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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-Q

     |X|     Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
             Exchange Act of 1934

                    For the quarter ended September 30, 2001

     |_|     Transition Report Pursuant to Section 13 or 15(d) of the Securities
             Exchange Act of 1934

                          Commission file number 1-9819




                               DYNEX CAPITAL, INC.
             (Exact name of registrant as specified in its charter)




           Virginia                                           52-1549373
(State or other jurisdiction of                            (I.R.S. Employer
 incorporation or organization)                           Identification No.)

4551 Cox Road, Suite 300, Glen Allen, Virginia                    23060
   (Address of principal executive offices)                    (Zip Code)

                                 (804) 217-5800
              (Registrant's telephone number, including area code)


     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past ninety days. |_| Yes |X| No

     On  October 31, 2001,  the registrant had 11,446,031 shares of common stock
of $.01 value outstanding, which is the registrant's only class of common stock.

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                               DYNEX CAPITAL, INC.
                                    FORM 10-Q

                                      INDEX

                                                                            Page

PART I.  FINANCIAL INFORMATION

      Item 1.  Financial Statements

               Consolidated Balance Sheets at September 30, 2001
               (unaudited) and December 31, 2000                              1

               Consolidated Statements of Operations for the three and
               nine months ended September 30, 2001 and 2000 (unaudited)      2

               Consolidated Statements of Cash Flows for the nine months
               ended September 30, 2001 and 2000 (unaudited)                  3

               Notes to Unaudited Consolidated Financial Statements           4

     Item 2.  Management's Discussion and Analysis of
              Financial Condition and Results of Operations                  14

     Item 3.  Quantitative and Qualitative Disclosures about Market Risk     26


PART II.  OTHER INFORMATION

     Item 1.  Legal Proceedings                                              28

     Item 2.  Changes in Securities and Use of Proceeds                      29

     Item 3.  Defaults Upon Senior Securities                                29

     Item 4.  Submission of Matters to a Vote of Security Holders            29

     Item 5.  Other Information                                              29

     Item 6.  Exhibits and Reports on Form 8-K                               29


SIGNATURES                                                                   31

PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements
DYNEX CAPITAL, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands except share data)



                                                                               (Unaudited)
                                                                              September 30,           December 31,
  ASSETS                                                                          2001                    2000
                                                                            -------------------    ------------------

  Investments:
    Collateral for collateralized bonds                                      $      2,558,555       $     3,042,158
    Securities                                                                          5,163                 9,364
    Other investments                                                                  34,143                42,284
    Loans held for sale                                                                 2,891                19,102
                                                                            -------------------    ------------------
                                                                                    2,600,752             3,112,908

  Cash, including restricted                                                           18,071                26,773
  Accrued interest receivable                                                              25                   323
  Other assets                                                                         14,802                19,592
                                                                            -------------------    ------------------
         Total Assets                                                        $      2,633,650       $     3,159,596
                                                                            ===================    ==================

  LIABILITIES AND SHAREHOLDERS' EQUITY

  LIABILITIES
  Non-recourse debt                                                          $      2,384,670       $     2,856,728
  Recourse debt                                                                        64,964               134,168
                                                                            -------------------    ------------------
                                                                                    2,449,634             2,990,896

  Accrued interest payable                                                                958                 3,775
  Accrued expenses and other liabilities                                                1,716                 7,794
                                                                            -------------------    ------------------
         Total Liabilities                                                          2,452,308             3,002,465
                                                                            -------------------    ------------------

  SHAREHOLDERS' EQUITY
  Preferred stock, par value $.01 per share, 50,000,000 shares authorized:
        9.75% Cumulative Convertible Series A,
          1,106,971 and 1,309,061 issued and outstanding, respectively
                                                                                                         
       ($31,748 and $36,012 aggregate liquidation preference, respectively)            25,284                29,900

        9.55% Cumulative Convertible Series B,
          1,548,726 and 1,912,434 issued and outstanding, respectively
       ($45,192 and $53,567 aggregate liquidation preference, respectively)            36,254                44,767
        9.73% Cumulative Convertible Series C,
          1,585,197 and 1,840,000 issued and outstanding, respectively
       ($56,813 and $63,259 aggregate liquidation preference, respectively)            45,437                52,740
  Common stock, par value $.01 per share,
    100,000,000 shares authorized,
    11,446,206 issued and outstanding                                                     114                   114
  Additional paid-in capital                                                          361,469               351,999
  Accumulated other comprehensive loss                                               (94,738)             (124,589)
  Accumulated deficit                                                               (192,478)             (197,800)
                                                                            -------------------    ------------------
         Total Shareholders' Equity                                                   181,342               157,131
                                                                            -------------------    ------------------

         Total Liabilities and Shareholders' Equity                          $      2,633,350       $     3,159,596
                                                                            ===================    ==================

See notes to unaudited consolidated financial statements.

DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS, UNAUDITED
(amounts in thousands except share data)



                                                                      Three Months Ended                 Nine Months Ended
                                                                        September 30,                      September 30,
                                                                -------------------------------    -------------------------------
                                                                    2001              2000             2001              2000
                                                                -------------     -------------    -------------     -------------

Interest income:
   Collateral for collateralized bonds                          $     50,767      $    68,300       $  168,358       $   209,923
   Securities                                                            157              301              831             3,303
   Other investments                                                   1,373            1,180            4,767             4,216
   Loans held for sale or securitization                                  98              704              431            10,570
                                                                -------------     -------------    -------------     -------------
                                                                      52,395           70,485          174,387           225,012
                                                                -------------     -------------    -------------     -------------

Interest and related expense:
   Non-recourse debt                                                  39,192           59,881          132,863           176,577
   Recourse debt                                                       1,316            3,492            5,739            18,785
   Other                                                                  62              590              531             4,417
                                                                -------------     -------------    -------------     -------------
                                                                      40,570           63,963          139,133           199,779
                                                                -------------     -------------    -------------     -------------

Net interest margin before provision for losses                       11,825            6,522           35,254            25,233
Provision for losses                                                 (14,247)          (5,270)         (27,424)          (16,101)
                                                                   ----------     -------------    -------------     -------------
Net interest margin                                                   (2,422)           1,252            7,830             9,132

Net (loss) gain on sales, write-downs,
    impairment charges, and litigation                                  (650)            (557)           6,893           (85,467)
Trading losses                                                        (1,161)              --           (2,881)               --
Other income                                                              59               42               39             2,619
                                                                  -----------     -------------    -------------     -------------
                                                                      (4,174)             737           11,881           (73,716)

General and administrative expenses                                   (2,299)          (1,573)          (6,777)           (6,519)
                                                                  -----------     -------------    -------------     -------------
(Loss) income before extraordinary item                               (6,473)            (836)           5,104           (80,235)

                                                                                                                
Extraordinary item  - (loss)/gain on extinguishment of debt           (1,010)              --            1,835                --
                                                                   ----------     -------------    -------------     -------------
Net (loss) income                                                     (7,483)            (836)           6,939           (80,235)
Preferred stock (charges) benefit                                     (1,097)          (3,227)           6,053            (9,683)
                                                                  -----------     -------------    -------------     -------------
Net (loss) income to common shareholders                          $   (8,580)     $    (4,063)     $    12,992       $   (89,918)
                                                                  ===========     =============    =============     =============

Net (loss) income per common share before extraordinary item:
   Basic                                                          $    (0.66)     $     (0.35)     $      0.97       $     (7.86)
                                                                  ===========     =============    =============     =============
   Diluted                                                        $    (0.66)     $     (0.35)     $      0.97       $     (7.86)
                                                                  ===========     =============    =============     =============
Net (loss) income per common share after extraordinary item:
   Basic                                                          $    (0.75)     $     (0.35)     $      1.14       $     (7.86)
                                                                  ===========     =============    =============     =============
   Diluted                                                        $    (0.75)     $     (0.35)     $      1.14       $     (7.86)
                                                                  ===========     =============    =============     =============
Weighted average number of common shares outstanding
   Basic and diluted                                              11,446,090       11,446,010       11,446,167        11,444,911
                                                                  ===========     =============    =============     =============


See notes to unaudited consolidated financial statements.

 DYNEX CAPITAL, INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS, UNAUDITED



                                                                                           Nine Months Ended
 (amounts in thousands)                                                                      September 30,
                                                                                ----------------------------------------
                                                                                    2001                   2000
                                                                              -------------------    ------------------
 Operating activities:
   Net income (loss)                                                          $                      $
                                                                                          6,939                (80,235)
   Adjustments to reconcile net income (loss) to net cash
      provided (used) by operating activities:
       Provision for losses                                                              27,424                 16,101
       Net (gain) loss on sales, write-downs, impairment
          charges and litigation                                                         (6,893)                85,467
       Equity in net earnings of Dynex Holding, Inc.                                          -                 (1,778)
       AutoBond related litigation settlement (payment)                                   7,111                (20,000)
       Extraordinary item  - net gain on extinguishment of debt                          (1,835)                     -
       Amortization and depreciation                                                      9,272                 12,836
       Net change in accrued interest, other assets and
          other liabilities                                                              (7,288)               (18,926)
                                                                              -------------------    ------------------
          Net cash provided (used) by operating activities                               34,730                 (6,535)
                                                                              -------------------    ------------------

 Investing activities:
   Collateral for collateralized bonds:
     Principal payments on collateral                                                   473,917                396,666
     Decrease in accrued interest receivable                                              2,786                  1,188
     Net (increase) decrease in funds held by trustee                                      (206)                   441
                                                                                                           
   Net decrease in loans held for sale or securitization                                 16,601                203,679
   Purchase of other investments                                                         (2,838)                (1,658)
   Payments received on other investments                                                 4,210                  3,111
   Proceeds from sales of other investments                                                 233                  4,468
   Decrease in restricted cash                                                           14,361                      -
   Payments received on securities                                                        1,873                 20,060
   Proceeds from sales of securities                                                      3,893                 20,111
    Payment on tax-exempt bond obligations                                                    -                (30,284)
   Investment in and net advances to Dynex Holding, Inc.                                      -                  5,414
   Proceeds from sale of loan production operations                                       9,500                  9,500
   Capital expenditures                                                                    (212)                   (81)
                                                                              -------------------    ------------------
        Net cash provided by investing activities                                       524,118                632,615
                                                                              -------------------    ------------------

 Financing activities:
   Collateralized bonds:
     Proceeds from issuance of bonds                                                    507,641                140,724
     Principal payments on bonds                                                       (979,959)              (398,998)
     Change in accrued interest payable                                                    (958)                 1,001
   Repayment of recourse debt borrowings, net                                           (67,334)              (394,554)
   Capital stock transactions                                                           (10,963)                     4
   Dividends paid                                                                        (1,614)                     -
                                                                              -------------------    ------------------
        Net cash used for financing activities                                         (553,187)              (651,823)
                                                                              -------------------    ------------------

 Net increase (decrease) in cash                                                          5,661                (25,743)
 Cash at beginning of period (unrestricted)                                               3,485                 54,433
                                                                              -------------------    ------------------
 Cash at end of period (unrestricted)                                         $           9,146      $          28,690
                                                                              ===================    ==================

 Cash paid for interest                                                       $         140,180      $         194,004
                                                                              ===================    ==================

Securities owned subsequently securitized                                     $               -      $          71,209
                                                                              ===================    ==================
Collateral on Collateralized Bonds acquired through litigation settlement     $               -      $          60,339
                                                                              ===================    ==================

See notes to unaudited consolidated financial statements.

DYNEX CAPITAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(amounts in thousands except share data)


NOTE 1 -- BASIS OF PRESENTATION

     The accompanying  consolidated  financial  statements have been prepared in
accordance  with the  instructions  to Form 10-Q and do not  include  all of the
information and notes required by generally accepted  accounting  principles for
complete financial statements. The consolidated financial statements include the
accounts of Dynex Capital,  Inc. and its qualified REIT subsidiaries  (together,
"Dynex REIT").  Certain of the Company's  operations were  previously  conducted
through Dynex Holding,  Inc. ("DHI"),  a taxable affiliate of Dynex REIT. During
2000, Dynex REIT owned all of the outstanding  non-voting preferred stock of DHI
representing a 99% economic  ownership  interest in DHI. The common stock of DHI
represented a 1% economic  ownership of DHI and was owned by certain officers of
Dynex REIT. For the nine months ended  September 30, 2000, DHI was accounted for
under an  accounting  method  similar to the equity  method.  In November  2000,
certain  subsidiaries  of DHI were sold to Dynex REIT, and on December 31, 2000,
DHI was liquidated in a taxable  transaction into Dynex REIT. As a result of the
liquidation,  substantially  all of the assets and  liabilities of DHI have been
transferred  to Dynex REIT as of December 31, 2000.  References to the "Company"
mean Dynex Capital, Inc., its consolidated subsidiaries, and, to the extent they
existed,  DHI and its consolidated  subsidiaries.  All significant  intercompany
balances and transactions with Dynex REIT's consolidated  subsidiaries have been
eliminated in consolidation of Dynex REIT.

