Dynex Capital, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Dynex is a mortgage REIT investing primarily in Agency and non-Agency mortgage-backed securities, financed largely with repurchase agreements. Unless noted, dollar amounts below are in millions.
Financial performance and position
| Metric | Q2 2019 / June 30, 2019 | Comparable period / prior date |
|---|---|---|
| Interest income | $43.7 | $25.9 in Q2 2018 |
| Net interest income | $12.9 | $11.7 in Q2 2018; $13.7 in Q1 2019 |
| Net loss to common shareholders | $(122.2); $(4.98) per share | Q2 2018 income of $12.7; $0.68 per share |
| Comprehensive loss to common shareholders | $(11.1) | Q2 2018 income of $3.0 |
| Core net operating income to common shareholders (non-GAAP) | $10.6; $0.43 per share | $12.1; $0.53 per share in Q1 2019 |
| Net interest spread | 0.76% | 1.07% in Q2 2018 |
| Total assets / shareholders’ equity | $5,868.9 / $598.6 | $3,886.1 / $527.2 at December 31, 2018 |
| Repurchase agreements | $4,815.5 at a 2.69% weighted-average rate | $3,268.0 at December 31, 2018 |
| Book value per common share | $17.68 | $18.71 at March 31, 2019 |
| Most liquid assets | $198.2 | $210.8 at December 31, 2018 |
For the six months ended June 30, net interest income was $26.6 versus $25.3 in 2018; net loss to common shareholders was $177.5 versus income of $54.1. Operating cash flow was $84.9, investing cash flow was $(1,647.3), and financing cash flow was $1,585.0. Cash, cash equivalents and restricted cash ended the period at $111.4, up $22.6 from year-end. These cash flows reflect substantial securities purchases and repurchase-agreement activity.
Material changes and unusual items
- The portfolio expanded: mortgage-backed securities increased to $5,713.8 from $3,749.5 at year-end. Repurchase financing also rose substantially.
- Q2 derivative losses were $117.5, driven mainly by losses on interest-rate swaps as rates fell; the six-month derivative loss was $179.2. A $111.1 Q2 gain in other comprehensive income, primarily unrealized gains on MBS, partly offset the quarterly comprehensive loss.
- Higher funding costs and a flattening/inverted yield curve pressured spreads. Management also cited faster Agency RMBS prepayments, increased premium amortization, lower CMBS IO prepayment compensation, and reduced TBA dollar-roll income. Q2 net interest income declined $0.7 from Q1 despite a larger portfolio.
- Book value fell $1.03 per share during Q2; including the $0.54 dividend, quarterly total economic return was a loss of $0.49 per share, or 2.6%.
- On June 20, the company effected a 1-for-3 reverse split of common stock. During the first half, it issued approximately $76.9 of common and preferred equity, net of expenses. Preferred shares outstanding increased to 6.5 million from 6.0 million at year-end.
Outlook, risks and contingencies
- Management expected a lower-rate environment, with the 10-year Treasury yield spending substantial time in a 2%–3% range and potentially ranging 1.5%–2.5% near term. Management noted that multiple Federal Funds Rate cuts were priced into markets, but the timing of lower funding costs remained important.
- Management expected the Board to reduce the common dividend to $0.15 per month beginning with the dividend to be declared in August, citing elevated short-term funding costs and expected high prepayments. The filing separately reports a July 8 declaration of $0.18 per share payable August 1.
- Leverage was 9.4 times shareholders’ equity including TBA dollar-roll positions at cost, versus 8.0 times at year-end. The company said leverage remained within Board limits and liquidity was adequate, while acknowledging increased exposure to adverse markets and reduced capacity to absorb margin calls.
- Key risks include short-term, generally uncommitted repo funding and renewal risk; collateral margin calls; interest-rate, yield-curve, spread, prepayment, reinvestment and credit risks; TBA settlement liquidity; and possible reduced market liquidity or financing availability. The company reported compliance with repo covenants at June 30 and no material off-balance-sheet arrangements identified.
- Previously disclosed litigation and a DCI garnishment action remained ongoing, with no material developments during the quarter. Management reported no other known pending or threatened proceedings expected to have a material adverse effect.
- The company estimated an $89.8 tax NOL carryforward at June 30, beginning to substantially expire in 2020. It did not expect adoption of the expected-credit-loss standard to materially affect its financial statements, given its predominantly Agency MBS portfolio.
Important facts for investors to verify
- Whether the anticipated common-dividend reduction occurred and how it affects dividend coverage and total return.
- Subsequent changes in book value, portfolio prepayments, MBS spreads, swap valuation and net interest margins.
- Leverage, unencumbered liquidity, repo counterparties and refinancing capacity, especially under market stress or increased margin requirements.
- Performance and risk of the growing Agency CMBS allocation, as well as the effects of the 1-for-3 reverse split and equity issuance on per-share measures.
- How much of reported earnings and cash generation reflects recurring investment income versus derivative fair-value movements, securities sales and financing activity; core net operating income is a non-GAAP measure.