Dynex Capital, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Dynex is an internally managed mortgage REIT investing primarily in leveraged Agency mortgage-backed securities (MBS) and TBA securities.
Financial performance and position
| Metric | Q2 2023 / June 30, 2023 | Comparison |
|---|---|---|
| Interest income; interest expense | $42.2 million; $45.1 million | Q2 2022: $18.3 million; $4.3 million |
| Net interest income (expense) | $(2.9) million; net interest spread of (1.62)% | Q2 2022: $14.1 million |
| Net income; net income to common shareholders | $54.3 million; $52.4 million | Q2 2022: $29.3 million; $27.4 million |
| Diluted EPS; common dividend declared | $0.96; $0.39 per share | Q2 2022: $0.69; $0.39 per share |
| Comprehensive income to common shareholders | $43.0 million | Q2 2022: loss of $33.5 million |
| MBS at fair value; total assets | $5.06 billion; $5.53 billion | December 31, 2022: $3.11 billion; $3.61 billion |
| Repurchase borrowings; shareholders’ equity | $4.20 billion; $881.0 million | December 31, 2022: $2.64 billion; $901.3 million |
| Book value per common share | $14.20 | $13.80 at March 31, 2023 |
Q2 total economic return was $0.79 per common share, comprising the $0.39 dividend and a $0.40 increase in book value. For the first half, net income was $12.6 million and net income to common shareholders was $8.8 million, versus $146.5 million and $142.7 million, respectively, in first-half 2022; diluted EPS was $0.16 versus $3.72. First-half dividends declared were $0.78 per common share.
Q2 derivative gains were $116.0 million, including $171.2 million on U.S. Treasury futures, while investment fair-value changes and sales resulted in losses. Net realized investment sale losses were $51.6 million in Q2 and $74.9 million for the first half. Management attributed hedge gains in Q2 to rising rates and said they helped offset MBS valuation declines.
For the six months, operating cash flow was $35.2 million, investing cash flow was $(1.57) billion, and financing cash flow was $1.52 billion. Cash, including cash posted to counterparties, decreased $17.1 million to $432.8 million. Management reported most liquid assets of $561.5 million, down from $632.3 million at year-end.
Material changes and outlook
- Higher Federal Funds rates raised financing costs: the weighted-average repo rate increased to 5.26% from 4.18% at year-end. First-half net interest income shifted from $29.8 million in 2022 to a $3.4 million expense in 2023.
- The portfolio expanded, with MBS fair value rising to $5.06 billion. Dynex shifted toward higher-coupon Agency RMBS and reduced TBA exposure compared with year-end.
- Repo borrowings rose to $4.20 billion. Leverage was 7.7 times shareholders’ equity using management’s measure including TBA cost basis, and 4.8 times based on repo borrowings. Repo facilities are principally uncommitted; the Wells Fargo committed facility matured June 8, 2023 and was not extended.
- Management expects spread volatility to persist in the short to intermediate term, while describing spread widening as an investment opportunity. It intends to maintain flexibility and higher liquidity, continue purchasing MBS with attractive yields, and adjust investments, hedges, and leverage as conditions warrant. Longer term, management expects potential returns from spread tightening, but provided no formal earnings or dividend guidance.
- Q2 GAAP results included volatile investment and derivative fair-value effects. Management’s non-GAAP earnings available for distribution (EAD) was a loss of $0.27 per common share in Q2; EAD is not GAAP earnings or a direct measure of REIT taxable income.
Risks, contingencies, and other disclosures
- Key exposures include interest-rate and spread movements, prepayment speeds, repo renewal and margin-call risk, liquidity, and the ability to roll or settle TBA positions. A modeled parallel 100-basis-point rate increase implied a 10.3% decline in common equity; modeled spread widening implied a 10.8% decline. These sensitivities depend on assumptions and are not forecasts.
- Repo financing is recourse and generally lacks guaranteed renewal. The company reported compliance with financing covenants, no material difficulty obtaining financing, and no counterparty exposure above 5% of equity at risk.
- Management reported no pending lawsuits or contingencies expected to have a material adverse effect, and no material changes to the risk factors in the 2022 Form 10-K. Disclosure controls were reported effective.
- Dynex estimated $649.7 million of net deferred tax hedge gains to be recognized as taxable income over future periods, including $36.1 million in the second half of 2023. It said the effect on dividend declarations cannot be reasonably estimated.
Important facts for investors to verify
- Whether higher repo funding costs continue to exceed portfolio yields, and how this affects net interest income and dividend coverage.
- Changes in book value, MBS spreads, hedge effectiveness, and the sensitivity of equity to rate and spread shocks.
- Available liquidity, repo renewals and haircuts, margin requirements, and exposure to TBA settlement obligations.
- How portfolio growth, leverage, and the shift toward higher-coupon assets affect risk and returns.
- The distinction between GAAP income, EAD, and REIT taxable income when assessing distributions, including the timing of deferred hedge gains.