     In the opinion of  management,  all  material  adjustments,  consisting  of
normal recurring  adjustments,  considered  necessary for a fair presentation of
the  consolidated  financial  statements  have been included.  The  Consolidated
Balance Sheet at September 30, 2001, the  Consolidated  Statements of Operations
for  the  three  and  nine  months  ended  September  30,  2001  and  2000,  the
Consolidated  Statements  of Cash Flows for the nine months ended  September 30,
2001  and 2000  and  related  notes to  consolidated  financial  statements  are
unaudited.  Operating  results for the nine months ended  September 30, 2001 are
not  necessarily  indicative  of the results  that may be expected  for the year
ending  December  31,  2001.  For  further  information,  refer  to the  audited
consolidated  financial  statements and footnotes included in the Company's Form
10-K for the year ended December 31, 2000.

Certain reclassifications have been made to the financial statements for 2000 to
conform to presentation for 2001.

     Risks and  Uncertainties  Since  early  1999,  the  Company has focused its
efforts on  conserving  its capital base and repaying its  outstanding  recourse
borrowings.  On  a  long-term  basis,  the  Company  believes  that  competitive
pressures,  including  competing  against larger  companies which generally have
significantly lower costs of capital and access to both short-term and long-term
financing  sources,  will generally keep specialty  finance companies like Dynex
from  earning an adequate  risk-adjusted  return on its  invested  capital.  The
Company's current business  operations are essentially limited to the management
of its  investment  portfolio  and the active  collection  of its  portfolio  of
delinquent  property  tax  receivables.   The  Company  currently  has  no  loan
origination  operations,  and for the  foreseeable  future  does not  intend  to
purchase loans or securities in the secondary market.  However, as a result of a
previously  existing  contractual  obligation,  the Company  acquired  $8,719 in
delinquent property tax receivables during September and October 2001.

     The  Board  of the  Company  initiated  a  process  in the  fall of 1999 to
evaluate  various  courses  of action to  improve  shareholder  value  given the
depressed  prices of the Company's  preferred and common stocks.  As a result of
this  evaluation,  the Company entered into a merger agreement in November 2000,
which was subsequently terminated in January 2001 by the Company due to breaches
by the other party. See Note 11 below. In addition,  in an effort to improve the
liquidity  of the  Company's  Series A, Series B, and Series C  Preferred  Stock
(together,  the "Preferred  Stock"),  on June 8, 2001,  the Company  completed a
tender offer on its Preferred Stock, resulting in the purchase by the Company of
820,601  shares of the Preferred  Stock,  and on September 6, 2001,  the Company
announced a second tender offer on the Preferred Stock for up to 815,320 shares.
This tender offer was completed on November 2, 2001 with the purchase of 486,517
shares of Preferred Stock.

     Since December 31, 2000, the Company has repaid $69,204 of on-balance sheet
recourse debt  outstanding,  and has satisfied  off-balance sheet liabilities of
$66,765.  While the Company's current business  prospects are limited,  based on
current projected cash flow estimates on its investment  portfolio and estimated
proceeds  on the call and  subsequent  sale or  resecuritization  of  investment
portfolio  assets,  the  Company  anticipates  that it will be able to repay its
remaining outstanding recourse debts in accordance with their respective terms.

     Cash - Restricted. At September 30, 2001 and December 31, 2000, cash in the
aggregate amount of approximately $8,928 and $23,288,  respectively, was held in
escrow  as  collateral   for  letters  of  credit,   collateral  for  repurchase
agreements, or to cover losses on securities not otherwise covered by insurance.


NOTE 2 -- 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 to
the extent that there are rights  outstanding,  using the treasury stock method,
but only if these items are dilutive.  As a result of the  two-for-one  split in
May 1997 and the one-for-four  reverse split in July 2000 of Dynex REIT's common
stock, the preferred stock is convertible into one share of common stock for two
shares of preferred stock.

     The following  table  reconciles the numerator and denominator for both the
basic and  diluted  net income per  common  share for the three and nine  months
ended September 30, 2001 and 2000.



                                                                        Three months ended                  Nine months ended
                                                                           September 30,                     September 30,
                                                                 -------------------------------    ------------------------------
                                                                      2001             2000              2001             2000
                                                                 --------------   --------------    -------------    -------------

                                                                                                                 
Income (loss) before extraordinary item                          $      (6,473)   $      (836)      $      5,104     $    (80,235)
Extraordinary item - net gain on extinguishment of debt                 (1,010)             -                  -            1,835
                                                                 --------------   --------------    -------------    -------------
Net income (loss)                                                       (7,483)          (836)             6,939          (80,235)
Preferred Stock benefits (charges)                                      (1,097)        (3,227)             6,053           (9,683)
                                                                 --------------   --------------    -------------    -------------

Basic and Diluted net income (loss) to common shareholders       $      (8,580)   $    (4,063)      $     12,992     $    (89,918)
                                                                 ==============   ==============    =============    =============

Weighted average common shares outstanding
 Basic                                                              11,446,090       11,446,010       11,446,167       11,444,911
 Diluted                                                            11,446,090       11,446,010       11,446,167       11,444,911

Basic net income (loss) per common share before
extraordinary item:
Basic                                                        $          (0.66)           (0.35)  $          0.97  $        (7.86)
                                                                 ==============   ==============    =============    =============
Diluted                                                      $          (0.66)           (0.35)  $          0.97  $        (7.86)
                                                                 ==============   ==============    =============    =============

Basic net income (loss) per common share after extraordinary item:
Basic                                                        $          (0.75)           (0.35)  $          1.14  $        (7.86)
                                                                 ==============   ==============    =============    =============
Diluted                                                      $          (0.75)           (0.35)  $          1.14  $        (7.86)$
                                                                 ==============   ==============    =============    =============

Additional shares of preferred stock
Series A 9.75% cumulative convertible                                  553,486          654,531          616,407          654,531
Series B 9.55% cumulative convertible                                  774,363          956,217          887,605          956,217
Series C 9.73% cumulative convertible                                  792,599          920,000          871,933          920,000
Incremental shares of stock appreciation rights                              -           24,462                -           24,462
                                                                 --------------   --------------    -------------    -------------
                                                                     2,120,448        2,555,372        2,375,945        2,555,372
                                                                 ==============   ==============    =============    =============



NOTE 3 -- COLLATERAL FOR COLLATERALIZED BONDS AND SECURITIES

     The following table  summarizes  Dynex REIT's amortized cost basis and fair
value of investments classified as available-for-sale,  as of September 30, 2001
and December 31, 2000, and the related average effective interest rates:




                                                    September 30, 2001                 December 31, 2000
-----------------------------------------------------------------------------------------------------------------
                                                                 Effective                          Effective
                                                 Fair Value    Interest Rate       Fair Value     Interest Rate
-------------------------------------------- ---------------- ----------------- ---------------- ----------------
                                                                                             
Collateral for collateralized bonds:
   Amortized cost                            $   2,678,534            7.7%      $   3,189,414           7.8%
   Allowance for losses                            (26,133)                           (25,314)
-----------------------------------------------------------------------------------------------------------------
     Amortized cost, net                         2,652,401                          3,164,100
   Gross unrealized gains                           35,108                             37,803
   Gross unrealized losses                        (128,954)                          (159,745)
-----------------------------------------------------------------------------------------------------------------
                                             $   2,558,555                      $   3,042,158
-----------------------------------------------------------------------------------------------------------------

Securities:
  Adjustable-rate mortgage securities                  673           13.1%              5,008          10.9%
  Fixed-rate mortgage securities                       551           10.6%              1,505           9.3%
  Derivative and residual securities                 4,886            9.1%              5,553           7.9%
-----------------------------------------------------------------------------------------------------------------
                                                     6,110                             12,066
  Allowance for losses                                 (55)                               (55)
-----------------------------------------------------------------------------------------------------------------
    Amortized cost, net                              6,055                             12,011
    Gross unrealized gains                           1,325                                411
    Gross unrealized losses                         (2,217)                            (3,058)
-----------------------------------------------------------------------------------------------------------------
                                             $       5,163                      $       9,364
-----------------------------------------------------------------------------------------------------------------


     Collateral for collateralized  bonds.  Collateral for collateralized  bonds
consists  primarily  of  securities  backed by  adjustable-rate  and  fixed-rate
mortgage loans secured by first liens on single family housing, fixed-rate loans
on multifamily and commercial  properties and manufactured  housing  installment
loans secured by either a UCC filing or a motor vehicle  title.  Collateral  for
collateralized  bonds also includes  delinquent  property tax  receivables.  All
collateral  for  collateralized  bonds is  pledged  to secure  repayment  of the
related collateralized bonds. All principal and interest (less servicing-related
fees) on the collateral is remitted to a trustee and is available for payment on
the  collateralized  bonds.  Dynex  REIT's  exposure to loss on  collateral  for
collateralized bonds is generally limited to the amount of collateral pledged to
the  collateralized  bonds in excess of the amount of the  collateralized  bonds
issued,  as the  collateralized  bonds  issued  by the  limited-purpose  finance
subsidiaries are non-recourse to Dynex REIT.

     Securities. Adjustable-rate mortgage ("ARM") securities consist of mortgage
certificates  secured by ARM loans.  Fixed-rate  mortgage  securities consist of
mortgage  certificates  secured  by  mortgage  loans  that have a fixed  rate of
interest  for at  least  one  year  from  the  balance  sheet  date.  Derivative
securities  are  classes  of   collateralized   bonds,   mortgage   pass-through
certificates or mortgage  certificates that pay to the holder  substantially all
interest (i.e.,  an  interest-only  security),  or  substantially  all principal
(i.e., a principal-only  security).  Residual  interests  represent the right to
receive  the excess of (i) the cash flow from the  collateral  pledged to secure
related  mortgage-backed  securities,  together  with  any  reinvestment  income
thereon,  over (ii) the amount  required for principal and interest  payments on
the  mortgage-backed  securities or repurchase  arrangements,  together with any
related administrative expenses.

     Sale of Securities.  Proceeds from sales of securities  totaled $20,111 for
the nine months ended September 30, 2000. Three securities have been sold during
the nine months ended September 30, 2001 for aggregate proceeds of $4,561 and an
aggregate  loss of $11.  See Note 9,  Net Gain  (Loss)  on  Sales,  Write-downs,
Impairment Charges and Litigation for further discussion.


NOTE 4 -- USE OF ESTIMATES

     Fair Value.  Dynex REIT uses estimates in  establishing  fair value for its
financial instruments.  Estimates of fair value for financial instruments may be
based on market prices provided by certain dealers.  Estimates of fair value for
certain other  financial  instruments  including  collateral for  collateralized
bonds,  are  determined by  calculating  the present value of the projected cash
flows of the instruments using appropriate discount rates,  prepayment rates and
credit loss assumptions. Discount rates used are those management believes would
be used by willing buyers of these  financial  instruments at prevailing  market
rates.  The  discount  rate  used  in the  determination  of fair  value  of the
collateral for collateralized  bonds at both September 30, 2001 and December 31,
2000 was 16%. Variations in market discount rates,  prepayments rates and credit
loss  assumptions  may  materially  impact  the  resulting  fair  values  of the
Company's financial instruments.  In addition to variations in such assumptions,
as  discussed  further  in Note 11,  due to an adverse  ruling  rendered  by the
Commonwealth  Court of  Pennsylvania  on July 5, 2001, the Company's  ability to
collect certain  amounts of interest,  fees and costs incurred on its delinquent
property tax receivables  pledged as collateral for collateralized  bonds may be
adversely impacted. The Company, based on consultation with counsel,  reasonably
believes that the Appellate Court's decision will ultimately be reversed or that
the ultimate  outcome of the litigation  will not result in a material impact on
the carrying value of the related delinquent property tax receivables.

     Estimates of fair value for other financial instruments are based primarily
on  management's  judgment.  Since  the fair  value of  Dynex  REIT's  financial
instruments is based on estimates, actual gains and losses recognized may differ
from those estimates recorded in the consolidated financial statements.


