments
|
144,532
|
286,212
|
294,785
|
|||||||
|
Purchase
of securities and other investments
|
(56,246
|
)
|
(71,468
|
)
|
(32,196
|
)
|
||||
|
Payments
received on securities, other investments and loans
|
117,264
|
21,601
|
17,781
|
|||||||
|
Proceeds
from sales of securities and other investments
|
15,321
|
32,066
|
2,937
|
|||||||
|
Other
|
168
|
180
|
245
|
|||||||
|
Net
cash and cash equivalents provided by investing
activities
|
221,039
|
268,591
|
283,552
|
|||||||
|
Financing
activities:
|
||||||||||
|
Proceeds
from issuance of securitization financing
|
-
|
7,377
|
-
|
|||||||
|
Principal
payments on securitization financing
|
(102,510
|
)
|
(286,330
|
)
|
(301,573
|
)
|
||||
|
Redemption
of securitization financing
|
(195,653
|
)
|
-
|
-
|
||||||
|
Repayment
of senior notes
|
-
|
(10,872
|
)
|
(22,030
|
)
|
|||||
|
Proceeds
from repurchase agreement borrowings, net
|
62,847
|
46,584
|
23,884
|
|||||||
|
Retirement
of preferred stock
|
-
|
(648
|
)
|
(19,552
|
)
|
|||||
|
Dividends
paid
|
(5,347
|
)
|
(2,599
|
)
|
(1,787
|
)
|
||||
|
Net
cash and cash equivalents used for financing activities
|
(240,663
|
)
|
(246,488
|
)
|
(321,058
|
)
|
||||
|
Net
(decrease) increase in cash and cash equivalents
|
(7,287
|
)
|
45,136
|
(7,690
|
)
|
|||||
|
Cash
and cash equivalents at beginning of period
|
52,522
|
7,386
|
15,076
|
|||||||
|
Cash
and cash equivalents at end of period
|
$
|
45,235
|
$
|
52,522
|
$
|
7,386
|
||||
See
notes to consolidated financial statements.
F
-
8
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DYNEX
CAPITAL, INC.
December
31, 2005, 2004, and 2003
(amounts
in thousands except share and per share data)
NOTE
1 - BASIS OF PRESENTATION
Basis
of Presentation
The
accompanying consolidated financial statements have been prepared in accordance
with the instructions to Form 10-K and 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 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 of Dynex.
Dynex
believes it has complied with the requirements for qualification as a REIT
under
the Internal Revenue Code (the “Code”). As such, Dynex believes that it
qualifies as a REIT, and 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.
Dynex
uses estimates in establishing fair value for its securities as discussed
in
Note 2.
Dynex
also has credit risk on certain investments in its portfolio as discussed
in
Note 4. An allowance for loan losses has been estimated and established for
currently existing losses based on management’s judgment. The allowance for loan
losses is evaluated and adjusted periodically by management based on the
actual
and estimated timing and amount of currently existing credit losses. Provisions
made to increase the allowance related to credit risk are presented as provision
for loan losses in the accompanying consolidated statements of operations.
Dynex’s actual credit losses may differ from those estimates used to establish
the allowance.
Certain
amounts for 2003 and 2004 have been reclassified to conform to the presentation
adopted in 2005.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation
of Subsidiaries
The
consolidated financial statements represent Dynex’s accounts after the
elimination of inter-company transactions. Dynex consolidates entities in
which
it owns more than 50% of the voting equity and control does not rest with
others. Dynex follows the equity method of accounting for investments with
greater than 20% and less than a 50% interest in partnerships and corporate
joint ventures or when it is able to influence the financial and operating
policies of the investee but owns less than 50% of the voting equity. For
all
other investments, the cost method is applied.
Federal
Income Taxes
Dynex
believes it has complied with the requirements for qualification as a REIT
under
the Internal Revenue Code (the “Code”). As such, Dynex believes that it
qualifies as a REIT for federal income tax purposes, and 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. Dynex uses the calendar year for
both
tax and financial reporting purposes. There may be differences between taxable
income and income computed in accordance with accounting principles generally
accepted in the United States of America (“GAAP”). Dynex has a cumulative tax
net operating loss carryforward of $134,519 as of December 31, 2004 and
anticipates reporting a tax loss for the year ended December 31, 2005 but
has
not yet finalized the related calculations.
F
-
9
Investments
Securitized
Finance Receivables.
Securitized finance receivables consist of collateral pledged to support
the
repayment of non-recourse securitization financing issued by Dynex. Loans
included in securitized finance receivables are reported at amortized cost.
An
allowance has been established for currently existing losses on such loans.
Debt
securities included in securitized finance receivables are considered
available-for-sale and are reported at fair value, with unrealized gains
and
losses excluded from earnings and reported in accumulated other comprehensive
income. The basis for any gain/loss on any debt securities sold is computed
using the specific identification method. Securitized finance receivables
can
only be sold subject to the lien of the respective securitization financing
indenture.
Other
Investments.
Other
investments may include unsecuritized delinquent property tax receivables,
securities backed by delinquent property tax receivables, and real estate
owned.
The unsecuritized delinquent property tax receivables are carried at amortized
cost. Securities
backed by delinquent property tax receivables are classified as
available-for-sale and are carried at fair value.
Other
investments also include real estate owned acquired through, or in lieu of
foreclosure in connection with the servicing of the delinquent tax lien
receivables portfolio. Such investments are considered held for sale and
are
initially recorded at fair value less cost to sell (“net realizable value”) at
the date of foreclosure, establishing a new cost basis. Subsequent to
foreclosure, management periodically performs valuations and adjusts the
property to the lower of cost and net realizable value. Revenue and expenses
related to and changes in the valuation of the real estate owned are included
in
other income (expense).
Securities.
Securities
include debt and equity securities, which are considered available-for-sale
under SFAS No. 115 and are reported at fair value, with unrealized gains
and
losses excluded from earnings and reported as accumulated other comprehensive
income. The basis used to determine the gain or loss on any debt and equity
securities sold is the specific identification method and average cost method,
respectively.
Other
loans.
Other
loans are carried at amortized cost.
Interest
Income.
Interest
income is recognized when earned according to the terms of the underlying
investment and when, in the opinion of management, it is collectible. For
loans,
the accrual of interest is discontinued when, in the opinion of management,
the
interest is not collectible in the normal course of business, when the loan
is
significantly past due or when the primary servicer of the loan fails to
advance
the interest and/or principal due on the loan. For securities and other
investments, the accrual of interest is discontinued when, in the opinion
of
management, it is probable that all amounts contractually due will not be
collected. Loans are considered past due when the borrower fails to make
a
timely payment in accordance with the underlying loan agreement, inclusive
of
all applicable cure periods. All interest accrued but not collected for
investments that are placed on a non-accrual status or are charged-off is
reversed against interest income. Interest on these investments is accounted
for
on the cash-basis or cost-recovery method, until qualifying for return to
accrual status. Investments are returned to accrual status when all the
principal and interest amounts contractually due are brought current and
future
payments are reasonably assured.
Premiums,
Discounts and Hedging Basis Adjustments
Premiums
and discounts on investments and obligations are amortized into interest
income
or expense, respectively, over the life of the related investment or obligation
using the effective yield method. Hedging basis adjustments on associated
debt
obligations are amortized over the expected remaining life of the debt
instrument. If the indenture for a particular debt obligation provides for
a
step-up of interest rates on the optional redemption date for that obligation
and Dynex has the ability and intent to exercise its call option, then premiums,
discounts, and deferred hedging losses are amortized to that optional redemption
date. Otherwise, these amounts are amortized over the estimated remaining
life
of the obligation.
F
-
10
Debt
Issuance Costs
Costs
incurred in connection with the issuance of non-recourse debt and recourse
debt
are deferred and amortized over the estimated lives of their respective debt
obligations using the effective yield method.
