Dynex Capital, Inc. 10-Q Summary
Period: First quarter ended March 31, 2014; unaudited. Financial statement amounts below are in millions of dollars unless otherwise noted. Dynex is a leveraged mortgage REIT investing primarily in Agency and non-Agency mortgage-backed securities (MBS).
Financial performance and position
| Metric | Q1 2014 | Comparable period / prior date |
|---|---|---|
| Interest income | $27.6 | $33.0 in Q1 2013 |
| Net interest income | $20.0 | $22.5 in Q1 2013 |
| GAAP net income (loss) to common shareholders | $(3.0); $(0.06) per share | $18.4; $0.34 per share in Q1 2013 |
| Core net operating income to common shareholders, non-GAAP | $13.7; $0.25 per share | $17.0; $0.31 per share in Q1 2013 |
| Adjusted net interest spread, non-GAAP | 1.88% | 1.87% in Q1 2013; 1.77% in Q4 2013 |
| Effective borrowing rate, non-GAAP | 0.86% | 1.17% in Q1 2013 |
| Comprehensive income to common shareholders | $26.5 | $27.4 in Q1 2013 |
Lower asset yields and a smaller average interest-earning asset balance reduced net interest income year over year. GAAP results also reflected a $13.4 million net derivative loss and a $3.3 million net loss on investment sales. The derivative loss includes fair-value changes following Dynex’s discontinuation of cash-flow hedge accounting in June 2013; it should not be read as equivalent to the company’s core operating measure. Core net operating income is a company-defined non-GAAP measure, not a substitute for GAAP results.
Other comprehensive income was $29.6 million, largely reflecting higher MBS fair values. Book value per common share increased to $8.87 from $8.69 at December 31, 2013, according to management.
| Balance-sheet and liquidity measure | March 31, 2014 | December 31, 2013 |
|---|---|---|
| Total assets | $4,144.3 | $4,217.1 |
| Repurchase agreements | $3,485.5 | $3,580.8 |
| Total liabilities | $3,545.3 | $3,631.3 |
| Shareholders’ equity | $599.0 | $585.9 |
| Cash and cash equivalents | $61.2 | $69.3 |
Management reported $200.7 million of available liquid assets at quarter-end, including $61.2 million of unrestricted cash, $131.6 million of unencumbered Agency MBS, and $8.0 million of unrestricted cash collateral. Total liabilities were 5.9 times shareholders’ equity, down from 6.2 times at year-end. Repurchase borrowings had a 0.59% weighted-average rate and a 93-day average original term; most were short-term, uncommitted financing. The company had 21 counterparties with borrowings outstanding out of 31 available and reported compliance with financing and derivative covenants.
Operating cash flow was $49.9 million and investing cash flow was $60.0 million; financing used $118.0 million. Cash declined $8.2 million during the quarter. Common dividends declared were $13.7 million; preferred dividends were $2.3 million. The company declared a $0.25-per-share common dividend payable April 30, 2014.
Material changes and management commentary
- Management said tighter credit spreads and lower interest rates helped increase book value per common share. It continued to reduce leverage and retained some portfolio principal payments rather than reinvesting them.
- Agency MBS declined modestly as principal repayments and sales exceeded purchases. Non-Agency MBS increased about 13%, primarily from purchases of non-Agency CMBS interest-only securities.
- Agency RMBS prepayments slowed: the reported constant prepayment rate fell to 12.7% from 24.8% in Q1 2013. Management attributed the reduction mainly to higher mortgage rates and less refinancing.
- Management reported that adjusted net interest spread rose 0.11 percentage point from Q4 2013, reflecting higher asset yields and a lower effective borrowing rate. It maintained modeled duration gap toward the higher end of its 0.5-to-1.5-year target range.
- No specific full-year earnings or dividend guidance was provided. Management anticipated that non-Agency CMBS and CMBS IO could continue to offer comparatively attractive risk-adjusted returns, while noting that investment opportunities and market conditions may change.
Risks, contingencies and unusual items
- Interest-rate, spread, prepayment, reinvestment, credit and liquidity risks are material for this highly leveraged portfolio. In management’s modeled parallel-rate scenarios, a 100-basis-point increase reduced projected adjusted net interest income by 12.5% and portfolio market value by 1.5%; a 50-basis-point decrease increased them by 8.0% and 0.5%, respectively. These are estimates, not forecasts, and exclude changes in credit spreads.
- Repurchase financing is generally short-term and renewable at lenders’ discretion. Falling collateral values can trigger margin calls; reduced financing availability or higher costs could force asset sales. Regulatory changes affecting banks and repo markets, and possible reform of Fannie Mae and Freddie Mac, could affect funding and investment opportunities.
- Derivative fair-value movements can make GAAP earnings volatile. The filing reports $7.1 million of remaining accumulated losses on de-designated cash-flow hedges, with an estimated $5.5 million expected to be reclassified to earnings over the next 12 months.
- Management said pending legal proceedings were not expected, based on current knowledge, to materially affect consolidated financial condition or liquidity; their resolution could affect results or cash flows in a future period. No material changes to previously reported proceedings were noted.
- No significant subsequent events or material changes in critical accounting policies were reported. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether core net operating income and adjusted spread remain resilient as asset yields, funding costs and portfolio size change; review the non-GAAP reconciliations alongside GAAP results.
- Whether leverage, available liquidity and counterparty diversification can withstand repo haircuts, margin calls, or reduced renewal capacity.
- Whether derivative hedge performance offsets portfolio valuation and funding changes, including the effects of the post-hedge-accounting presentation.
- Whether MBS fair values, prepayment assumptions and non-Agency credit performance support reported book value and future income.
- Whether declared dividends are supported by sustainable earnings and REIT taxable-income requirements; GAAP loss and core earnings differed substantially this quarter.