NOTE 5 -- RECOURSE DEBT

     Dynex REIT utilizes repurchase agreements, notes payable and secured credit
facilities  (together,  "recourse  debt") to finance certain of its investments.
The  following  table  summarizes  Dynex REIT's  recourse  debt  outstanding  at
September 30, 2001 and December 31, 2000:

                                        September 30, 2001     December 31, 2000
                                        ------------------     -----------------

  Repurchase agreements                 $      6,823           $    35,015
  Credit facility                                  -                 2,000
  Capital lease obligations                      292                   430
                                        ------------------     -----------------
                                               7,115                37,445

  7.875% July 2002 Senior Notes               57,969                97,250
  Net unamortized issuance costs                (120)                 (527)
--------------------------------------------------------------------------------
                                        $     64,964            $  134,168
--------------------------------------------------------------------------------

     At September  30, 2001 and December 31, 2000,  recourse  debt  consisted of
$6,823 and $35,015,  respectively,  of  repurchase  agreements  secured by cash,
investments  and retained  collateralized  bonds;  $0 and $2,000,  respectively,
outstanding under a revolving credit facility secured by other investments;  and
$292 and $430,  respectively,  of amounts outstanding under a capital lease. The
secured revolving credit facility was extinguished in January 2001. At September
30, 2001, all recourse debt in the form of repurchase agreements was with Lehman
Brothers, Inc., had overnight or "one-day" maturity, and bears interest at rates
indexed  to  LIBOR.  If Lehman  Brothers  fails to return  the  collateral,  the
ultimate realization of the security by Dynex REIT may be delayed or limited.

     As of September 30, 2001 and December 31, 2000,  Dynex REIT had $57,969 and
$97,250, respectively,  outstanding of its Senior Unsecured Notes issued in July
1997 and due July 15,  2002 (the  "July 2002  Notes").  On March 30,  2001,  the
Company  entered into an amendment to the related  indenture  governing the July
2002 Notes  whereby  the  Company  pledged to the Trustee of the July 2002 Notes
substantially  all of  the  Company's  unencumbered  assets  in  its  investment
portfolio and the stock of its  subsidiaries.  In  consideration of this pledge,
the indenture was further amended to provide for the release of the Company from
certain covenant  restrictions in the indenture,  and specifically  provided for
the Company's  ability to make  distributions  on its capital stock in an amount
not to exceed the sum of (i) $26,000,  (ii) the cash proceeds of any  "permitted
subordinated  indebtedness",  (iii) the cash  proceeds  of the  issuance  of any
"qualified capital stock", and (iv) any distributions  required in order for the
Company to maintain its REIT status.  In  addition,  the Company  entered into a
Purchase  Agreement  with holders of 50.1% of the July 2002 Notes which  require
the Company to purchase,  and such holders to sell,  their  respective July 2002
Notes at various  discounts  prior to  maturity  based on a  computation  of the
Company's  available cash.  Through  September 30, 2001, the Company has retired
$39,281of July 2002 Notes for $35,549 in cash under the Purchase Agreement.  The
discounts provided for under the Purchase Agreement are as follows: by April 15,
2001,  10%; by July 15, 2001,  8%; by October 15, 2001, 6%; by January 15, 2002,
4%; by March 1, 2002, 2%; thereafter until maturity, 0%.

     At  December  31,  2000,  Dynex  REIT had a  secured  non-revolving  credit
facility  under which $66,765 of letters of credit to support  tax-exempt  bonds
had been issued.  These letters of credit were released during the first quarter
of  2001,  as a result  of the  purchase,  sale or  transfer  of the  underlying
tax-exempt bonds, and the facility was extinguished.


NOTE 6 -- ADOPTION OF FINANCIAL ACCOUNTING STANDARDS

     Statement of Financial  Accounting  Standards ("FAS") No. 133,  "Accounting
for Derivative  Instruments and Hedging  Activities" is effective for all fiscal
years  beginning  after June 15,  2000.  FAS No. 133,  as  amended,  establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts,  and for hedging activities.
The Company  adopted FAS No. 133 effective  January 1, 2001. The adoption of FAS
No. 133 did not have a significant impact on the financial position,  results of
operations, or cash flows of the Company.

     In  September  2000,  the  Financial   Accounting  Standards  Board  issued
Statement of Financial  Accounting  Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and  Extinguishment of Liabilities"  ("FAS No.
140"). FAS No. 140 replaces the Statement of Financial  Accounting Standards No.
125  "Accounting  for the  Transfers  and  Servicing  of  Financial  Assets  and
Extinguishment  of  Liabilities"  ("FAS  No.  125").  FAS No.  140  revises  the
standards for accounting  for  securitization  and other  transfers of financial
assets and collateral and requires certain disclosure,  but it carries over most
of FAS No. 125 provisions without reconsideration.  FAS No. 140 is effective for
transfers and servicing of financial  assets and  extinguishment  of liabilities
occurring  after March 31, 2001.  FAS No. 140 is effective for  recognition  and
reclassification  of collateral and for disclosures  relating to  securitization
transactions  and  collateral  for fiscal years ending after  December 15, 2000.
Disclosures about  securitization  and collateral  accepted need not be reported
for  periods  ending  on or  before  December  15,  2000,  for  which  financial
statements are presented for comparative purposes.  FAS No. 140 is to be applied
prospectively with certain exceptions.  Other than those exceptions,  earlier or
retroactive  application  of its  accounting  provision  is not  permitted.  The
adoption  of FAS  No.  140 did  not  have a  material  impact  on the  Company's
financial statements

     In June 2001, the Financial  Accounting Standards Board issued Statement of
Financial  Accounting Standard (SFAS) No. 141, Business  Combinations.  SFAS No.
141 requires  that all business  combinations  initiated  after June 30, 2001 be
accounted for under the purchase  method and  addresses the initial  recognition
and measurement of goodwill and other  intangible  assets acquired in a business
combination. Business combinations originally accounted for under the pooling of
interest method will not be changed.  Management does not expect the adoption of
SFAS 141 to have an impact on the financial  position,  results of operations or
cash flows of the Company.

     In June 2001, the Financial  Accounting Standards Board issued Statement of
Financial  Accounting  Standard  (SFAS) No. 142,  Goodwill and Other  Intangible
Assets.  SFAS No. 142  addresses  the initial  recognition  and  measurement  of
intangible assets acquired outside of a business  combination and the accounting
for goodwill and other intangible assets subsequent to their  acquisition.  SFAS
No. 142 provides  that  intangible  assets with finite useful lives be amortized
and that  goodwill  and  intangible  assets  with  indefinite  lives will not be
amortized,  but will rather be tested at least annually for  impairment.  As the
Company has no goodwill or intangible assets that it is amortizing, the adoption
of SFAS No.  142 will have no  effect  on the  financial  position,  results  of
operations or cash flows of the Company.

     In June 2001, the Financial  Accounting Standards Board issued Statement of
Financial  Accounting Standard (SFAS) No. 143,  "Accounting for Asset Retirement
Obligations."  SFAS  143  addresses  financial   accounting  and  reporting  for
obligations associated with the retirement of tangible long-lived assets and the
associated  asset  retirement  costs.  SFAS 143 is  effective  for fiscal  years
beginning  after June 15, 2002.  The Company is in the process of evaluating the
impact of implementing SFAS No. 143.

     In  August  2001,  the  FASB  issued  SFAS  No.  144,  "Accounting  for the
Impairment of Long-Lived Assets" which supercedes SFAS No. 121,  "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of"
and the  accounting  and  reporting  provisions  of APB No. 30,  "Reporting  the
Results of  Operations  -  Reporting  and  Effects of Disposal of a Segment of a
Business,  and  Extraordinary,  Unusual and  Infrequently  Occurring  Events and
Transactions"  for the  disposal of a segment of  business.  This  statement  is
effective  for fiscal years  beginning  after  December  15, 2001.  SFAS No. 144
retains  many  of  the  provisions  of  SFAS  No.  121,  but  addresses  certain
implementation  issues associated with that Statement.  The Company is currently
evaluating the impact of implementing SFAS No. 142.


NOTE 7 -- DERIVATIVE FINANCIAL INSTRUMENTS

     Dynex REIT may enter into interest rate swap agreements,  interest rate cap
agreements,  interest  rate  floor  agreements,  financial  forwards,  financial
futures and options on financial futures  ("Interest Rate Agreements") to manage
its sensitivity to changes in interest rates. These Interest Rate Agreements are
intended  to  provide  income  and cash flow to  offset  potential  reduced  net
interest income and cash flow under certain interest rate  environments.  At the
inception  of the  hedge,  these  instruments  are  designated  as either  hedge
positions or trade positions using criteria established in FAS No. 133.

     For Interest Rate Agreements  designated as hedge  instruments,  Dynex REIT
evaluates the  effectiveness  of these hedges  against the financial  instrument
being hedged under various interest rate scenarios. The effective portion of the
gain or loss on an Interest Rate Protection  Agreement  designated as a hedge is
reported in accumulated other comprehensive  income, and the ineffective portion
of such hedge is reported in income.

     As a part of Dynex REIT's interest rate risk management process, Dynex REIT
may be required  periodically to terminate hedge instruments.  Any realized gain
or loss  resulting  from the  termination of a hedge is amortized into income or
expense of the corresponding  hedged instrument over the remaining period of the
original hedge or hedged instrument.

     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  is no longer  accounted  for as a hedge.  Under these
circumstances,  the  accumulated  change  in the  market  value of the  hedge is
recognized in current  income to the extent that the effects of interest rate or
price  changes of the hedged item have not offset the hedge results or otherwise
previously been recognized in 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  activities in the period in
which the changes  occur or when such trade  instruments  are  settled.  Amounts
payable to or  receivable  from  counterparties,  if any,  are  included  on the
consolidated balance sheets in accrued expenses and other liabilities.  In March
2001,  the Company  entered  into three  separate  short  positions  aggregating
$1,300,000 on the June 2001, September 2001, and December 2001 90-day Eurodollar
Futures  Contracts.  The Company  entered  into these  positions  to, in effect,
lock-in its  borrowing  costs on a forward basis  relative to its  floating-rate
liabilities.  In addition,  in April and May 2001, the Company  entered into two
short  positions on the  one-month  LIBOR futures  contract,  both of which were
settled  during the second  quarter.  These  instruments  fail to meet the hedge
criteria of FAS No. 133, and therefore  are  accounted  for on a trading  basis.
Changes in market value for these contracts,  and the gain or loss recognized at
the termination of these  contracts,  are recognized in current period earnings.
During the nine months ended September 30, 2001, given the continued  decline in
one-month  LIBOR due to  reductions  in the  targeted  Federal  Funds Rate,  the
Company recognized $2,914 in losses related to these contracts. At September 30,
2001,  the  aggregate  remaining  short  position was  $150,000  relating to the
December 2001 contract.


NOTE 8 -- PREFERRED STOCK

     On June 8, 2001,  the  Company  completed  a tender  offer on its Series A,
Series B, and  Series C  Preferred  Stock  (together,  the  "Preferred  Stock"),
resulting  in the  purchase  by the Company of 820,601  shares of the  Preferred
Stock,  consisting of 202,090 shares of Series A, 363,708 shares of Series B and
254,803 shares of Series C, respectively, for an aggregate $10,918 and which had
an  aggregate  issue price of $21,405,  a book value of $20,503,  and  including
dividends in arrears,  a liquidation  preference of $25,110.  The  difference of
$9,470 between the repurchase  price and the book value has been included in the
accompanying  Statement of Operations for the three and nine month periods ended
September 30, 2001 as an addition to net income available to common shareholders
in the line item  captioned  Preferred  Stock  benefit  (charges) as required by
EITF's D-42 and D-53. Also included in Preferred Stock benefit  (charges) is the
cumulative  dividend in arrears of $3,964  related to those  shares  tendered on
June 8, 2001,  and which was  effectively  cancelled at such time.  In addition,
Preferred  Stock benefit  (charges)  includes the current period dividend amount
for the Preferred  Stock  outstanding for the three and nine month periods ended
September 30, 2001.

     On May 22,  2001,  dividends  of $0.2925 per share of Series A and Series B
Preferred  Stock and $0.3649 per share of Series C Preferred Stock were declared
payable to holders of record as of June 8, 2001.  Total dividends of $1,614 were
paid on July 20, 2001.

     On September 6, 2001, the Company announced a tender offer on the Preferred
Stock, offering to purchase up to 212,817 shares of its Series A Preferred Stock
for $16.80  per share,  up to  297,746  shares of Series B  Preferred  Stock for
$17.15 per share and up to 304,757 shares of Series C Preferred Stock for $21.00
per share. 486,517 shares were tendered for an aggregate $9,080 and which had an
aggregate  issue  price of  $12,971,  and  including  dividends  in  arrears,  a
liquidation  preference of $15,639.  The purchase of the 486,517 tendered shares
was  completed on November 2, 2001 and as a result will be accounted  for in the
fourth quarter of 2001.

     As of  September  30,  2001 and  December  31,  2000,  the total  amount of
dividends in arrears were $23,042 and $19,367  respectively.  Individually,  the
amount of  dividends  in  arrears on the Series A, the Series B and the Series C
were $5,505  ($4.97 per Series A share),  $7,701  ($4.97 per Series B share) and
$9,836  ($6.21 per Series C share),  at September 30, 2001 and $4,595 ($3.51 per
Series A share),  $6,713 ($3.51 per Series B share) and $8,059 ($4.38 per Series
C share), at December 31,2000.