Derivative
Financial Instruments
On
occasion, Dynex may enter into interest rate swap agreements, interest rate
cap
agreements, interest rate floor agreements, financial forwards, financial
futures and options on financial futures (“Interest Rate Agreement”) to manage
its sensitivity to changes in interest rates. These interest rate agreements
are
intended to provide income and cash flow to offset potential reduced net
interest income and cash flow under certain interest rate environments. At
the
inception of the Interest Rate Agreement, these instruments are designated
as
either hedge positions or trading positions using criteria established in
SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities” (as
amended). If, at the inception of the Interest Rate Agreement, formal
documentation is prepared that describes the risk being hedged, identifies
the
hedging instrument and the means to be used for assessing the effectiveness
of
the hedge and if it can be demonstrated that the hedging instrument will
be
highly effective at hedging the risk exposure, the derivative instrument
will be
designated as a cash flow hedge position. Otherwise, the Interest Rate Agreement
will be classified as a trading position.
For
Interest Rate Agreements designated as cash flow hedges, Dynex evaluates
the
effectiveness of these hedges against the financial instrument being hedged.
The
effective portion of the hedge relationship on an interest rate agreement
designated as a cash flow hedge is reported in accumulated other comprehensive
income, and the ineffective portion of such hedge is reported in income.
Amounts
in accumulated other comprehensive income are reclassified into earnings
in the
same period during which the hedged transaction affects earnings. Derivative
instruments are carried at fair value in the financial statements of
Dynex.
As
a part
of Dynex’s interest rate risk management process, Dynex may be required
periodically to terminate hedge instruments. Any basis adjustments or changes
in
the fair value of hedges recorded in other comprehensive income are recognized
into income or expense in conjunction with the original hedge or hedged
exposure.
If
the
underlying asset, liability or commitment is sold or matures, the hedge is
deemed partially or wholly ineffective, or the criteria that was executed
at the
time the hedge instrument was entered into no longer exists, the interest
rate
agreement no longer qualifies as a designated hedge. Under these circumstances,
such changes in the market value of the interest rate agreement are recognized
in current income.
For
interest rate agreements entered into for trading purposes, realized and
unrealized changes in fair value of these instruments are recognized in the
consolidated statements of operations as trading income or loss in the period
in
which the changes occur or when such trade instruments are settled. Amounts
receivable from counter-parties, if any, are included on the consolidated
balance sheets in other assets.
Cash
Equivalents
Cash
and
cash equivalents include cash on hand and highly liquid investments with
original maturities of three months or less.
Net
Income Per Common Share
Net
income per common share is presented on both a basic net income per common
share
and diluted net income per common share basis. Diluted net income per common
share assumes the conversion of the convertible preferred stock into common
stock, using the if-converted method, and stock appreciation rights, using
the
treasury stock method, but only if these items are dilutive. Each share of
preferred stock is convertible into one share of common stock.
F
-
11
Use
of
Estimates
The
preparation of financial statements, in conformity with accounting principles
generally accepted in the United States of America, 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 reported period. Actual results could differ from those estimates. The
primary estimates inherent in the accompanying consolidated financial statements
are discussed below.
Fair
Value. Securities
classified as available-for-sale are carried in the accompanying financial
statements at estimated fair value. 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 using estimates of market-based
discount rates, prepayment rates and credit loss assumptions. The estimate
of
fair value for securities pledged as securitized finance receivables is
determined by calculating the present value of the projected cash flows of
the
instruments, using discount rates, prepayment rate assumptions and credit
loss
assumptions based on historical experience and estimated future activity,
and
using discount rates commensurate with those Dynex believes would be used
by
third parties in a market purchase.
Estimates
of fair value for financial instruments are based primarily on management’s
judgment. Since the fair value of Dynex’s financial instruments
is based
on estimates, actual fair values recognized may differ from those estimates
recorded in the consolidated financial statements. The fair value of all
financial instruments is presented in Note 10.
Allowance
for Loan Losses. An
allowance for loan losses has been estimated and established for currently
existing probable losses for loans in Dynex’s investment portfolio. Factors
considered in establishing an allowance include current loan delinquencies,
historical cure rates of delinquent loans, and historical and anticipated
loss
severity of the loans as they are liquidated. The allowance for losses is
evaluated and adjusted periodically by management based on the actual and
estimated timing and amount of probable credit losses, using the above factors,
as well as industry loss experience. Where loans are considered homogeneous,
the
allowance for losses are established and evaluated on a pool basis. Otherwise,
the allowance for losses is established and evaluated on a loan-specific
basis.
Provisions made to increase the allowance are charged as a current period
expense. Single-family loans are considered impaired when they are 60-days
past
due. Commercial mortgage loans are evaluated on an individual basis for
impairment. Commercial mortgage loans are secured by income-producing real
estate and is evaluated for impairment when the debt service coverage ratio
on
the loan is less than 1:1. Certain of the commercial mortgage loans are covered
by loan guarantees that limit Dynex’s exposure on these loans. The level of
allowance for loan losses required for these loans is reduced by the amount
of
applicable loan guarantees. Dynex’s actual credit losses may differ from the
estimates used to establish the allowance.
Impairments.
Dynex
evaluates all securities in its investment portfolio for other-than-temporary
impairments. A security is generally defined to be other-than-temporarily
impaired if, for a maximum period of three consecutive quarters, the carrying
value of such security exceeds its estimated fair value and Dynex estimates,
based on projected future cash flows or other fair value determinants, that
the
fair value will remain below the carrying value for the foreseeable future.
If
an other-than-temporary impairment is deemed to exist, Dynex records an
impairment charge to adjust the carrying value of the security down to its
estimated fair value. In certain instances, as a result of the
other-than-temporary impairment analysis, the recognition or accrual of interest
will be discontinued and the security will be placed on non-accrual
status.
Dynex
considers an investment to be impaired if the fair value of the investment
is
less than its recorded cost basis. Impairments of other investments are
generally considered to be other-than-temporary when the fair value remains
below the carrying value for three consecutive quarters. If the impairment
is
determined to be other-than-temporary, an impairment charge is recorded in
order
to adjust the carrying value of the investment to its estimated
value.
Mortgage
Servicing Liability.
Dynex
retains the primary servicing rights for certain of its loans, and subcontracts
the performance of the primary servicing to unrelated third parties. Dynex
recognizes a liability for the amount by which the estimated value of the
payments to the third-party servicer exceeds the estimated value of
F
-
12
Dynex’s
expected servicing cash inflows on the related loans. The value of the mortgage
servicing liability is estimated using a discounted cash flow model. The
mortgage servicing liability is amortized in proportion to and over the period
of the estimated net servicing loss.
Contingencies.
In the
normal course of business, there are various lawsuits, claims, and contingencies
pending against the Company. In accordance with SFAS No. 5, Accounting
for Contingencies,
we have
established provisions for estimated losses from pending claims, investigations
and proceedings. Although the ultimate outcome of the various matters cannot
be
ascertained at this point, it is the opinion of management, after consultation
with counsel, that the resolution of the foregoing matters will not have
a
material adverse effect on the financial condition of the Company, taken
as a
whole, such resolution may, however, have a material effect on the results
of
operations or cash flows in any future period, depending on the level of
income
for such period.
Securitization
Transactions
Dynex
securitizes loans and securities in a securitization financing transaction
by
transferring financial assets to a wholly owned trust, and the trust issues
non-recourse bonds pursuant to an indenture. Generally, Dynex retains some
form
of control over the transferred assets, and/or the trust is not deemed to
be a
qualified special purpose entity. In instances where the trust is deemed
not to
be a qualified special purpose entity, the trust is included in the consolidated
financial statements of Dynex. A
transfer of financial assets in which Dynex surrenders control over those
assets
is accounted for as a sale to the extent that consideration other than
beneficial interests in the transferred assets is received in exchange.
