Dynex Capital, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Dynex is an internally managed mortgage REIT investing primarily in Agency and non-Agency mortgage-backed securities (MBS), financed mainly with repurchase agreements. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2019 / Sep. 30, 2019 | Comparable period / prior date |
|---|---|---|
| Interest income | $44.5 million | $26.9 million in Q3 2018 |
| Interest expense | $31.3 million | $14.8 million in Q3 2018 |
| Net interest income | $13.2 million; net interest spread 0.82% | $12.2 million; 1.08% in Q3 2018 |
| Net loss to common shareholders | $39.9 million; $1.65 loss per share | $22.6 million income; $1.18 per share in Q3 2018 |
| Comprehensive income to common shareholders | $15.3 million | $0.7 million in Q3 2018 |
| Non-GAAP core net operating income | $11.5 million; $0.48 per share | $10.6 million; $0.43 per share in Q2 2019 |
| Total assets / shareholders’ equity | $5.487 billion / $584.4 million | $3.886 billion / $527.2 million at Dec. 31, 2018 |
| MBS / repurchase agreements | $5.303 billion / $4.873 billion | $3.749 billion / $3.268 billion at Dec. 31, 2018 |
| Cash and restricted cash | $138.9 million combined; $41.8 million unrestricted | $113.6 million combined at year-end 2018 |
| Book value per common share | $18.07 | $17.68 at June 30, 2019; $18.07 at Dec. 31, 2018 |
For the nine months, net interest income was $39.9 million versus $37.5 million in 2018, while net loss to common shareholders was $217.4 million versus income of $76.7 million. Net interest spread declined to 0.87% from 1.23%. Derivative losses were $50.7 million for the quarter and $229.9 million year to date; these were substantially offset in comprehensive income by MBS unrealized gains recorded in OCI of $55.2 million and $252.8 million, respectively.
Nine-month cash flows included $122.1 million provided by operating activities, $1.680 billion used in investing activities, and $1.608 billion provided by financing activities. These large investing and financing flows reflect portfolio activity and substantial repo borrowing and repayment turnover; they should not be read as ordinary operating cash generation alone.
Changes and capital actions
- The MBS portfolio expanded materially from year-end 2018, especially Agency CMBS; the company reported $5.303 billion of MBS at fair value at September 30.
- Repo borrowings rose to $4.873 billion from $3.268 billion. Including TBA net-long positions at cost, leverage was 9.1 times shareholders’ equity, up from 8.0 times at year-end.
- The company reduced its interest-rate-swap notional to $3.88 billion from $4.515 billion at year-end and lowered its weighted-average pay rate.
- In Q3, Dynex repurchased 1.71 million common shares for $25.0 million at an average $14.65 per share. It had $15.0 million remaining under its $40 million authorization at September 30.
- A 1-for-3 reverse common-stock split took effect June 20, 2019; share and per-share figures in the filing are adjusted for it.
Outlook, risks and other matters
- Management’s stated view was that the 10-year U.S. Treasury yield would remain in a 1.5%–2.5% range for the foreseeable future. Management identified a rapid decline below 1.5% as a risk because faster RMBS prepayments could reduce net interest earnings. This is an outlook, not formal earnings guidance.
- Management expected repo rates to decline in Q4 2019 versus Q3, while remaining somewhat elevated relative to their historical relationship with the Federal Funds rate. It cited funding-market constraints and noted Federal Reserve liquidity operations were expected to continue through the remainder of 2019.
- Key exposures include interest-rate and spread movements, mortgage prepayments and reinvestment, credit, leverage, and liquidity. Repo financing is predominantly short-term, uncommitted, and renewable at lenders’ discretion; margin calls or non-renewal could pressure liquidity. The company reported compliance with repo covenants at September 30 and said it believed liquidity and repo capacity were adequate.
- Management reported $198.4 million of most-liquid assets, down from $210.8 million at year-end 2018, and $97.2 million of cash posted as collateral. About 88% of common dividends declared in the first nine months were expected to be treated as return of capital, principally due to tax hedge losses. The estimated $89.8 million REIT NOL carryforward begins to substantially expire in 2020.
- Management reported that the DCI Plaintiffs’ fraudulent-transfer and alter-ego claims were dismissed with prejudice on October 28, 2019. A separate cost-sharing case remained pending. Dynex considered the matters without merit and did not expect a material adverse effect, but noted outcomes cannot be predicted with certainty.
- The board declared a $0.15 per-share common dividend on October 11, payable November 1, 2019. No material change in internal controls was reported, and management concluded disclosure controls were effective.
Important facts for investors to verify
- How much of reported earnings and book-value volatility is driven by derivative fair-value changes versus portfolio interest earnings; review the company’s non-GAAP core-income reconciliation alongside GAAP results.
- Whether repo funding costs, collateral haircuts, counterparty availability, and margin requirements remain manageable given 9.1x leverage including TBA net-long positions.
- Whether prepayments, reinvestment yields, and the rate outlook match management’s assumptions, particularly if long-term rates fall below its stated range.
- The sustainability and tax character of common dividends, including the NOL expiration schedule and deferred tax hedge losses.
- Developments in the pending cost-sharing litigation and any resulting change in the company’s assessment of potential exposure.