NOTE 9 -- NET GAIN (LOSS) ON SALES, WRITE-DOWNS, IMPAIRMENT CHARGES
          AND LITIGATION

     The following table sets forth the composition of net gain (loss) on sales,
write-downs and impairment  charges for the nine months ended September 30, 2001
and 2000.

                                                Nine months ended September 30,
                                               ---------------------------------
                                                    2001                2000
                                               --------------       ------------

Phase-out of commercial production operations        402            $    (1,482)
Sales of investments                                  11                (15,639)
Impairment/Writedowns                                  -                (63,545)
AutoBond litigation and AutoBond securities        7,111                      -
Other                                               (631)                  (380)
                                               -------------        ------------
                                               $   6,893            $   (81,046)

     During the nine months  ending  September  30,  2001 the  Company  resolved
litigation related to AutoBond Acceptance Corporation to the mutual satisfaction
of the parties involved.  The Company received $7,111 net of legal fees incurred
related to the litigation.  During the nine months ended September 30, 2000, the
Company recognized losses of $63,545 related to (i) the permanent  impairment in
the carrying value of certain  securities,  (ii)  write-downs to market value of
commercial and  multifamily  loans held for sale and (iii) the accrual of losses
related to contingent  obligations  on its  off-balance  sheet  tax-exempt  bond
positions.  Also, securities with an aggregate principal balance of $34,448 were
sold during the nine months ended  September  30, 2000 for an aggregate  loss of
$15,639.  Loss on sale of  investments  at  September  30,  2000  also  includes
realized  losses of $1,482  related to the sale of $268,732 of commercial  loans
during the nine months ended September 30, 2000.


NOTE 10 -- COMMITMENTS

     The Company makes various  representations  and warranties  relating to the
sale or securitization of loans. To the extent the Company were to breach any of
these  representations or warranties,  and such breach could not be cured within
the allowable  time period,  the Company  would be required to  repurchase  such
loans, and could incur losses. In the opinion of management,  no material losses
are expected to result from any such representations and warranties.

     The Company has made various representations and warranties relating to the
sale of various production operations.  To the extent the Company were to breach
any of these  representations or warranties,  and such breach could not be cured
within the  allowable  time period,  the Company  would be required to cover any
losses and  expenses  up to certain  limits.  In the opinion of  management,  no
material  losses  are  expected  to  result  from any such  representations  and
warranties.


NOTE 11 -- LITIGATION

     On November 7, 2000,  the Company  entered  into an  Agreement  and Plan of
Merger with California  Investment Fund, LLC ("CIF"), for the purchase of all of
the equity securities of the Company for $90,000 (the "Merger  Agreement").  The
Merger Agreement was subsequently  amended on December 22, 2000 as a result of a
breach  of  the  requirements  of the  Merger  Agreement  by  CIF in  delivering
sufficient evidence of a financing commitment. Among other things, the amendment
to the Merger Agreement  obligated CIF to deliver to the Company written binding
financing  commitments  and  evidence  of the consent of the holders of the July
2002 Notes to the merger  transaction  on or before January 25, 2001. On January
25,  2001,  CIF  failed  to meet the  requirements  as set  forth in the  Merger
Agreement and the letter of December 22, 2000,  and the Company  terminated  the
Merger Agreement  effective January 26, 2001 and requested that the escrow agent
release to the  Company  the $1,000 and  572,178  shares of common  stock of the
Company  which CIF placed in escrow  under the  Merger  Agreement  (the  "Escrow
Amount").  On January 29, 2001,  the Company filed for  Declaratory  Judgment in
United States  District Court for the Eastern  District of Virginia,  Alexandria
Division (the "Court").  CIF filed a counterclaim  and demand for jury trial and
asked for damages of $45,000.  The Court subsequently  capped CIF's damage claim
to $2,000 as set forth in the Merger Agreement and held a jury trial. On October
16,  2001,  the jury  returned a verdict  which  would  result in (i) the escrow
amount  consisting of $1,000 and 572,178 shares of common stock being awarded to
the Company, and (ii) the Company having to pay CIF a termination fee of $2,000.
The Court has yet to enter judgment pending its decision regarding motions filed
by the two parties.  Assuming  the Court  upholds the jury verdict on the $2,000
termination fee the Company will most likely appeal.  Neither the receipt of the
escrow amount nor the payment of the $2,000 termination fee has been accrued for
in the accompanying financial statements.

     In  February  2001,  the  Company  resolved a matter  related  to  AutoBond
Acceptance  Corporation to the mutual  satisfaction of the parties involved.  In
connection with the resolution of this matter,  the Company received $7,111, net
of related legal fees.

     GLS Capital,  Inc. ("GLS"), a subsidiary of the Company,  together with the
County of Allegheny,  Pennsylvania  ("Allegheny  County"),  were defendants in a
lawsuit in the Commonwealth  Court of Pennsylvania  (the  "Commonwealth  Court")
wherein  the  plaintiffs  challenged  the right of  Allegheny  County and GLS to
collect certain interest,  costs and expenses related to delinquent property tax
receivables in Allegheny County. This lawsuit was related to the purchase by GLS
of delinquent  property tax receivables from Allegheny County in 1997, 1998, and
1999  for  approximately  $58,258.   On  July 5, 2001,  the  Commonwealth  Court
ruling addressed,  among other things, (i) the right of the Company to charge to
the  delinquent  taxpayer a rate of interest of 12% versus 10% on the collection
of its delinquent property tax receivables, (ii) the charging of attorney's fees
to the delinquent taxpayer for the collection of such tax receivables, and (iii)
the charging to the  delinquent  taxpayer of certain  other fees and costs.  The
Commonwealth  Court  remanded for further  consideration  to the Court of Common
Pleas items (i) and (iii),  and ruled that neither  Allegheny County nor GLS had
the right to charge  attorney's fees to the delinquent  taxpayer  related to the
collection  of such  tax  receivables,  reversing  the  Court  of  Common  Pleas
decision.  On  September  10th the  Commonwealth  Court  denied  the  County  of
Allegheny and GLS's Application for Re-argument.  The Pennsylvania Supreme Court
has accepted the Application for Extraordinary  Jurisdiction  filed by Allegheny
County  and GLS.  No  damages  have been  claimed  in the  action;  however,  as
discussed in Note 4, the decision may impact the ultimate  recoverability of the
delinquent property tax receivables. To date, GLS has incurred attorneys fees of
approximately  $2,000 related to foreclosures  on such  delinquent  property tax
receivables,  approximately  $1,000 of which have been  reimbursed to GLS by the
taxpayer or through liquidation of the underlying real property.

     On May 4, 2001, ACA Financial  Guaranty  Corporation  ("ACA")  commenced an
action in the United States District Court for the Southern District of New York
(the "District Court"), (the "Action"), in which ACA sought injunctive relief as
well as money  damages  of  $25,000  based on causes of  action  for  fraudulent
conveyance and breach of contract. The complaint challenged, among other things,
the  validity of the March 30, 2001  Supplemental  Indenture  to the 1997 Senior
Note  Indenture as amended ("1997  Indenture")  discussed in Note 5, pursuant to
which in 1997 Dynex issued its 7.875% Senior Notes due July 2002. In particular,
the  complaint  challenged  the validity,  among other  things,  of the Purchase
Agreement,  and the Supplemental  Indenture and the related amendment to certain
restrictive  covenants in the  Indenture to allow for certain  distributions  to
holders of Dynex equity  securities,  including  the Preferred  Stock.  ACA is a
financial  guaranty  company who has insured  $25,000 of the July 2002 Notes for
repayment  at  maturity on July 15,  2002,  for the benefit of the holder of the
Notes.  The Company is not a party to this  insurance  contract.  On October 31,
2001,  the  Company and ACA settled  this  matter out of court.  The  settlement
provides  for,  among other things,  that the Company could  complete the tender
offer of Preferred Stock announced on September 6, 2001 (and subsequently funded
on November 2, 2001),  but that the Company would  generally not be permitted to
make further  distributions  on its capital  stock until the July 2002 Notes are
repaid or defeased.

     The Company is also  subject to other  lawsuits or claims which have arisen
in the ordinary  course of its  business,  some of which seek damages in amounts
which could be material to the financial  statements.  Although no assurance can
be given with respect to the ultimate  outcome of any such  litigation or claim,
the Company  believes the  resolution of such lawsuits or claims will not have a
material  effect  on  the  Company's   consolidated  balance  sheet,  but  could
materially affect consolidated results of operations in a given year.


NOTE 12 -- RELATED PARTY TRANSACTIONS

     During 2000,  Dynex REIT had a credit  arrangement with DHI whereby DHI and
any of DHI's  subsidiaries  could  borrow  funds from Dynex REIT to finance  its
operations. Under this arrangement, Dynex REIT could also borrow funds from DHI.
The terms of the agreement  allowed DHI and its subsidiaries to borrow up to $50
million from Dynex REIT at a rate of Prime plus 1.0%. Dynex REIT could borrow up
to $50 million from DHI at a rate of one-month  LIBOR plus 1.0%.  Effective with
the  liquidation  of DHI  at  December  31,  2000,  this  credit  agreement  was
terminated.  Net interest  expense under this  agreement was $1,087 for the nine
months ended September 30, 2000.

     Dynex REIT has entered into  subservicing  agreements with Dynex Commercial
Services,  Inc.  ("DCSI")  and GLS Capital  Services,  Inc  ("GLSCS") to service
commercial loans and property tax receivables, respectively. DCSI and GLSCS were
subsidiaries  of DHI in  2000,  and are now  subsidiaries  of  Dynex  REIT.  For
servicing the commercial  loans,  DCSI receives an annual servicing fee of 0.02%
of the  aggregate  unpaid  principal  balance of the loans.  For  servicing  the
property tax receivables, GLSCS receives an annual servicing fee of 0.72% of the
aggregate  unpaid principal  balance of the property tax receivables.  Servicing
fees paid by Dynex REIT under such  agreements  were $211 during the nine months
ended  September  30, 2000 and $57 during the same period  ended  September  30,
2001.

     The Company has made a loan to Thomas H. Potts,  president  of the Company,
as evidenced by a demand promissory note (the "Potts Note").  Mr. Potts directly
owns  399,502  shares of common  stock of the  Company,  all of which  have been
pledged as collateral to secure the Potts Note. Interest is charged on the Potts
Note at the  applicable  short-term  monthly  applicable  federal rate (commonly
known as the AFR Rate) as  published  by the  Internal  Revenue  Service.  As of
September 30, 2001 and December 31, 2000, the  outstanding  balance of the Potts
Note was $543 and $687, respectively, and interest was current.

Item 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
         CONDITION AND RESULTS OF OPERATIONS

     Dynex Capital,  Inc. (the "Company") is a financial  services  company that
invests in a portfolio of  securities  and  investments  backed  principally  by
single family mortgage loans, commercial mortgage loans and manufactured housing
installment  loans.  Such loans have been funded generally by the Company's loan
production  operations or purchased in bulk in the market.  Loans funded through
the Company's  production  operations  have generally been pooled and pledged as
collateral  using a  collateralized  bond  security  structure,  which  provides
long-term  financing  for the loans while  limiting  credit,  interest  rate and
liquidity risk.

                              FINANCIAL CONDITION
                  (amounts in thousands except per share data)

                                       September 30, 2001      December 31, 2000
                                       ------------------      -----------------
Investments:
  Collateral for collateralized bonds  $        2,558,555      $       3,042,158
  Securities                                        5,163                  9,364
  Other investments                                34,143                 42,284
  Loans held for sale                               2,891                 19,102

Non-recourse debt - collateralized              2,384,670              2,856,728
Recourse debt                                      64,964                134,168

Shareholders' equity                              181,342                157,131

     Collateral for  collateralized  bonds Collateral for  collateralized  bonds
consists  primarily  of  securities  backed by  adjustable-rate  and  fixed-rate
mortgage loans secured by first liens on single family housing, fixed-rate loans
secured by first liens on multifamily  and commercial  properties,  manufactured
housing  installment  loans  secured by either a UCC  filing or a motor  vehicle
title and  delinquent  property tax  receivables.  As of September 30, 2001, the
Company had 24 series of collateralized  bonds  outstanding.  The collateral for
collateralized  bonds  decreased to $2.56 billion at September 30, 2001 compared
to $3.04  billion at  December  31,  2000.  This  decrease  of $0.48  billion is
primarily the result of $473.9 million in paydowns on the collateral.

     Securities  Securities consist primarily of adjustable-rate  and fixed-rate
mortgage-backed  securities.  Securities  also include  derivative  and residual
securities. Securities decreased during the nine months ended September 30, 2001
by $4.2  million to $5.2  million at  September  30,  2001 from $9.4  million at
December 31, 2000 due primarily to the sale of two ARM securities.