For
accounting and tax purposes, the loans and securities financed through the
issuance of bonds in a securitization financing transaction are treated as
assets of Dynex, and the associated bonds issued are treated as debt of Dynex
as
securitization financing. Dynex may retain certain of the bonds issued by
the
trust, and Dynex generally will transfer collateral in excess of the bonds
issued. This excess is typically referred to as over-collateralization. Each
securitization trust generally provides Dynex the right to redeem, at its
option, the remaining outstanding bonds prior to their maturity date.
Recent
Accounting Pronouncements
|
2005
|
2004
|
2003
|
||||||||
|
Net
(loss) income to common shareholders
|
$
|
4,238
|
$
|
(5,194
|
)
|
$
|
(14,260
|
)
|
||
|
Fair
value method stock based compensation expense
|
(95
|
)
|
-
|
(126
|
)
|
|||||
|
Stock
based compensation expense under APB 25
|
-
|
-
|
38
|
|||||||
|
Pro
forma net (loss) income to common shareholders
|
$
|
4,143
|
$
|
(5,194
|
)
|
$
|
(14,348
|
)
|
||
|
Net
(loss) income per common share:
|
||||||||||
|
Basic
- as reported
|
$
|
0.35
|
$
|
(0.46
|
)
|
$
|
(1.31
|
)
|
||
|
Basic
- pro forma
|
$
|
0.34
|
$
|
(0.46
|
)
|
$
|
(1.32
|
)
|
||
In
May
2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections.”
SFAS 154 changes the requirements for the accounting for and reporting of a
change in accounting principle. Previous
F
-
13
guidance
required that most voluntary changes in accounting principle be recognized
by
including in net income of the period of the change the cumulative effect
of
changing to the new accounting principle. SFAS 154 requires retrospective
application to prior periods’ financial statements of changes in accounting
principle, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. The Company does not believe
SFAS 154 will have an impact on its financial statements.
In
February 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid
Financial Instruments”. Key provisions of SFAS 155 include: (1) a broad
fair value measurement option for certain hybrid financial instruments that
contain an embedded derivative that would otherwise require bifurcation;
(2) clarification that only the simplest separations of interest payments
and principal payments qualify for the exception afforded to interest-only
strips and principal-only strips from derivative accounting under paragraph
14
of FAS 133 (thereby narrowing such exception); (3) a requirement that
beneficial interests in securitized financial assets be analyzed to determine
whether they are freestanding derivatives or whether they are hybrid instruments
that contain embedded derivatives requiring bifurcation; (4) clarification
that concentrations of credit risk in the form of subordination are not embedded
derivatives; and (5) elimination of the prohibition on a QSPE holding
passive derivative financial instruments that pertain to beneficial interests
that are or contain a derivative financial instrument. In general, these
changes
will reduce the operational complexity associated with bifurcating embedded
derivatives, and increase the number of beneficial interests in securitization
transactions, including interest-only strips and principal-only strips, required
to be accounted for in accordance with FAS 133. Management does not believe
that
SFAS 155 will have a material effect on the financial statements of the
Company.
In
March
2006 the FASB issued SFAS No.156, “Accounting for Servicing of Financial
Assets—an amendment of FASB Statement No. 140” (SFAS 156). This Statement amends
FASB Statement No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. This Statement requires an entity to recognize a
servicing asset or servicing liability each time it undertakes an obligation
to
service a financial asset by entering into a servicing contract in certain
situations and to initially measure those servicing assets and servicing
liabilities at fair value, if practicable. SFAS 156 permits an entity to
measure
each class of separately recognized servicing assets and servicing liabilities
by either amortizing the servicing asset or liability and assessing the mortgage
servicing asset or servicing liability for impairment at each reporting date.
Alternatively, an entity may choose to measure the servicing asset or servicing
liability at fair value at each reporting date and report changes in fair
value
in earnings in the period the changes occur. SFAS 156 permits, at its initial
adoption, a one-time reclassification of available-for-sale securities to
trading securities by entities with recognized servicing rights, without
calling
into question the treatment of other available-for-sale securities under
Statement 115, provided that the available-for-sale securities are identified
in
some manner as offsetting the entity’s exposure to changes in fair value of
servicing assets or servicing liabilities that a servicer elects to subsequently
measure at fair value. This statement is effective as of the beginning of
its
first fiscal year that begins after September 15, 2006. The Company is currently
evaluating the potential impact this statement may have on its financial
statements.
F
-
14
NOTE
3 - SECURITIZED FINANCE RECEIVABLES
The
following table summarizes the components of securitized finance receivables
as
of December 31, 2005 and 2004.
|
2005
|
2004
|
||||||
|
Loans,
at amortized cost
|
$
|
741,187
|
$
|
1,064,137
|
|||
|
Allowance
for loan losses
|
(19,035
|
)
|
(28,014
|
)
|
|||
|
Loans,
net
|
722,152
|
1,036,123
|
|||||
|
Debt
securities at fair value
|
-
|
206,434
|
|||||
|
$
|
722,152
|
$
|
1,242,557
|
||||
The
following table summarizes the amortized cost basis, gross unrealized gains
and
losses and estimated fair value of debt securities pledged as securitized
finance receivables as of December 31, 2005 and 2004.
|
2005
|
2004
|
||||||
|
Debt
securities, available-for-sale, at amortized cost
|
$
|
-
|
$
|
205,370
|
|||
|
Gross
unrealized gains
|
$
|
-
|
1,064
|
||||
|
Estimated
fair value
|
$
|
-
|
$
|
206,434
|
|||
The
components of securitized finance receivables at December 31, 2005 and 2004
are
as follows:
|
2005
|
2004
|
||||||||||||||||||
|
Loans,
net
|
Debt
Securities
|
Total
|
Loans,
net
|
Debt
Securities
|
Total
|
||||||||||||||
|
Collateral:
|
|||||||||||||||||||
|
Commercial
|
$
|
570,199
|
$
|
-
|
$
|
570,199
|
$
|
640,090
|
$
|
-
|
$
|
640,090
|
|||||||
|
Manufactured
housing
|
-
|
-
|
-
|
198,246
|
149,420
|
347,666
|
|||||||||||||
|
Single-family
|
161,058
|
-
|
161,058
|
225,055
|
52,753
|
277,808
|
|||||||||||||
|
731,257
|
-
|
731,257
|
1,063,391
|
202,173
|
1,265,564
|
||||||||||||||
|
Allowance
for loan losses
|
(19,035
|
)
|
-
|
(19,035
|
)
|
(28,014
|
)
|
-
|
(28,014
|
)
|
|||||||||
|
Funds
held by trustees
|
6,648
|
-
|
6,648
|
130
|
43
|
173
|
|||||||||||||
|
Accrued
interest receivable
|
5,114
|
-
|
5,114
|
6,548
|
202
|
6,750
|
|||||||||||||
|
Unamortized
premiums and (discounts), net
|
(1,832
|
)
|
-
|
(1,832
|
)
|
(5,932
|
)
|
2,952
|
(2,980
|
)
|
|||||||||
|
Unrealized
gain, net
|
-
|
-
|
-
|
-
|
1,064
|
1,064
|
|||||||||||||
|
$
|
722,152
|
$
|
-
|
$
|
722,152
|
$
|
1,036,123
|
$
|
206,434
|
$
|
1,242,557
|
||||||||
All
of
the securitized finance receivables are encumbered by securitization financing
(see Note 8).
During
2005, Dynex redeemed, at par, $195,653 of securitization financing bonds
collateralized by the single-family loans pursuant to its redemption rights
within the respective indenture. The redemption was partially financed with
$170,655 of repurchase agreements, of which $133,104 remained outstanding
at
December 31, 2005. The redeemed bonds, which collateralize the related
repurchase agreement financing, have been removed from Dynex’s financial
statements. The repurchase agreement financing has been presented as repurchase
agreements secured by securitization financing in the accompanying financial
statements. The redeemed non-recourse securitization financing bonds have
not
been retired by Dynex, because of its plans to reissue the bonds.