     Other investments Other investments at September 30, 2001 consist primarily
of delinquent property tax receivables.  Other investments  decreased from $42.3
million at December  31,  2000 to $34.1  million at  September  30,  2001.  This
decrease is primarily the result of the receipt of the final $9.5 million annual
principal  payment on the note  receivable  from the 1996 sale of the  Company's
single  family  mortgage  operations,  offset  in part by the  purchase  of $2.7
million of delinquent property tax receivables.

     Loans held for sale  Loans held for sale,  which  consists  principally  of
commercial  mortgage and mezzanine  loans on healthcare  facilities at September
30, 2001,  decreased  from $19.1 million at December 31, 2000 to $2.9 million at
September  30,  2001 as the  result of the sale of loans  during  the first nine
months of the year.  These loans are  currently  carried at the lower of cost or
market.

     Non-recourse  debt  Collateralized  bonds issued by Dynex REIT are recourse
only to the assets  pledged as  collateral,  and are otherwise  non-recourse  to
Dynex REIT.  Collateralized  bonds  decreased  from $2.9 billion at December 31,
2000 to $2.4 billion at September 30, 2001. This decrease was primarily a result
of principal  payments received on the associated  collateral pledged which were
used to pay down the  collateralized  bonds in  accordance  with the  respective
indentures.

     Recourse  debt  Recourse  debt  decreased to $65.0 million at September 30,
2001 from $134.2  million at December 31, 2000.  This  decrease was due to $39.3
million of repurchases on the July 2002 Notes,  $26.0 million of repayments made
on repurchase agreements and the $2.0 million payoff of a note payable.

     Shareholders'  equity  Shareholders'  equity increased to $181.3 million at
September 30, 2001 from $157.1 million at December 31, 2000. This increase was a
combined  result  of a $29.9  million  decrease  in the net  unrealized  loss on
investments available-for-sale from $124.6 million at December 31, 2000 to $94.7
million at  September  30, 2001 and net income of $6.9  million  during the nine
months ended September 30, 2001. This was partially  offset by the completion of
the tender  offer on  Preferred  Stock  completed  in June 2001,  which  reduced
shareholders'  equity by $11.0  million  and the  payment of  dividends  of $1.6
million in July 2001.

                              RESULTS OF OPERATIONS



                                                                     Three Months Ended                   Nine Months Ended
                                                                        September 30,                        September 30,
(amounts in thousands except per share information)                2001              2000               2001             2000
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                            
Net interest margin                                           $   (2,422)       $   1,252          $   7,830        $   9,132

Net (loss) gain on sales, write-downs, impairment
  charges and litigation                                            (650)            (557)             6,893          (85,467)
Trading losses                                                    (1,161)               -             (2,881)               -
General and administrative expenses                                2,299           (1,573)             6,777            6,519
Extraordinary item - (loss) gain on extinguishment of debt        (1,010)               -              1,835                -
Net (loss) income before preferred stock benefits (charges)       (7,483)            (836)             6,939          (80,235)

Basic net (loss) income per common share before
  extraordinary gain                                          $    (0.66)       $   (0.35)         $    0.97        $   (7.86)
Diluted net (loss) income per common share before
  extraordinary gain                                               (0.66)           (0.35)              0.97            (7.86)

Basic net (loss) income per common share after
  extraordinary item                                          $    (0.75)       $   (0.35)          $   1.14         $  (7.86)
Diluted net (loss) income per common share after
  extraordinary item                                               (0.75)           (0.35)              1.14            (7.86)


     Three and Nine Months Ended  September  30, 2001 Compared to Three and Nine
Months Ended  September 30, 2000.  The increase in net income and net income per
common share during the nine months ended  September 30, 2001 as compared to the
same period in 2000 is primarily  the result of several  positive  non-recurring
items  in  2001,  including  the  favorable  settlement  of  litigation,  and an
extraordinary  gain related to the early  extinguishment of $39.3 million of the
Company's   July  2002  Notes,   versus  losses  in  2000   resulting  from  the
sale/write-down  of certain  securities,  the  write-down of certain  commercial
mortgage loans held for sale,  and the accrual of losses on certain  off-balance
sheet  tax-exempt bond positions.  In addition,  basic and diluted  earnings per
common  share for the nine months ended  September  2001 reflect the discount to
book value of the purchase price of the Company's Series A, Series B, and Series
C Preferred Stock tendered  pursuant to the tender offer for the Preferred Stock
completed on June 8, 2001, and the associated  cumulative dividend in arrears on
those tendered shares, which were cancelled.

     Net interest  margin for the nine months ended September 30, 2001 decreased
to $7.8 million from $9.1  million for the same period for 2000.  This  decrease
was primarily the result of an increase in provision for losses to $27.4 million
during the nine months ended September 30, 2001 compared to $16.1 million during
the nine months ended  September 30, 2000. This increase in provision for losses
was  a  result  of  increasing  the  reserve  for  probable  losses  on  various
manufactured  housing loan pools pledged as collateral for collateralized  bonds
where  the   Company  has   retained   credit   risk.   In   addition,   average
interest-earning  assets  declined  from $3.8  billion for the nine months ended
September 30, 2000 to $3.0 billion for the nine months ended September 30, 2001.
These decreases were partially  offset by an increase in the net interest spread
from 0.57% for the nine months  ending  September 30, 2000 to 1.22% for the nine
months ended September 30, 2001.

     Net gain (loss) on sales,  write-downs,  impairment  charges and litigation
improved  $92.4  million,  from a loss of $85.5  million  during the nine months
ended September 30, 2000, to a gain of $6.9 million during the nine months ended
September 30, 2001. During 2001, the Company favorably  resolved  litigation for
$7.1 million, net of legal expenses.  During the nine months ended September 30,
2000,  the  Company  recognized  losses  of  $63.5  million  related  to (i) the
permanent  impairment  in  the  carrying  value  of  certain  securities,   (ii)
write-downs  to market value of commercial and  multifamily  loans held for sale
and (iii) the  accrual  of  losses  related  to  contingent  obligations  on its
off-balance sheet tax-exempt bond positions.  Also, securities with an aggregate
principal  balance  of $34.4  million  were sold  during the nine  months  ended
September  30, 2000 for an  aggregate  loss of $15.6  million.  The Company also
realized  losses  of $1.5  million  related  to the sale of  $268.7  million  of
commercial loans during the nine months ended September 30, 2000.

     The following  table  summarizes the average  balances of  interest-earning
assets and their  average  effective  yields,  along with the average  interest-
bearing  liabilities and the related average effective  interest rates, for each
of the periods presented.

                  Average Balances and Effective Interest Rates



                                              Three Months Ended September 30,               Nine Months Ended September 30,
                                        --------------------------------------------- ----------------------------------------------
                                                2001                   2000                   2001                    2000
                                        ----------------------  --------------------- -----------------------  ---------------------
                                         Average    Effective   Average     Effective   Average     Effective  Average     Effective
                                         Balance      Rate      Balance       Rate      Balance      Rate      Balance       Rate
                                        ----------  ----------  ----------  ---------  -----------  ---------  ----------  ---------
Interest-earning assets:(1)
  Collateral for collateralized
    bonds(2)(3)                         $2,722,657    7.46%     $3,418,086    7.99%    $2,902,187    7.73%     $3,530,831    7.81%
  Securities                                 5,558   11.28          12,930    9.32          9,507   10.53          69,777     6.31
  Other investments                         35,534   14.69          36,271   13.20         35,970   15.08          43,402    13.43
  Loans held for sale or
    securitization                           3,386   11.36          35,765    7.88          4,432   12.74         174,623     8.07
  Cash investments                           7,642    3.62               -       -         16,609    4.68               -        -
                                        -----------  --------  ------------  --------  -----------  ---------  -----------  --------
                                                                                                       
     Total interest-earning assets      $2,774,778    7.55%    $ 3,503,052    8.05%    $2,968,724    7.82%     $3,818,634     7.86%
                                        ===========  ========  ============  ========  ===========  =========  ===========  ========

Interest-bearing liabilities:
  Non-recourse debt(3)                  $2,528,348    6.11%    $3,101,953     7.61%    $2,654,283    6.58%     $3,193,760     7.27%
  Recourse debt - collateralized
    bonds retained                           8,364    5.41         41,878      7.54        21,123    6.37          75,223     6.97
                                        -----------  --------  ------------  --------  -----------  ---------  -----------  --------
                                         2,536,712    6.11%     3,143,831      7.61     2,675,406    6.58       3,268,983     7.27

  Credit facilities                            702    5.30          2,191      7.01         1,637    6.33          27,506     8.60
  Other recourse debt - secured             58,010    8.18         23,704      9.25        73,974    8.33         130,872     6.38
  Other recourse debt - unsecured                -       -         98,309      8.43             -       -         102,776     8.62
                                        -----------  --------  ------------  --------  -----------  ---------  -----------  --------
  Total interest-bearing liabilities    $2,595,423    6.15%    $3,268,035      7.65%   $2,751,017      6.63%   $3,530,138     7.29%
                                        ===========  ========  ============  ========  ===========  =========  ===========  ========
Net interest spread on all
  investments(3)                                      1.40%                    0.40%                   1.19%                  0.57%
                                                    ==========              ==========              =========               ========
Net yield on average interest-earning                 1.80%                    0.92%                   1.68%                  1.12%
  assets(3)                                         ==========              ==========              =========               ========


(1)  _____Average balances exclude adjustments made in accordance with Statement
     of Financial Accounting Standards No. 115, "Accounting for Certain
     Investments in Debt and Equity Securities" to record available-for-sale
     securities at fair value.
(2)  Average balances exclude funds held by trustees of $579 and $698 for the
     three months ended September 30, 2001 and 2000, respectively, and $502 and
     $932 for the nine months ended September 30, 2001 and 2000, respectively.
(3)  Effective rates are calculated excluding non-interest related
     collateralized bond expenses and provision for credit losses. If included,
     the net yield on average interest-earning assets would be 0.75% and 0.14%
     for the three months ended September 30, 2001 and 2000, respectively, and
     0.34% and 0.32% for the nine months ended September 30, 2001 and 2000,
     respectively.



     The net  interest  spread  increased  1.00%,  to 1.40% for the three months
ended  September  30,  2001  from  0.40% for the same  period  in 2000.  The net
interest  spread for the nine months  ended  September  30,  2001 also  improved
relative to the same period in 2000, to 1.68% from 0.57%. The improvement in the
Company's  net  interest  spread can be  attributed  to a decline in the cost of
interest-bearing  liabilities  for  the  respective  2001  periods,  which  have
declined  as a result  in the  decline  of  One-Month  LIBOR  due to the  recent
reduction in short-term  interest rates by the Federal Reserve.  The majority of
the Company's variable-rate  interest-bearing liabilities are priced relative to
One-Month LIBOR.  Interest-bearing  liability costs declined 1.50% and 0.66% for
the three and nine-month periods ended September 30, 2001,  compared to the same
periods in 2000.  For both the three and nine month periods ended  September 30,
2001, there has been a lesser decline in the effective interest-earning yield on
the collateral for collateralized bonds due to the `reset' lag and "floors" (the
loans  generally  adjust or `reset' every six or twelve months and are generally
limited to maximum  adjustments  upwards or  downwards of 1% each six months) on
the approximate $779 million in single-family  ARM loans that comprise a portion
of the collateral  for  collateralized  bonds.  The Company would expect its net
interest  spread  on its  interest-earning  assets  for the  balance  of 2001 to
improve relative to the first  nine-months of 2001 due to further  reductions in
short term interest rates since September 30, 2001.

     For the three months ended  September 30, 2001 compared to the three months
ended September 30, 2000, average interest-earning assets declined $728 million,
or approximately 21%. The decline for the nine-month period was $850 million, or
approximately  22%. A large portion of such reduction relates to paydowns on the
Company's   adjustable-rate   single-family  mortgage  loans  and  the  sale  of
fixed-rate  commercial  mortgage  loans that were held for sale.  The  Company's
portfolio  now  consists of $778.7  million of  adjustable  rate assets and $1.8
billion of  fixed-rate  assets.  The Company  currently  finances  approximately
$195.5  million  of  the  fixed-rate  assets  with   non-recourse   LIBOR  based
floating-rate  liabilities,  and to the extent that short-term rates continue to
decline,  the Company's net interest  spread  should  continue to benefit.  Once
rates stabilize,  however, the remaining single-family ARM loans should continue
to reset  downwards in rate (subject to "floors")  which will have the impact of
reducing net interest spread in future periods.

     Interest Income and  Interest-Earning  Assets. At September 30, 2001, $1.80
billion of the investment  portfolio consists of loans which pay a fixed-rate of
interest.  Also  at  September  30,  2001,  approximately  $800  million  of the
investment  portfolio is comprised of loans or securities that have coupon rates
which adjust over time (subject to certain periodic and lifetime limitations) in
conjunction with changes in short-term interest rates.  Approximately 66% of the
ARM loans underlying the ARM securities and collateral for collateralized  bonds
are indexed to and reset based upon the level of six-month LIBOR;  approximately
22% of the ARM  loans  are  indexed  to and  reset  based  upon the level of the
one-year  Constant Maturity Treasury (CMT) index. The following table presents a
breakdown,  by principal balance, of the Company's collateral for collateralized
bonds and ARM and fixed  mortgage  securities by type of underlying  loan.  This
table excludes derivative and residual  securities,  other investments and loans
held for sale.

                      Investment Portfolio Composition(1)
                                 ($ in millions)



                        LIBOR Based      CMT Based       Other Indices      Fixed-Rate
                         ARM Loans       ARM Loans       Based ARM Loans       Loans        Total
----------------------------------------------------------------------------------------------------
                                                                              
1999, Quarter 4          $1,048.5         $430.8            $121.1           $2,061.5     $3,661.9
2000, Quarter 1             976.7          362.6             117.4            2,029.4      3,486.1
2000, Quarter 2             902.5          375.8             110.8            1,998.2      3,387.3
2000, Quarter 3             830.1          348.9             103.2            1,960.8      3,243.0
2000, Quarter 4             758.6          309.9              97.4            1,926.3      3,092.2
2001, Quarter 1             688.4          271.6              91.3            1,892.8      2,944.1
2001, Quarter 2             604.4          224.0              81.3            1,852.7      2,762.4
2001, Quarter 3             527.4          173.2              78.2            1,802.4      2,581.2
----------------------------------------------------------------------------------------------------


(1)  Includes only the principal amount of collateral for collateralized bonds,
     ARM securities and fixed-rate mortgage securities.



     The average asset yield is reduced for the amortization of premiums, net of
discounts on the  investment  portfolio.  As  indicated in the table below,  net
premium on the collateral for collateralized  bonds, ARM securities,  fixed-rate
mortgage  securities at September 30, 2001 was $23.7 million,  or  approximately
0.90% of the  aggregate  balance of collateral  for  collateralized  bonds,  ARM
securities and fixed-rate securities.  The $23.7 million net premium consists of
gross collateral premiums of $51.0 million,  less gross collateral  discounts of
$27.3  million.  Of the $51.0  million in gross  premiums on  collateral,  $34.2
million relates to the premium on multifamily and commercial mortgage loans with
a principal  balance of $807.9  million at  September  30,  2001,  and that have
average initial prepayment lockouts or yield maintenance for at least ten years.
Net  premium  on  such  multifamily  and  commercial  loans  is  $27.8  million.
Amortization  expense as a percentage of principal  paydowns has decreased  from
1.59% for the three months ended September 30, 2000 to 1.30% for the same period
in 2001. The principal  prepayment rate for the Company  (indicated in the table
below as "CPR Annualized Rate") was approximately 28% for the three months ended
September 30, 2001. CPR or "constant prepayment rate" is a measure of the annual
prepayment rate on a pool of loans.

                         Premium Basis and Amortization
                                 ($ in millions)



                                                                                                          Amortization
                                                                        CPR                               Expense as a % of
                                                Amortization        Annualized            Principal      Principal Paydowns
                            Net Premium           Expense              Rate               Paydowns
     ----------------------------------------------------------------------------------------------------------------------
                                                                                                
1999, Quarter 4             $    38.3            $    2.2              20%                $  165.0              1.41%
2000, Quarter 1                  36.2                 2.0              18%                   122.6              1.64%
2000, Quarter 2                  34.1                 2.1              18%                   131.6              1.56%
2000, Quarter 3                  32.0                 2.1              18%                   134.1              1.59%
2000, Quarter 4                  30.1                 1.9              20%                   134.7              1.41%
2001, Quarter 1                  28.0                 2.0              23%                   142.6              1.43%
2001, Quarter 2                  25.7                 2.3              28%                   174.6              1.31%
2001, Quarter 3                  23.7                 2.1              28%                   162.9              1.30%
---------------------------------------------------------------------------------------------------------------------------


     Credit  Exposures.  The Company  securitizes its loans into  collateralized
bonds or pass-through  securitization  structures.  With either  structure,  the
Company may use  overcollateralization,  subordination,  third-party guarantees,
reserve funds, bond insurance, mortgage pool insurance or any combination of the
foregoing as a form of credit enhancement. With all forms of credit enhancement,
the  Company  may  retain a limited  portion  of the  direct  credit  risk after
securitization.

     The following table summarizes the aggregate principal amount of collateral
for collateralized bonds and ARM and fixed-rate mortgage pass-through securities
outstanding;  the direct credit exposure retained by the Company (represented by
the amount of overcollateralization pledged and subordinated securities owned by
the  Company  and rated  below BBB by one of the  nationally  recognized  rating
agencies),  net of the  credit  reserves  maintained  by the  Company  for  such
exposure;  and the actual credit losses incurred for each year.  Credit reserves
maintained by the Company and included in the table below  includes  third-party
reimbursement  guarantees of $30.3 million. The table excludes any risks related
to  representations  and  warranties  made on loans  funded by the  Company  and
securitized in mortgage pass-through  securities generally funded prior to 1995.
This  table  also  excludes  any  credit  exposure  on  loans  held  for sale or
securitization,   and  other  investments,  including  delinquent  property  tax
receivables.  The Company's credit exposure declines  principally as a result of
charge-offs  against  the  Company's   investment  in  the  respective  security
structure,  and the amount of  provision  for losses  that the  Company  records
during the period relative to such charge-offs.

     The Company is currently  engaged in a dispute with the counterparty to the
$30.3 million in  reimbursement  guarantees.  Such  guarantees  are payable when
cumulative  loss  trigger  levels  are  reached  on  certain  of  the  Company's
single-family  mortgage loan  securitizations.  Currently,  these trigger levels
have been reached on four of the Company's securities,  and the Company has made
claims under the reimbursement guarantees in amounts approximating $1.7 million.
The counterparty has denied payment on these claims, citing various deficiencies
in loan  underwriting  which would render these loans and  corresponding  claims
ineligible  under  the  reimbursement  agreements.  The  Company  disputes  this
classification and is pursuing this matter through court-ordered arbitration.

                    Credit Reserves and Actual Credit Losses
                                 ($ in millions)



                           Outstanding Loan     Credit Exposure, Net  Actual Credit   Credit Exposure, Net of Credit
                          Principal Balance     of Credit Reserves        Losses       Reserves to Outstanding Loan
                                                                                                 Balance
----------------------------------------------------------------------------------------------------------------------
                                                                                       
1999, Quarter 4           $     3,770.3         $     183.2 $              5.5                    4.86%
2000, Quarter 1                 3,679.6               136.0                4.8                    3.70%
2000, Quarter 2                 3,677.3               165.2                5.4                    4.49%
2000, Quarter 3                 3,503.1               142.4                6.8                    4.06%
2000, Quarter 4                 3,245.3               119.1                9.6                    3.67%
2001, Quarter 1                 3,137.0               111.7                8.1                    3.56%
2001, Quarter 2                 2,948.0               105.5                8.2                    3.58%
2001, Quarter 3                 2,771.2               100.1                9.2                    3.61%
----------------------------------------------------------------------------------------------------------------------


     The following table  summarizes  single family mortgage loan,  manufactured
housing loan and commercial  mortgage loan  delinquencies as a percentage of the
outstanding  collateral  balance  for those  securities  in which Dynex REIT has
retained a portion of the direct credit risk. The  delinquencies as a percentage
of the outstanding  collateral  balance have decreased to 1.75% at September 30,
2001 from 1.96% at September  30, 2000.  The Company  monitors and evaluates its
exposure to credit losses and has  established  reserves based upon  anticipated
losses,  general economic conditions and trends in the investment portfolio.  As
of September 30, 2001, management believes the credit reserves are sufficient to
cover  anticipated  losses  that may occur as a result of current  delinquencies
presented in the table below.

                            Delinquency Statistics(1)



                       60 to 90 days      90 days and over
                        delinquent         delinquent (2)          Total
-------------------------------------------------------------------------------------------------------------------------
                                                           
1999, Quarter 4           0.27%              1.37%                 1.64%
2000, Quarter 1           0.26%              1.46%                 1.72%
2000, Quarter 2           0.34%              1.52%                 1.86%
2000, Quarter 3           0.35%              1.61%                 1.96%
2000, Quarter 4           0.37%              1.59%                 1.96%
2001, Quarter 1           0.20%              1.55%                 1.75%
2001, Quarter 2           0.29%              1.45%                 1.74%
2001, Quarter 3           0.33%              1.42%                 1.75%
-------------------------------------------------------------------------------------------------------------------------


(1)      Excludes other investments and loans held for sale or securitization.
(2)      Includes foreclosures, repossessions and REO.



     Recent Accounting Pronouncements

     Statement of Financial  Accounting  Standards ("FAS") No. 133,  "Accounting
for Derivative  Instruments and Hedging  Activities" is effective for all fiscal
years  beginning  after June 15,  2000.  FAS No. 133,  as  amended,  establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts,  and for hedging activities.
The Company  adopted FAS No. 133 effective  January 1, 2001. The adoption of FAS
No. 133 did not have a significant impact on the financial position,  results of
operations, or cash flows of the Company.

     In  September  2000,  the  Financial   Accounting  Standards  Board  issued
Statement of Financial  Accounting  Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and  Extinguishment of Liabilities"  ("FAS No.
140"). FAS No. 140 replaces the Statement of Financial  Accounting Standards No.
125  "Accounting  for the  Transfers  and  Servicing  of  Financial  Assets  and
Extinguishment  of  Liabilities"  ("FAS  No.  125").  FAS No.  140  revises  the
standards for accounting  for  securitization  and other  transfers of financial
assets and collateral and requires certain disclosure,  but it carries over most
of FAS No. 125 provisions without reconsideration.  FAS No. 140 is effective for
transfers and servicing of financial  assets and  extinguishment  of liabilities
occurring  after March 31, 2001.  FAS No. 140 is effective for  recognition  and
reclassification  of collateral and for disclosures  relating to  securitization
transactions  and  collateral  for fiscal years ending after  December 15, 2000.
Disclosures about  securitization  and collateral  accepted need not be reported
for  periods  ending  on or  before  December  15,  2000,  for  which  financial
statements are presented for comparative purposes.  FAS No. 140 is to be applied
prospectively with certain exceptions.  Other than those exceptions,  earlier or
retroactive  application  of its  accounting  provision  is not  permitted.  The
adoption  of FAS  No.  140 did  not  have a  material  impact  on the  Company's
financial statements.

     In June 2001, the Financial  Accounting Standards Board issued Statement of
Financial  Accounting Standard (SFAS) No. 141, Business  Combinations.  SFAS No.
141 requires  that all business  combinations  initiated  after June 30, 2001 be
accounted for under the purchase  method and  addresses the initial  recognition
and measurement of goodwill and other  intangible  assets acquired in a business
combination. Business combinations originally accounted for under the pooling of
interest method will not be changed.  Management does not expect the adoption of
SFAS 141 to have an impact on the financial  position,  results of operations or
cash flows of the Company.

     In June 2001, the Financial  Accounting Standards Board issued Statement of
Financial  Accounting  Standard  (SFAS) No. 142,  Goodwill and Other  Intangible
Assets.  SFAS No. 142  addresses  the initial  recognition  and  measurement  of
intangible assets acquired outside of a business  combination and the accounting
for goodwill and other intangible assets subsequent to their  acquisition.  SFAS
No. 142 provides  that  intangible  assets with finite useful lives be amortized
and that  goodwill  and  intangible  assets  with  indefinite  lives will not be
amortized,  but will rather be tested at least annually for  impairment.  As the
company  has no  goodwill  or  intangible  assets  which it is  amortizing,  the
adoption of SFAS No. 142 will have no effect on the financial position,  results
of operations or cash flows of the Company.

     In June 2001, the Financial  Accounting Standards Board issued Statement of
Financial  Accounting Standard (SFAS) No. 143,  "Accounting for Asset Retirement
Obligations."  SFAS  143  addresses  financial   accounting  and  reporting  for
obligations associated with the retirement of tangible long-lived assets and the
associated  asset  retirement  costs.  SFAS 143 is  effective  for fiscal  years
beginning  after June 15, 2002.  The Company is in the process of evaluating the
impact of implementing SFAS No. 143.

     In  August  2001,  the  FASB  issued  SFAS  No.  144,  "Accounting  for the
Impairment of Long-Lived Assets" which supercedes SFAS No. 121,  "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of"
and the  accounting  and  reporting  provisions  of APB No. 30,  "Reporting  the
Results of  Operations  -  Reporting  and  Effects of Disposal of a Segment of a
Business,  and  Extraordinary,  Unusual and  Infrequently  Occurring  Events and
Transactions"  for the  disposal of a segment of  business.  This  statement  is
effective  for fiscal years  beginning  after  December  15, 2001.  SFAS No. 144
retains  many  of  the  provisions  of  SFAS  No.  121,  but  addresses  certain
implementation  issues associated with that Statement.  The Company is currently
evaluating the impact of implementing SFAS No. 142.