During
2005, Dynex, through its wholly-owned subsidiary MERIT Securities Corporation,
sold its interests in approximately $367,154 in securitization finance
receivables and the associated securitization trust, resulting in derecognition
of these receivables and the extinguishment of $363,871 in related
securitization financing bonds. Dynex received proceeds of $8,000 for the
sale
of these interests, recorded mortgage servicing assets of $3,176
for
F
-
15
the
retained servicing on the loans, and recognized a gain of $8,228. As part
of
this transaction, Dynex also sold one of its subsidiaries on which it recorded
a
gain of $1,000, which was recorded in other income.
NOTE
4 - ALLOWANCE FOR LOAN LOSSES
Dynex
reserves for credit risk where it has exposure to losses on loans in its
securitized finance receivables portfolio. The allowance for loan losses
is
included in securitized finance receivables in the accompanying consolidated
balance sheets. The following table summarizes the aggregate activity for
the
allowance for loan losses for the years ended December 31, 2005,
2004 and 2003:
|
2005
|
2004
|
2003
|
||||||||
|
Allowance
at beginning of year
|
$
|
28,014
|
$
|
43,364
|
$
|
25,472
|
||||
|
Provision
for loan losses
|
5,780
|
18,463
|
37,082
|
|||||||
|
Credit
losses, net of recoveries
|
(3,450
|
)
|
(17,651
|
)
|
(19,190
|
)
|
||||
|
Loans
sold
|
(11,309
|
)
|
(16,162
|
)
|
-
|
|||||
|
Allowance
at end of year
|
$
|
19,035
|
$
|
28,014
|
$
|
43,364
|
||||
The
transfer of $11,309 represents the amount of allowance that was derecognized
in
connection with the sale of the related securitized finance receivables
described above in Note 3.
The
following table presents certain information on commercial mortgage loans
that
Dynex has determined to be impaired.
|
December
31,
|
Total
Recorded Investment in Impaired Loans
|
Amount
for Which There is a Related Allowance for Credit
Losses
|
Amount
for Which There is no Related Allowance for Credit
Losses
|
|||||||
|
2004
|
72,431
|
17,379
|
55,052
|
|||||||
|
2005
|
54,558
|
21,609
|
32,949
|
|||||||
NOTE
5 - OTHER INVESTMENTS
The
following table summarizes the Company’s other investments at December 31, 2005
and 2004:
|
2005
|
2004
|
||||||
|
Delinquent
property tax receivables and security
|
$
|
3,220
|
$
|
6,000
|
|||
|
Real
estate owned
|
847
|
1,596
|
|||||
|
$
|
4,067
|
$
|
7,596
|
||||
The
balance of the delinquent property tax security includes an unrealized gain
of
$55 and none as of December 31, 2005 and 2004, respectively.
At
December 31, 2005 and 2004, Dynex has real estate owned with a current carrying
value of $847 and $1,596, respectively, resulting from foreclosures on
delinquent property tax receivables. Cash collections on all delinquent property
tax receivables, including proceeds from sales of real estate owned, amounted
to
$3,039 and $7,165 during 2005 and 2004, respectively.
F
-
16
NOTE
6 -
SECURITIES
The
following table summarizes Dynex’s amortized cost basis and fair value of
securities, all of which are classified as available-for-sale, as of December
31, 2005 and 2004, and the related average effective interest rates at December
31, 2005 and 2004:
|
2005
|
2004
|
||||||||||||
|
Fair
Value
|
Effective
Interest Rate
|
Fair
Value
|
Effective
Interest Rate
|
||||||||||
|
Securities,
available-for-sale:
|
|||||||||||||
|
Fixed-rate
mortgage securities
|
$
|
22,900
|
6.14
|
%
|
$
|
79,081
|
4.54
|
%
|
|||||
|
Other
securities
|
320
|
404
|
|||||||||||
|
Equity
securities
|
1,602
|
7,438
|
|||||||||||
|
24,822
|
86,928
|
||||||||||||
|
Gross
unrealized gains
|
332
|
852
|
|||||||||||
|
Gross
unrealized losses
|
(246
|
)
|
(74
|
)
|
|||||||||
|
Securities,
available-for-sale
|
$
|
24,908
|
$
|
87,706
|
|||||||||
Investment
activity.
During
2005, Dynex invested approximately $1,486 in the common stock of three publicly
traded REITs. The Company also sold 499 shares in another REIT during 2005
generating proceeds of $7,330 and a gain of $9.
Unrealized
gain/loss on securities.
At
December 31, 2005, unrealized gains on securities were $332 and unrealized
losses were $246, which were primarily related to the Company’s investment in
equity securities. The unrealized losses represent temporary declines in
value.
NOTE
7 - OTHER LOANS
The
following table summarizes Dynex’s carrying basis for other loans at December
31, 2005 and 2004, respectively.
|
2005
|
2004
|
||||||
|
Single-family
mortgage loans
|
$
|
4,825
|
$
|
3,693
|
|||
|
Multifamily
and commercial mortgage loans participations
|
995
|
2,878
|
|||||
|
5,820
|
6,571
|
||||||
|
Unamortized
discounts
|
(538
|
)
|
(982
|
)
|
|||
|
$
|
5,282
|
$
|
5,589
|
||||
NOTE
8 - NON-RECOURSE SECURITIZATION FINANCING
Dynex,
through limited-purpose finance subsidiaries, has issued bonds pursuant to
indentures in the form of non-recourse securitization financing. Each series
of
securitization financing may consist of various classes of bonds, either
at
fixed or variable rates of interest. Payments received on securitized finance
receivables and any reinvestment income thereon are used to make payments
on the
securitization financing (see Note 3). The obligations under the securitization
financings are payable solely from the securitized finance receivables and
are
otherwise non-recourse to Dynex. The stated maturity date for each class
of
bonds is generally calculated based on the final scheduled payment date of
the
underlying collateral pledged. The actual maturity of each class will be
directly affected by the rate of principal prepayments on the related
collateral. Each series is also subject to redemption at Dynex’s option
according to specific terms of the respective indentures. As a result, the
actual maturity of any class of a series of securitization financing is likely
to occur earlier than its stated maturity. If Dynex does not exercise its
option
to redeem a class or classes of bonds when it first has the right to do so,
the
interest rates on the bonds not redeemed will automatically increase from
0.30%
to 2.00%. During 2005, Dynex redeemed non-recourse securitization financing
as
discussed in Note 3.
F
-
17
Dynex
may
retain certain bond classes of securitization financing issued, including
investment grade classes, financing these retained bonds with equity. Total
investment grade bonds at December 31, 2005 and 2004 were none and $20,000,
respectively, and carried a rating of ‘BBB’ as rated by a nationally recognized
ratings agency. As these limited-purpose finance subsidiaries are included
in
the consolidated financial statements of Dynex, such retained bonds are
eliminated in the consolidated financial statements, while the associated
repurchase agreements outstanding, if any, are included as recourse
debt.