                         LIQUIDITY AND CAPITAL RESOURCES

     The Company has  historically  financed  its  operations  from a variety of
sources.  These sources have included cash flow  generated  from the  investment
portfolio, including net interest income and principal payments and prepayments,
common  stock  offerings  through the  dividend  reinvestment  plan,  short-term
warehouse  lines of credit with  commercial  and  investment  banks,  repurchase
agreements and the capital markets via the asset-backed securities market (which
provides  long-term  non-recourse  funding of the  investment  portfolio via the
issuance of collateralized  bonds).  Historically,  cash flow generated from the
investment  portfolio has satisfied its working  capital needs,  and the Company
has had sufficient access to capital to fund its loan production operations,  on
both a short-term (prior to  securitization,  and recourse) and long-term (after
securitization,  and  non-recourse)  basis.  However,  market  conditions  since
October 1998 have  substantially  reduced the Company's  access to capital.  The
Company has been unable to access  short-term  warehouse  lines of credit,  and,
with the exception for the  resecuritization of seasoned loans in its investment
portfolio,  has been unable to efficiently  access the  asset-backed  securities
market to meet its long-term funding needs. Largely as a result of its inability
to access  additional  capital,  the Company sold its  manufactured  housing and
model  home  purchase/leaseback  operations  in 1999,  and  ceased  issuing  new
commitments in its commercial  lending  operations.  Since 1999, the Company has
focused on  substantially  reducing its recourse debt and minimizing its capital
requirements.  The  Company  has made  substantial  progress in both areas since
1999,  and  based  upon  its  expected  investment  portfolio  cash  flows,  and
anticipated  proceeds from the sale or  resecuritization  of assets, the Company
anticipates  that  it  will  repay  all  of its  recourse  debt  obligations  in
accordance with their respective terms.

     Non-recourse   Debt.   Dynex   REIT,   through    limited-purpose   finance
subsidiaries,  has issued non-recourse debt in the form of collateralized  bonds
to fund the majority of its  investment  portfolio.  The  obligations  under the
collateralized  bonds are payable solely from the collateral for  collateralized
bonds  and  are   otherwise   non-recourse   to  Dynex  REIT.   Collateral   for
collateralized  bonds is not subject to margin calls. The maturity of each class
of  collateralized   bonds  is  directly  affected  by  the  rate  of  principal
prepayments on the related collateral. Each series is also subject to redemption
according to specific  terms of the  respective  indentures,  generally when the
remaining  balance  of the bonds  equals 35% or less of the  original  principal
balance of the bonds.  At  September  30,  2001,  Dynex REIT had $2.4 billion of
collateralized bonds outstanding.

     Recourse  Debt.  The Company also uses  repurchase  agreements to finance a
portion of its  investments.  Repurchase  agreements  allow the  Company to sell
investments  for cash together with a  simultaneous  agreement to repurchase the
same  investments  on a specified date for a price that is equal to the original
sales price plus an interest  component.  At September 30, 2001, the Company had
repurchase  agreements  outstanding of $6.8 million,  all with Lehman  Brothers,
Inc. (Lehman).  These repurchase  agreements remain on an "overnight" or one-day
basis,  and were secured by cash in escrow of $5.8 million,  and securities with
an unpaid principal balance of approximately $88 million,  and an estimated fair
value of approximately  $62 million.  The majority of these securities are rated
investment  grade.  The  Company  expects  to repay all  outstanding  repurchase
agreements by the end of 2001.

     As of September 30, 2001, the Company has $58.0 million  outstanding of its
senior notes issued in July 1997 and due July 15, 2002 (the "July 2002  Notes").
On March  30,  2001,  the  Company  entered  into an  amendment  to the  related
indenture  governing the July 2002 Notes (the "Supplemental  Indenture") whereby
the Company pledged to the Trustee of the July 2002 Notes  substantially  all of
the  Company's  unencumbered  assets  and  the  stock  of its  subsidiaries.  In
consideration  of this pledge,  the indenture was further amended to provide for
the release of the Company from certain covenant  restrictions in the indenture,
and specifically provided for the Company's ability to make distributions on its
capital  stock in an amount  not to exceed the sum of (a) $26  million,  (b) the
cash  proceeds  of any  "permitted  subordinated  indebtedness",  (c)  the  cash
proceeds  of  the  issuance  of any  "qualified  capital  stock",  and  (d)  any
distributions  required in order for the Company to  maintain  its REIT  status.
Pursuant  to its  settlement  with ACA (see Item 1 below),  the  Company  is not
permitted to make any further  distributions  on its capital  stock  pursuant to
clause (a) above.  In addition,  the Company  entered into a Purchase  Agreement
with  holders  of 50.1% of the July 2002  Notes  which  require  the  Company to
purchase,  and such holders to sell, their respective July 2002 Notes at various
discounts based on a computation of the Company's  available cash. The discounts
provided for under the  Purchase  Agreement  are as follows:  by April 15, 2001,
10%; by July 15, 2001,  8%; by October 15, 2001, 6%; by January 15, 2002, 4%; by
March 1, 2002, 2%;  thereafter until maturity,  0%. Through  September 30, 2001,
the Company has retired $39,281 of July 2002 Notes for $35,549 in cash under the
Purchase Agreement.

     The  Company's   ability  to  incur   additional   indebtedness   has  been
substantially limited by the Supplemental Indenture.  After the repayment of its
repurchase  agreement  obligations,  the  only  remaining  recourse  debt of the
Company will be the July 2002 Notes. Based on a pro forma analysis of cash flows
from its investment portfolio and proceeds from the call and resecuritization of
certain of its collateralized bond securities,  the Company anticipates that the
July 2002  Notes will be repaid in  accordance  with  their  contractual  terms,
although no assurances can be given of such repayment. A portion of the proceeds
for repayment of the July 2002 Notes will result from proceeds received from the
call and  resecuritization  of one  series of  collateralized  bond  obligations
currently  outstanding.  Such  series is  collateralized  primarily  by seasoned
single-family ARM loans. To the extent that there are significant disruptions in
the capital markets,  the Company's ability to call such series and resecuritize
the underlying loans may be inhibited.

     During the quarter ending  September 30, 2001 the Company called and resold
one series of  collateralized  bonds.  This  series of  collateralized  bonds is
collateralized  principally by adjustable-rate  single-family mortgage loans and
securities.  As a result  of this  call  and  resale  the  Company  incurred  an
extraordinary  loss of $1.0 million related to the write-off of unamortized bond
issue costs and discounts on the called series.

                                     Table 1
                              Net Balance Sheet(1)
                                ($ in thousands)



                                                                   September 30,
                                                                       2001
                                                                   -------------
ASSETS
Investments:
   Collateral for collateralized bonds                              $ 2,558,555
   Less:  Collateralized bonds issued                                (2,460,584)
                                                                   -------------
                                                                      
     Net investment in collateralized bonds                              97,971
   Collateralized bonds retained                                         75,647
   Securities                                                             5,162
   Other investments                                                     34,143
   Loans held for sale                                                    2,891
                                                                   -------------
                                                                        215,814

   Cash, including restricted                                            18,071
   Accrued interest receivable                                              292
   Other assets                                                          14,802
                                                                   -------------
    Total Assets                                                   $    248,979
                                                                   =============

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
   Repurchase agreements                                           $      6,823
   Notes payable                                                         58,141
   Accrued interest payable                                                 958
   Other liabilities                                                      1,715
                                                                   -------------
    Total Liabilities                                                     67,637
                                                                   -------------

Shareholders' Equity:
   Preferred stock, par value $.01 per share                            106,975

Common stock, par value $.01 per share,                                     114
   Additional paid-in capital                                           361,469
   Accumulated other comprehensive loss                                 (94,738)
   Accumulated deficit                                                 (192,478)
                                                                   -------------
    Total Shareholders' Equity                                          181,342
                                                                   -------------
    Total Liabilities and Shareholders' Equity                     $    248,979
                                                                   =============


(1)  This presents the balance sheet where the collateralized bonds are "netted"
     against the collateral for collateralized bonds. This presentation better
     illustrates the Company's net investment in the collateralized bonds and
     the collateralized bonds retained in its investment portfolio.



                           FORWARD-LOOKING STATEMENTS

     Certain written statements in this Form 10-Q made by the Company,  that are
not historical fact constitute  "forward-looking  statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such forward-looking statements may
involve  factors  that could  cause the actual  results of the Company to differ
materially from historical  results or from any results  expressed or implied by
such  forward-looking  statements.  The Company cautions the public not to place
undue reliance on forward-looking statements,  which may be based on assumptions
and anticipated events that do not materialize.  The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.

     Factors that may cause actual results to differ from historical  results or
from any results expressed or implied by forward-looking  statements include the
following:

     Economic   Conditions.   The  Company  is  affected  by  general   economic
conditions.  The risk of defaults  and credit  losses could  increase  during an
economic  slowdown  or  recession.  This  could  have an  adverse  effect on the
Company's financial performance and the performance on the Company's securitized
loan pools.

     Capital  Resources.  The Company  relies on a repurchase  facility  with an
investment-banking  firm to meet its remaining  short-term  funding needs.  This
repurchase  facility is currently on an overnight  maturity basis. The Company's
access to alternative or additional  sources of financing has been significantly
reduced.

     Capital  Markets.  The Company  relies on the capital  markets for the sale
upon  securitization of its  collateralized  bonds or other types of securities.
While the Company has historically been able to sell such  collateralized  bonds
and securities into the capital markets, the Company's access to capital markets
has been  substantially  reduced,  which may  impair  the  Company's  ability to
re-securitize its existing securitizations in the future.

     Interest Rate Fluctuations.  The Company's income depends on its ability to
earn greater interest on its investments than the interest cost to finance these
investments.  Interest rates in the markets served by the Company generally rise
or fall with  interest  rates as a whole.  A  majority  of the  loans  currently
pledged as collateral for  collateralized  bonds by the Company are  fixed-rate.
The Company  currently  finances these  fixed-rate  assets through  non-recourse
debt,  $195.5  million of which is variable  rate.  In addition,  a  significant
amount of the  investments  held by the Company are variable rate collateral for
collateralized  bonds.  These  investments  are  financed  through  non-recourse
long-term  collateralized  bonds and, to a lesser  extent,  recourse  short-term
repurchase  agreements.  The net  interest  spread for these  investments  could
decrease during a period of rapidly rising short-term  interest rates, since the
investments generally have periodic interest rate caps and the related borrowing
have no such  interest  rate caps.

     Defaults.  Defaults  by  borrowers  on  loans  included  in  the  Company's
investment  portfolio  may have an  adverse  impact on the  Company's  financial
performance,  if actual credit losses differ  materially  from estimates made by
the Company.  The  Company's  allowance for losses is calculated on the basis of
historical experience, industry data, and management's estimates. Actual default
rates or loss severities may differ from the Company's estimate for a variety of
reasons,  including economic conditions.  Defaults on the Company's manufactured
housing  loans have been  higher  than the  Company's  prior  estimates.  Actual
defaults on ARM loans may increase  during a rising  interest rate  environment.
The Company believes that its reserves are adequate for such risks on loans that
were delinquent as of September 30, 2001.

     Prepayments.  Prepayments by borrowers on loans  securitized by the Company
may have an adverse impact on the Company's financial  performance.  Prepayments
are expected to increase  during a declining  interest  rate or flat yield curve
environment.  The Company's  exposure to rapid  prepayments is primarily (i) the
faster amortization of premium on the investments and, to the extent applicable,
amortization of bond discounts, and (ii) the more rapid decline in its portfolio
of earning  assets.

     Competition.  The  financial  services  industry  is a  highly  competitive
market.  Increased competition in the market has adversely affected the Company,
and may continue to do so.

     Regulatory Changes.  The Company's  businesses as of September 30, 2001 are
not  subject  to  any  material   federal  or  state   regulation  or  licensing
requirements.  However,  changes  in  existing  laws and  regulations  or in the
interpretation  thereof, or the introduction of new laws and regulations,  could
adversely  affect the Company and the  performance of the Company's  securitized
loan pools or its ability to collect on its delinquent property tax receivables.

     Risks and  Uncertainties.  See Note 1 to the  Company's  audited  financial
statements  for the year ended  December  31,  2000.