The
components of non-recourse securitization financing along with certain other
information at December 31, 2005 and 2004 are summarized as
follows:
|
2005
|
2004
|
||||||||||||
|
Bonds
Outstanding
|
Range
of Interest Rates
|
Bonds
Outstanding
|
Range
of Interest Rates
|
||||||||||
|
Variable-rate
classes
|
$
|
-
|
$
|
405,236
|
2.6%
- 3.7
|
%
|
|||||||
|
Fixed-rate
classes
|
509,923
|
6.6%
- 8.8
|
%
|
760,672
|
6.3%
- 11.5
|
%
|
|||||||
|
Accrued
interest payable
|
3,438
|
5,237
|
|||||||||||
|
Deferred
costs
|
(16,912
|
)
|
(25,658
|
)
|
|||||||||
|
Unamortized
net bond premium
|
20,129
|
31,793
|
|||||||||||
|
$
|
516,578
|
$
|
1,177,280
|
||||||||||
|
Range
of stated maturities
|
2009-2028
|
2009-2033
|
|||||||||||
|
Estimated
weighted average life
|
3.5
years
|
4.7
years
|
|||||||||||
|
Number
of series
|
3
|
17
|
|||||||||||
The
variable rate classes were sold during 2005. At December 31, 2005, the
weighted-average effective rate of the fixed rate classes was 6.8%. The average
effective rate of interest for non-recourse securitization financing was
7.4%,
6.4%, and 5.9%, for the years ended December 31, 2005, 2004,
and
2003, respectively.
NOTE
9 - REPURCHASE AGREEMENTS
The
Company entered into a repurchase agreement, which is recourse to the Company,
to partially finance the redemption of certain securitization financing bonds
during 2005 as described in Note 3. The repurchase agreement has a remaining
balance of $133,104 and is collateralized by the related redeemed bonds,
which
were eliminated in the consolidated financial statements. The repurchase
agreement matures monthly and has a rate of a weighted average rate of 0.10%
over one-month LIBOR (4.48% at December 31, 2005). The bonds pledged as
collateral for the repurchase agreement have an estimated fair value of $153,499
and pay interest at a blended rate of one-month LIBOR plus 0.32%.
Dynex
also utilizes other recourse repurchase agreements to finance certain of
its
investments. There were $211 and $70,468 outstanding at December 31, 2005
and
2004, respectively, which were collateralized by securities with a market
value
of $20,133 and $78,491, respectively. These repurchase agreements bear interest
based on one-month LIBOR plus a spread ranging from 0.10% to 0.60%, which
represented a weighted average rate of 4.57% at December 31, 2005.
F
-
18
NOTE
10 - FAIR VALUE AND ADDITIONAL INFORMATION ABOUT FINANCIAL
INSTRUMENTS
SFAS
No.
107, “Disclosures about Fair Value of Financial Instruments” requires the
disclosure of the estimated fair value of financial instruments. The following
table presents the recorded basis and estimated fair values of Dynex’s financial
instruments as of December 31, 2005
and
2004:
|
2005
|
2004
|
||||||||||||
|
Recorded
Basis
|
Fair
Value
|
Recorded
Basis
|
Fair
Value
|
||||||||||
|
Assets:
|
|||||||||||||
|
Securitized
finance receivables
|
|||||||||||||
|
Loans,
net
|
$
|
722,152
|
$
|
761,287
|
$
|
1,036,123
|
$
|
1,096,971
|
|||||
|
Debt
securities
|
-
|
-
|
206,434
|
206,434
|
|||||||||
|
Securitized
finance receivables
|
722,152
|
761,287
|
1,242,557
|
1,303,405
|
|||||||||
|
Other
investments
|
4,067
|
4,067
|
7,596
|
7,596
|
|||||||||
|
Securities
|
24,908
|
24,908
|
87,706
|
87,706
|
|||||||||
|
Other
loans
|
5,282
|
6,040
|
5,589
|
7,872
|
|||||||||
|
Liabilities:
|
|||||||||||||
|
Non-recourse
securitization financing
|
516,578
|
556,610
|
1,177,280
|
1,236,899
|
|||||||||
|
Repurchase
agreements
|
133,315
|
133,315
|
70,468
|
70,468
|
|||||||||
Estimates
of fair value for securitized finance receivables are determined by calculating
the present value of the projected cash flows of the instruments, using discount
rates, prepayment rate assumptions and credit loss assumptions based on
historical experience and estimated future activity, and using discount rates
commensurate with those Dynex believes would be used by third parties.
Prepayment rate 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 loss assumptions
utilized vary for each series of securitized finance receivables, depending
on
the collateral pledged. Estimates of fair value for other investments are
determined by calculating the present value of the projected net cash flows,
inclusive of the estimated cost to service these investments. Estimates of
fair
value for securities are based principally on market prices provided by certain
dealers. Fair value for securitization financing is determined based on
estimated current market rates for similar instruments.
NOTE
11 - DERIVATIVE FINANCIAL INSTRUMENTS
In
June
2002, the Company entered into an interest rate swap to mitigate its interest
rate risk exposure on $100,000 in notional value of its variable rate
non-recourse securitization financing, which finance a like amount of fixed
rate
assets. Under the agreement, the Company paid interest at a fixed rate of
3.73%
on the notional amount and received interest based on one month LIBOR on
the
same amount. This contract had been treated 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. Amounts in accumulated
other comprehensive income are reclassified into earnings in the same period
during which the hedged transaction affects earnings. During 2005, the swap
matured, and the Company recognized the remaining $493 in other comprehensive
loss on this hedge instrument. At December 31, 2005 and 2004,
the
aggregate accumulated other comprehensive loss on this hedge instrument was
none
and $493, respectively.
In
October 2002, the Company entered into a synthetic three-year amortizing
interest-rate swap (using Eurodollar Futures contracts) with an initial notional
balance of approximately $81,000 to mitigate its exposure to rising interest
rates on a portion of its variable rate non-recourse securitization financing,
which finance a like amount of fixed rate assets. This contract was 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. Amounts in accumulated other comprehensive income are
reclassified into earnings in the same period during which the hedged
transaction affects earnings. During 2004, the Company determined that this
hedge
F
-
19
instrument
ceased to be effective due to a significant deterioration in the correlation
between the synthetic interest rate swap cash flow hedge and the financing
being
hedged, as measured by the correlation between the three-month Eurodollar
futures and one-month LIBOR. Accordingly, the Company discontinued hedge
accounting in 2004 and reflected subsequent changes in the market value of
the
hedge instrument in its statement of operations as other income (expense).
The
unrealized loss included in other comprehensive income at the time the Company
discontinued hedge accounting in 2004 was amortized over the remaining term
of
the hedge exposure. During 2005, the Company matched out of the position
and
recognized $116 in other comprehensive loss. At December 31, 2005 and 2004,
the
aggregate accumulated other comprehensive loss on this hedge instrument was
none
and $116, respectively.
NOTE
12 - INCOME (LOSS) PER SHARE
The
following table reconciles the numerator and denominator for both the basic
and
diluted EPS for the years ended December 31, 2005, 2004, and 2003.