        Item 3.  QUANTITATIVE  AND QUALITATIVE  DISCLOSURES ABOUT MARKET RISK

     Market risk generally  represents the risk of loss that may result from the
potential  change in the value of a financial  instrument due to fluctuations in
interest and foreign exchange rates and in equity and commodity  prices.  Market
risk is inherent to both derivative and  non-derivative  financial  instruments,
and  accordingly,  the scope of the  Company's  market risk  management  extends
beyond derivatives to include all market risk sensitive  financial  instruments.
As a financial  services  company,  net interest  income  comprises  the primary
component of the Company's earnings. As a result, the Company is subject to risk
resulting  from  interest  rate  fluctuations  to the extent that there is a gap
between the amount of the  Company's  interest-earning  assets and the amount of
interest-bearing  liabilities  that  are  prepaid,  mature  or  re-price  within
specified  periods.  The Company's  strategy has been to mitigate  interest rate
risk through the creation of a diversified  investment portfolio of high quality
assets  that,  in the  aggregate,  preserves  the  Company's  capital base while
generating   stable  income  in  a  variety  of  interest  rate  and  prepayment
environments.

     The Company  monitors  the  aggregate  cash flow,  projected  net yield and
market  value  of its  investment  portfolio  under  various  interest  rate and
prepayment  assumptions.  While  certain  investments  may perform  poorly in an
increasing  or decreasing  interest  rate  environment,  other  investments  may
perform  well,  and others may not be impacted at all.

     The Company measures the sensitivity of its net interest income,  excluding
various accounting  adjustments  including provision for losses, and premium and
discount  amortization,  to changes in interest rates. Changes in interest rates
are defined as instantaneous, parallel, and sustained interest rate movements in
100 basis point  increments.  The Company  estimates its interest income for the
next  twenty-four  months  assuming no changes in  interest  rates from those at
period end. Once the base case has been estimated,  cash flows are projected for
each of the defined  interest rate  scenarios.  Those scenario  results are then
compared against the base case to determine the estimated change to net interest
income,  excluding  various  accounting  adjustments  as set  forth  above.

     The  following   table   summarizes  the  Company's  net  interest   margin
sensitivity  analysis  as  of  September  30,  2001.  This  analysis  represents
management's  estimate of the percentage  change in net interest  margin given a
parallel shift in interest  rates.  The "Base" case represents the interest rate
environment  as it existed as of  September  30,  2001.  The analysis is heavily
dependent  upon the  assumptions  used in the  model.  The  effect of changes in
future  interest  rates,  the shape of the yield  curve or the mix of assets and
liabilities  may cause  actual  results to differ from the modeled  results.  In
addition,  certain financial  instruments provide a degree of "optionality." The
most  significant  option  affecting the Company's  portfolio is the  borrowers'
option to prepay  the  loans.  The model  applies  prepayment  rate  assumptions
representing  management's  estimate of prepayment activity on a projected basis
for each collateral pool in the investment portfolio. The model applies the same
prepayment rate  assumptions for all five cases indicated  below.  The extent to
which  borrowers  utilize the ability to exercise  their option may cause actual
results to significantly  differ from the analysis.  Furthermore,  its projected
results assume no additions or subtractions to the Company's  portfolio,  and no
change to the  Company's  liability  structure.  Historically,  there  have been
significant  changes  in the  Company's  assets and  liabilities,  and there are
likely to be such  changes in the future.



            Basis Point Increase (Decrease)        % Change in Net Interest
                   In Interest Rates                 Margin from Base Case
            -------------------------------        ------------------------

                                                             
                        +200                                   (7.6)%
                        +100                                   (3.8)%
                        Base
                        -100                                    3.8%
                        -200                                    7.6%


     The Company's investment policy sets forth guidelines for assuming interest
rate  risk.  The  investment  policy  stipulates  that  given a 200 basis  point
increase or decrease in interest rates over a twelve month period, the estimated
net  interest  margin may not change by more than 25% of  current  net  interest
margin during the subsequent one year period.  The Company is in compliance with
such investment policy.

     Approximately  $779  million of the  Company's  investment  portfolio as of
September  30, 2001 is comprised of loans or  securities  that have coupon rates
which adjust over time (subject to certain periodic and lifetime limitations) in
conjunction with changes in short-term interest rates. Approximately 66% and 22%
of the ARM loans  underlying  the Company's ARM  securities  and  collateral for
collateralized  bonds are indexed to and reset based upon the level of six-month
LIBOR and one-year CMT, respectively.

     Generally,  during  a period  of  rising  short-term  interest  rates,  the
Company's net interest spread earned on its investment  portfolio will decrease.
The  decrease of the net interest  spread  results from (i) the lag in resets of
the ARM loans  underlying the ARM  securities and collateral for  collateralized
bonds  relative to the rate resets on the  associated  borrowings  and (ii) rate
resets on the ARM loans which are generally limited to 1% every six months or 2%
every  twelve  months  and  subject  to  lifetime  caps,  while  the  associated
borrowings have no such limitation.  As short-term  interest rates stabilize and
the ARM loans reset, the net interest margin may be restored to its former level
as the  yields on the ARM loans  adjust to market  conditions.  Conversely,  net
interest margin may increase following a fall in short-term interest rates. This
increase  may be  temporary  as the  yields on the ARM  loans  adjust to the new
market conditions after a lag period. In each case, however, the Company expects
that the increase or decrease in the net  interest  spread due to changes in the
short-term  interest rates to be temporary.  The net interest spread may also be
increased or decreased  by the proceeds or costs of interest  rate swap,  cap or
floor  agreements,  to the  extent  that  the  Company  has  entered  into  such
agreements.

     The  remaining  portion  of  the  Company's  investments  portfolio  as  of
September  30,  2001,  approximately  $1.80  billion,  is  comprised of loans or
securities that have coupon rates that are fixed. The Company has  substantially
limited its interest rate risk on such  investments  through (i) the issuance of
fixed-rate  collateralized  bonds  and notes  payable  which  approximated  $1.4
billion as of September  30, 2001,  and (ii) equity,  which was $181.3  million.
Overall,  the Company's 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.


PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

     On November 7, 2000,  the Company  entered  into an  Agreement  and Plan of
Merger with California  Investment Fund, LLC ("CIF"), for the purchase of all of
the equity  securities of the Company for $90 million (the "Merger  Agreement").
The Merger Agreement was  subsequently  amended on December 22, 2000 as a result
of a breach of the  requirements  of the Merger  Agreement by CIF in  delivering
sufficient evidence of a financing commitment. Among other things, the amendment
to the Merger Agreement  obligated CIF to deliver to the Company written binding
financing  commitments  and  evidence  of the consent of the holders of the July
2002 Notes to the merger  transaction  on or before January 25, 2001. On January
25,  2001,  CIF  failed  to meet the  requirements  as set  forth in the  Merger
Agreement and the letter of December 22, 2000,  and the Company  terminated  the
Merger Agreement  effective January 26, 2001 and requested that the escrow agent
release to the Company the $1 million and 572,178  shares of common stock of the
Company  which CIF placed in escrow  under the  Merger  Agreement  (the  "Escrow
Amount").  On January 29, 2001,  the Company filed for  Declaratory  Judgment in
United States  District Court for the Eastern  District of Virginia,  Alexandria
Division (the "Court").  CIF filed a counterclaim  and demand for jury trial and
asked for damages of $45  million.  The Court  subsequently  capped CIF's damage
claim to $2 million as set forth in the Merger  Agreement and held a jury trial.
On October 16, 2001, the jury returned a verdict whwhich would result in (i) the
escrow amount  consisting of $1 million and 572,178 shares of common stock being
awarded to the Company, and (ii) the Company having to pay CIF a termination fee
of $2  million.  The  Court  has yet to  enter  judgment  pending  its  decision
regarding motions filed by the two parties.  Assuming the Court upholds the jury
verdict on the $2 million  termination  fee the Company will most likely appeal.
Neither  the  receipt  of the escrow  amount  nor the  payment of the $2 million
termination fee has been accrued for in the accompanying financial statements.

     GLS Capital,  Inc. ("GLS"), a subsidiary of the Company,  together with the
County of Allegheny,  Pennsylvania  ("Allegheny  County"),  were defendants in a
lawsuit in the Commonwealth  Court of Pennsylvania  (the  "Commonwealth  Court")
wherein  the  plaintiffs  challenged  the right of  Allegheny  County and GLS to
collect certain interest,  costs and expenses related to delinquent property tax
receivables in Allegheny County. This lawsuit was related to the purchase by GLS
of delinquent  property tax receivables from Allegheny County in 1997, 1998, and
1999 for approximately  $58.3 million.  On July 5, 2001, the Commonwealth  Court
ruling addressed,  among other things, (i) the right of the Company to charge to
the  delinquent  taxpayer a rate of interest of 12% versus 10% on the collection
of its delinquent property tax receivables, (ii) the charging of attorney's fees
to the delinquent taxpayer for the collection of such tax receivables, and (iii)
the charging to the  delinquent  taxpayer of certain  other fees and costs.  The
Commonwealth  Court  remanded for further  consideration  to the Court of Common
Pleas items (i) and (iii),  and ruled that neither  Allegheny County nor GLS had
the right to charge  attorney's fees to the delinquent  taxpayer  related to the
collection  of such  tax  receivables,  reversing  the  Court  of  Common  Pleas
decision.  On  September  10th the  Commonwealth  Court  denied  the  County  of
Allegheny and GLS's Application for Re-argument.  The Pennsylvania Supreme Court
has accepted the Application for Extraordinary  Jurisdiction  filed by Allegheny
County  and GLS.  No  damages  have been  claimed  in the  action;  however,  as
discussed in Note 4, the decision may impact the ultimate  recoverability of the
delinquent property tax receivables. To date, GLS has incurred attorneys fees of
approximately  $2,000 related to foreclosures  on such  delinquent  property tax
receivables,  approximately  $1,000 of which have been  reimbursed to GLS by the
taxpayer or through liquidation of the underlying real property.

     On May 4, 2001, ACA Financial  Guaranty  Corporation  ("ACA")  commenced an
action in the United States District Court for the Southern District of New York
(the "District Court"), (the "Action"), in which ACA sought injunctive relief as
well as money  damages of $25 million  based on causes of action for  fraudulent
conveyance and breach of contract. The complaint challenged, among other things,
the  validity of the March 30, 2001  Supplemental  Indenture  to the 1997 Senior
Note  Indenture as amended ("1997  Indenture")  discussed in Note 5, pursuant to
which in 1997 Dynex issued its 7.875% Senior Notes due July 2002. In particular,
the  complaint  challenged  the validity,  among other  things,  of the Purchase
Agreement,  and the Supplemental  Indenture and the related amendment to certain
restrictive  covenants in the  Indenture to allow for certain  distributions  to
holders of Dynex equity  securities,  including  the Preferred  Stock.  ACA is a
financial  guaranty  company  who has insured $25 million of the July 2002 Notes
for repayment at maturity on July 15, 2002, for the benefit of the holder of the
Notes.  The Company is not a party to this  insurance  contract.  On October 31,
2001,  the  Company and ACA settled  this  matter out of court.  The  settlement
provides  for,  among other things,  that the Company could  complete the tender
offer of Preferred Stock announced on September 6, 2001 (and subsequently funded
on November 2, 2001),  but that the Company would  generally not be permitted to
make further  distributions  on its capital  stock until the July 2002 Notes are
repaid or defeased.

     The Company is also  subject to other  lawsuits or claims which have arisen
in the ordinary  course of its  business,  some of which seek damages in amounts
which could be material to the financial  statements.  Although no assurance can
be given with respect to the ultimate  outcome of any such  litigation or claim,
the Company  believes the  resolution of such lawsuits or claims will not have a
material  effect  on  the  Company's   consolidated  balance  sheet,  but  could
materially affect consolidated results of operations in a given year.

Item 2.  Changes in Securities and Use of Proceeds

         Not applicable

Item 3.  Defaults Upon Senior Securities

         Not applicable

Item 4.  Submission of Matters to a Vote of Security Holders

         Not applicable

Item 5.  Other Information

         None

Item 6.  Exhibits and Reports on Form 8-K

         (a)  Exhibits

              Exhibit 10.8.  Terms of Employment between Dynex Capital, Inc. and
                             Mr. Thomas H. Potts, dated September 4, 2001.

              Exhibit 10.9.  Terms of Employment between Dynex Capital, Inc. and
                             Mr. Stephen J. Benedetti, dated September 4, 2001.

         (b)  Reports on Form 8-K


                                   SIGNATURES

     Pursuant to the  requirements  of the Securities  Exchange Act of 1934, the
registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.

                                      DYNEX CAPITAL, INC.




                                      By:   /s/ Thomas H. Potts
                                           ------------------------------------
                                           Thomas H. Potts, President
                                           (authorized officer of registrant)




                                            /s/ Stephen J. Benedetti
                                           ------------------------------------
                                           Stephen J. Benedetti, Chief Financial
                                           Officer, Executive Vice President,
                                           and Treasurer
                                           (principal accounting officer)

Dated:  November 14, 2001