|
2005
|
2004
|
2003
|
|||||||||||||||||
|
Income
(loss)
|
|
Weighted-Average
Number of Shares
|
|
Income
(loss)
|
|
Weighted-Average
Number of Shares
|
|
Income
(loss)
|
|
Weighted-Average
Number of Shares
|
|||||||||
|
Net
income (loss)
|
$
|
9,585
|
$
|
(3,375
|
)
|
$
|
(21,107
|
)
|
|||||||||||
|
Preferred
stock (charge) benefit
|
|
(5,347
|
)
|
|
(1,819
|
)
|
|
6,847
|
|||||||||||
|
Net
income (loss) available to common shareholders
|
$
|
4,238
|
$
|
12,163,062
|
$
|
(5,194
|
)
|
$
|
11,272,259
|
$
|
(14,260
|
)
|
$
|
10,873,903
|
|||||
|
Net
loss per share:
|
|||||||||||||||||||
|
Basic
and diluted EPS
|
$
|
0.35
|
$
|
(0.46
|
)
|
$
|
(1.31
|
)
|
|||||||||||
|
Dividends
and potentially anti-dilutive common shares assuming
conversion
of
preferred stock:
|
Shares
|
|
|
|
|
|
Shares
|
|
|
|
|
|
Shares
|
||||||
|
Series
A
|
$
|
–
|
–
|
$
|
337
|
$
|
94,403
|
$
|
1,252
|
$
|
287,083
|
||||||||
|
Series
B
|
–
|
–
|
|
537
|
|
131,621
|
|
1,745
|
|
399,903
|
|||||||||
|
Series
C
|
–
|
–
|
|
666
|
|
130,990
|
|
2,170
|
|
398,912
|
|||||||||
|
Series
D
|
|
5,347
|
|
5,628,737
|
|
3,936
|
|
3,491,047
|
–
|
–
|
|||||||||
|
Expense
and incremental shares of stock appreciation rights
|
–
|
|
64
|
–
|
|
21,045
|
–
|
|
20,164
|
||||||||||
|
$
|
5,347
|
$
|
5,628,801
|
$
|
5,476
|
$
|
3,869,106
|
$
|
5,476
|
$
|
1,106,062
|
||||||||
NOTE
13 - PREFERRED AND COMMON STOCK
The
following table presents a summary of Dynex’s issued and outstanding preferred
stock:
|
Issue
Price
|
Dividends
Paid Per Share
|
|||||||||||
|
Cumulative
Convertible Preferred Stock
|
Per
share
|
2005
|
2004
|
2003
|
||||||||
|
Series
A 9.75% (“Series A”)
|
$
|
24.00
|
$
|
-
|
$
|
-
|
$
|
0.8775
|
||||
|
Series
B 9.55% (“Series B”)
|
$
|
24.50
|
$
|
-
|
$
|
-
|
$
|
0.8775
|
||||
|
Series
C 9.73% (“Series C”)
|
$
|
30.00
|
$
|
-
|
$
|
-
|
$
|
1.0950
|
||||
|
Series
D 9.50% (“Series D”)
|
$
|
10.00
|
$
|
0.9500
|
$
|
0.6993
|
$
|
-
|
||||
In
2004,
the Company completed a recapitalization plan whereby the Company converted
the
Series A, Series B, and Series C preferred stock into a new Series D preferred
stock and common stock. As part of the recapitalization plan, the Company
also
exchanged 9.50% Senior Notes due 2007 for Series A, Series B and Series C
preferred stock. The remaining shares of Series A, Series B and Series C
preferred stock were converted into 5,628,737 shares of Series D preferred
stock
and 1,288,488 shares of common stock. The Series D preferred stock had an
issue
price of $10 per share and pays $0.95 per year in dividends. All prior
dividends-in-arrears on the Series A, Series B and Series C preferred stock
were
extinguished.
F
-
20
Dynex
is
authorized to issue up to 50,000,000 shares of preferred stock. For all series
issued, dividends are cumulative from the date of issue and are payable
quarterly in arrears. The dividends are equal, per share, to the greater
of
(i) the per quarter base rate of $0.2375 for Series D, or (ii) the
quarterly dividend declared on Dynex’s common stock. One share of Series D
preferred stock is convertible at any time at the option of the holder into
one
share of common stock. The series is redeemable by Dynex at any time, in
whole
or in part, (i) at a rate of one share of preferred stock for one share of
common stock, plus accrued and unpaid dividends, provided that for 20 trading
days within any period of 30 consecutive trading days, the closing price
of the
common stock equals or exceeds the issue price, or (ii) for cash at the
issue price, plus any accrued and unpaid dividends.
In
the
event of liquidation, the holders of this series of preferred stock will
be
entitled to receive out of the assets of Dynex, prior to any such distribution
to the common shareholders, the issue price per share in cash, plus any accrued
and unpaid dividends. For purposes of determining net income (loss) to common
shareholders used in the calculation of earnings (loss) per share, preferred
stock charge includes the current period dividend accrual amount for the
Preferred Stock outstanding for the years ended December 31, 2005, 2004 and
2003
of $5,347, $3,936, and $5,167, respectively. As of December 31, 2005, 2004,
and
2003, the total amount of dividends-in-arrears was none, none, and $18,466,
respectively. If Dynex fails to pay dividends for two quarterly dividend
periods
or if Dynex fails to maintain consolidated shareholders’ equity of at least 200%
of the aggregate issue price of the Series D preferred stock, then these
shares
automatically convert into a new series of 9.50% senior notes.
The
following table presents the changes in the number of preferred and common
shares outstanding:
|
Preferred
Shares
|
Common
|
|||||||||||||||||
|
Series
A
|
Series
B
|
Series
C
|
Series
D
|
Total
|
Shares
|
|||||||||||||
|
January
1, 2003
|
992,038
|
1,378,707
|
1,383,532
|
-
|
3,754,277
|
10,873,903
|
||||||||||||
|
Tender
offer
|
(498,443
|
)
|
(690,518
|
)
|
(698,639
|
)
|
-
|
(1,887,600
|
)
|
-
|
||||||||
|
December
31, 2003
|
493,595
|
688,189
|
684,893
|
-
|
1,866,677
|
10,873,903
|
||||||||||||
|
Recapitalization
|
(493,595
|
)
|
(688,189
|
)
|
(684,893
|
)
|
5,628,737
|
3,762,060
|
1,288,488
|
|||||||||
|
December
31, 2004
|
-
|
-
|
-
|
5,628,737
|
5,628,737
|
12,162,391
|
||||||||||||
|
Grant
|
-
|
-
|
-
|
-
|
-
|
1,000
|
||||||||||||
|
December
31, 2005
|
-
|
-
|
-
|
5,628,737
|
5,628,737
|
12,163,391
|
||||||||||||
On
January 9, 2006, the Company paid approximately $14,105 to redeem 1,407,198
shares of its Series D Preferred Stock. After the redemption, there were
4,221,539 shares of Series D Preferred Stock outstanding. The Company also
announced a common stock repurchase program under which it may repurchase
up to
one million shares of its common stock.
NOTE
14 - IMPAIRMENT CHARGES
Impairment
charges for 2005, 2004, and 2003 are summarized below. Impairment charges
include other-than-temporary impairment of debt securities arising from credit
losses on securities backed by manufactured housing loans, declining valuations
on delinquent property tax receivable securities, and valuation adjustments
for
related real estate owned. These impairments arose from revised projections
of
collections on the delinquent property tax receivable portfolio, as discussed
in
Note 5, and lower expected recoveries on real estate owned.
|
2005
|
2004
|
2003
|
|||||||
|
Debt
securities, manufactured housing
|
$
|
-
|
$
|
9,072
|
$
|
5,494
|
|||
|
Debt
securities, delinquent property tax receivables
|
1,673
|
4,891
|
10,364
|
||||||
|
Other
|
801
|
793
|
497
|
||||||
|
Total
impairments
|
$
|
2,474
|
$
|
14,756
|
$
|
16,355
|
|||
F
-
21
NOTE
15 - EMPLOYEE BENEFITS
Stock
Incentive Plan
Pursuant
to Dynex’s 2004 Stock Incentive Plan, as approved by the shareholders at Dynex’s
2005 annual shareholders’ meeting (the “Stock Incentive Plan”), Dynex may grant
to eligible officers, directors and employees stock options, stock appreciation
rights (“SARs”) and restricted stock awards. An aggregate of 1,500,000 shares of
common stock is available for distribution pursuant to the Employee Incentive
Plan. Dynex may also grant dividend equivalent rights (“DERs”) in connection
with the grant of options or SARs.
On
January 2, 2005, Dynex granted 126,297 stock appreciation rights (SAR) to
certain of its employees and officers under the Stock Incentive Plan. The
SARs
vest over the next four years in equal annual installments, expire on December
31, 2011 and have an exercise price of $7.81 per share, which was the market
price of the stock on the grant date.
On
June
17, 2005, Dynex granted options to acquire an aggregate of 40,000 shares
of
common stock to the members of its Board of Directors under the Stock Incentive
Plan. The options have an exercise price of $8.46 per share, which represents
110% of the closing stock price on the grant date, expire on June 17, 2010
and
were fully vested when granted.
Dynex
incurred expense of none, $13 and $38 for SARs and options related to the
Stock
Incentive Plan during 2005, 2004 and 2003, respectively.
The
following table presents a summary of the SAR activity for the Stock Incentive
Plan:
|
Year
ended December 31,
|
|||||||||||||||||||
|
2005
|
2004
|
2003
|
|||||||||||||||||
|
Number
Of
Shares
|
Weighted-
Average
Exercise
Price
|
Number
Of
Shares
|
Weighted-
Average
Exercise
Price
|
Number
Of
Shares
|
Weighted-
Average
Exercise
Price
|
||||||||||||||
|
SARs
outstanding at beginning of year
|
-
|
$
|
-
|
30,000
|
$
|
2.00
|
30,000
|
$
|
2.00
|
||||||||||
|
SARs
granted
|
126,297
|
7.81
|
-
|
-
|
-
|
-
|
|||||||||||||
|
SARs
forfeited or redeemed
|
-
|
-
|
-
|
-
|
-
|
-
|
|||||||||||||
|
SARs
exercised
|
-
|
-
|
30,000
|
2.00
|
-
|
-
|
|||||||||||||
|
SARs
outstanding at end of year
|
126,297
|
7.81
|
-
|
-
|
30,000
|
2.00
|
|||||||||||||
|
SARs
vested and exercisable
|
31,574
|
$
|
7.81
|
-
|
$
|
-
|
30,000
|
$
|
2.00
|
||||||||||
The
following table presents a summary of the option activity for the Stock
Incentive Plan:
|
Year
ended December 31,
|
|||||||||||||||||||
|
2005
|
2004
|
2003
|
|||||||||||||||||
|
Number
Of
Shares
|
Weighted-
Average
Exercise
Price
|
Number
Of
Shares
|
Weighted-
Average
Exercise
Price
|
Number
Of
Shares
|
Weighted-
Average
Exercise
Price
|
||||||||||||||
|
Options
outstanding at beginning of year
|
-
|
$
|
-
|
-
|
-
|
-
|
-
|
||||||||||||
|
Options
granted
|
40,000
|
8.46
|
-
|
-
|
-
|
-
|
|||||||||||||
|
Options
forfeited or redeemed
|
-
|
-
|
-
|
-
|
-
|
-
|
|||||||||||||
|
Options
exercised
|
-
|
-
|
-
|
-
|
-
|
-
|
|||||||||||||
|
Options
outstanding at end of year
|
40,000
|
8.46
|
-
|
-
|
-
|
-
|
|||||||||||||
|
Options
vested and exercisable
|
40,000
|
$
|
8.46
|
-
|
-
|
-
|
-
|
||||||||||||
F
-
22
Employee
Savings Plan
Dynex
provides an Employee Savings Plan under Section 401(k) of the Internal Revenue
Code. The Employee Savings Plan allows eligible employees to defer up to
25% of
their income on a pretax basis. Dynex matches the employees’ contribution, up to
6% of the employees’ eligible compensation. Dynex may also make discretionary
contributions based on the profitability of Dynex. The total expense related
to
Dynex’s matching and discretionary contributions in 2005, 2004, and 2003 was
$94, $122 and $136, respectively. Dynex does not provide post employment
or post
retirement benefits to its employees.
401(k)
Overflow Plan
During
1997, Dynex adopted a non-qualifying overflow plan which covers employees
who
have contributed to the Employee Savings Plan the maximum amount allowed
under
the Internal Revenue Code. The excess contributions are made to the overflow
plan on an after-tax basis. However, Dynex partially reimburses employees
for
the effect of the contributions being made on an after-tax basis. Dynex matches
the employee’s contribution up to 6% of the employee’s eligible compensation.
There was no reimbursement expense in 2005, 2004 or 2003.
NOTE
16 - COMMITMENTS AND CONTINGENCIES
Dynex
makes various representations and warranties relating to the sale or
securitization of loans. To the extent Dynex were to breach any of these
representations or warranties, and such breach could not be cured within
the
allowable time period, Dynex would be required to repurchase such loans,
and
could incur losses. In the opinion of management, no material losses are
expected to result from any such representations and warranties and, therefore,
have not been accrued for as a liability.
As
of
December 31, 2005, Dynex is obligated under non-cancelable operating leases
with
expiration dates through 2008. Rent and lease expense under those leases
was
$186, $473, and $489, respectively in 2005, 2004,
and
2003.
The
future minimum lease payments under these non-cancelable leases are as follows:
|
Years
Ending December 31,
|
||||
|
2006
|
$
|
146
|
||
|
2007
|
149
|
|||
|
2008
|
63
|
|||
|
2009
|
-
|
|||
|
2010
and thereafter
|
-
|
|||
|
Total
|
$
|
358
|
||
NOTE
17 - LITIGATION
The
Company and its subsidiaries may be involved in certain litigation matters
arising in the ordinary course of business. Although the ultimate outcome
of
these matters cannot be ascertained at this time, and the results of legal
proceedings cannot be predicted with certainty, the Company believes, based
on
current knowledge, that the resolution of these matters will not have a material
adverse effect on its financial position or results of operations. Information
on litigation arising out of the ordinary course of business is described
below.
Dynex
Capital, Inc. , and one of our subsidiaries, GLS Capital, Inc. (“GLS”), together
with the County of Allegheny, Pennsylvania (“Allegheny County”), are defendants
in a lawsuit in the Court of Common Pleas, in Allegheny County, Pennsylvania.
Plaintiffs are two local businesses seeking status to represent as a class,
delinquent taxpayers in Allegheny County whose delinquent tax liens had been
purchased by, and subsequently assigned to, GLS. This lawsuit relates to
the
purchase by GLS of delinquent property tax receivables from Allegheny County
in
1997, 1998, and 1999, and subsequent collection of certain amounts related
to
the property tax receivables purchased. The suit was initially filed in 1997,
and challenges GLS’ right to charge certain
attorney fees, costs and
F
-
23
expenses,
and interest in the collection of delinquent property tax receivables owned
by
GLS. During 2005, the Court held hearings in this matter, and has not yet
ruled
on whether it will grant class action status in the litigation. Plaintiffs
have not enumerated its damages in this matter. GLS believes the claims
are without merit and intends to vigorously defend itself in this matter.
The
Company believes that the ultimate outcome of this litigation will not have
a
material impact on its financial condition, but may have a material impact
on
reported results for the particular period presented.
Dynex
Capital, Inc. and Dynex Commercial, Inc. (“DCI”), formerly an affiliate and now
known as DCI Commercial, Inc., are appellees (or “respondents”) in the Court of
Appeals for the Fifth Judicial District of Texas at Dallas, related to the
matter of Basic Capital Management et al (collectively, “BCM” or “the
Plaintiffs”) versus Dynex Commercial, Inc. et al. The appeal seeks to
overturn a judgment in favor of the Company and DCI which denied recovery
to
Plaintiffs, as discussed further below, and to have a judgment entered in
favor
of Plaintiffs based on a jury award for damages against the Company of $0.3
million, and against DCI for $2.2 million or $25.6 million, all of which
was set
aside by the trial court. In the alternative, Plaintiffs are seeking a new
trial. The appeal relates to a suit filed against us and DCI in 1999, alleging,
among
other things, that DCI and we failed to fund tenant improvement or other
advances allegedly required on various loans made by DCI to BCM, which loans
were subsequently acquired by Dynex; that DCI breached an alleged $160 million
“master” loan commitment entered into in February 1998; and that DCI breached
another alleged loan commitment of approximately $9 million. The original
trial
commenced in January 2004, and, in February 2004, the jury in the case rendered
a verdict in favor of one of the Plaintiffs and against the Company on the
alleged breach of the loan agreements for tenant improvements and awarded
that
Plaintiff damages in the amount of $0.25 million. The jury entered a separate
verdict against DCI in favor of BCM under two mutually exclusive damage models,
for $2.2 million and $25.6 million, respectively. The jury found in favor
of DCI
on the alleged $9 million loan commitment, but did not find in favor of DCI
for
counterclaims made against BCM. The jury also awarded the Plaintiffs attorneys’
fees in the amount of $2.1 million. After considering post-trial motions,
the
presiding judge entered judgment in favor of the Company and DCI, effectively
overturning the verdicts of the jury and dismissing damages awarded by the
jury.
DCI is a former affiliate of the Company, and the Company believes that it
will
have no obligation for amounts, if any, awarded to the Plaintiffs as a result
of
the actions of DCI. The
Court
of Appeals has scheduled an oral argument on the matter for April 18, 2006.
On
February 11, 2005, a putative class action complaint alleging violations
of the
federal securities laws and various state common law claims was filed against
Dynex Capital, Inc., our subsidiary MERIT Securities Corporation, Stephen
J.
Benedetti, the Company's Executive Vice President, and Thomas H. Potts, the
Company's former President and a former Director, in United States District
Court for the Southern District of New York (“District Court”) by the Teamsters
Local 445 Freight Division Pension Fund ("Teamsters"). The lawsuit
purported to be a class action on behalf of purchasers of MERIT Series 13
securitization financing bonds, which are collateralized by manufactured
housing
loans. On May 31, 2005, the Teamsters filed an amended class action
complaint. The amended complaint dropped all state common law claims but
added federal securities claims related to the MERIT Series 12 securitization
financing bonds. In February 2006, based on a motion to dismiss filed by
the Company, the District Court dismissed Messrs. Benedetti and Potts from
the
suit, but did not dismiss the claims against us or MERIT. The Company has
evaluated the allegations and believes them to be without merit and intends
to
vigorously defend itself against them.
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 its consolidated balance sheet but could materially
affect
its consolidated results of operations in a given year.
NOTE
18 - SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
INFORMATION
|
Years
ended December 31,
|
||||||||||
|
2005
|
2004
|
2003
|
||||||||
|
Cash
paid for interest
|
$
|
61,824
|
$
|
96,473
|
$
|
107,737
|
||||
|
Supplemental
disclosure of non-cash activities:
|
||||||||||
|
9.75%
senior unsecured notes due April 2007 issued in connection with
recapitalization plan
|
-
|
823
|
-
|
|||||||
|
9.50%
senior unsecured notes due February 2005 issued in connection with
Preferred Stock tender offer
|
-
|
-
|
32,079
|
NOTE
19 - RELATED PARTY TRANSACTIONS
Dynex
and
Dynex Commercial, Inc., now known as DCI Commercial, Inc (“DCI”) have been
jointly named in litigation regarding the activities of DCI while it was
an
operating subsidiary of an affiliate of Dynex. Dynex and DCI entered into
a
Litigation Cost Sharing Agreement whereby the parties set forth how the costs
of
defending against litigation would be shared, and whereby Dynex agreed to
fund
all costs of such litigation, including DCI’s portion. DCI’s cumulative portion
of costs associated with litigation and funded by Dynex is $3,276 and is
secured
by the proceeds of any counterclaims that DCI may receive in the litigation.
DCI
costs funded by Dynex are considered loans, and bear simple interest at the
rate
of Prime plus 8.0% per annum. At December 31, 2005, the total amount due
Dynex
under the Litigation Cost Sharing Agreement, including interest, was $4,624,
which has been fully reserved by Dynex. DCI is currently wholly owned by
ICD
Holding, Inc. An executive of Dynex is the sole shareholder of ICD Holding.
NOTE
20 - NON-CONSOLIDATED AFFILIATES
The
following tables summarize the financial condition and result of operations
of
all entities for which Dynex accounts for by use of the equity
method.
|
Condensed
Statement of Operations
|
||||||||||
|
2005
|
2004
|
2003
|
||||||||
|
Total
revenues
|
$
|
2,538
|
$
|
2,537
|
$
|
2,537
|
||||
|
Total
expenses
|
1,729
|
1,831
|
1,948
|
|||||||
|
Net
income
|
809
|
706
|
589
|
|||||||
|
Condensed
Balance Sheet
|
|||||||
|
2005
|
2004
|
||||||
|
Total
assets
|
$
|
16,103
|
$
|
16,587
|
|||
|
Total
expenses
|
12,240
|
13,533
|
|||||
|
Total
equity
|
3,863
|
3,054
|
|||||
Dynex
has
a 99% limited partnership interest in a partnership that owns a commercial
office building located in St. Paul, Minnesota. The building is leased pursuant
to a triple-net master lease to a single-tenant and the second mortgage lender
has a bargain purchase option to purchase the building in 2007. Rental income
derived from the master lease for the term of the lease exactly covers the
operating cash requirements on the building, including the payment of debt
service. Dynex accounts for the partnership using the cost method. The
partnership had net income of $809, $706 and $589 for the years ended December
31, 2005, 2004
and
2003,
respectively. Due to the bargain purchase option, any increase in basis of
the
investment due to the accrual of its share of earnings of the partnership
is
immediately reduced by a charge of a like amount to the same account, given
the
probability of exercise of the option by the second mortgage lender. Dynex’s
investment in this partnership amounted to $11 at December 31, 2005,
2004
and
2003.
Dynex
owns a 1% limited partnership interest in a partnership that owns a low income
housing tax credit multifamily housing property located in Texas. In May
2001,
Dynex sold a 98% limited partnership interest in a partnership to a former
director for a purchase price of $198, which was equal to its estimated fair
value. By reason of the former director’s investment in the partnership, Dynex
has guaranteed to the director the use of the low-income housing tax credits
associated with the property, proportionate to his investment, that are reported
annually to the Internal Revenue Service. During 2005, Dynex loaned the
partnership $107. These advances bear interest at
F
-
24
a
rate of
7.50% and are due on demand. Dynex, through a subsidiary has made a first
mortgage loan to the partnership secured by the property, with a current
unpaid
principal balance of $1,717. As Dynex does not have control or exercise
significant influence over the operations of this partnership, its investment
and total advances of $355 at December 31, 2005 are accounted for using the
cost
method.
NOTE
21 - SUMMARY OF FOURTH QUARTER RESULTS (UNAUDITED)
The
following table summarizes selected information for the quarter ended December
31, 2005:
|
Fourth
Quarter, 2005
|
||||
|
Operating
results:
|
||||
|
Net
interest income
|
$
|
2,086
|
||
|
Provisions
for losses
|
(1,233
|
)
|
||
|
Net
interest income after provision for losses
|
853
|
|||
|
Impairment
charges
|
(1,300
|
)
|
||
|
Loss
on sale of investments
|
(193
|
)
|
||
|
Net
income
|
955
|
|||
|
Net
loss to common shareholders
|
(382
|
)
|
||
|
Basic
and diluted loss per common share
|
$
|
(0.03
|
)
|
|
During
the three-months ended December 31, 2005, Dynex recognized a loss of $213
associated with the sale of equity securities owned by Dynex. Dynex recognized
impairment charges of $215 on its investment in the limited partnership interest
discussed in Note 20.
F
-
25
EXHIBIT
INDEX
|
Number
|
Exhibit
|
|
21.1
|
List
of consolidated entities of Dynex (filed herewith)
|
|
23.1
|
Consent
of BDO Seidman, LLP (filed herewith)
|
|
23.2
|
Consent
of Deloitte & Touche, LLP (filed herewith)
|
|
31.1
|
Certification
of Principal Executive Officer and Principal Financial Officer
pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
|
|
32.1
|
Certification
of Principal Executive Officer and Chief Financial Officer pursuant
to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
|