Dynex Capital, Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; filed August 8, 2012. Dynex is an internally managed mortgage REIT investing in Agency and non-Agency mortgage-backed securities, using leverage. Unless indicated otherwise, financial-statement amounts below are in U.S. dollars; balance-sheet and income-statement amounts are converted from thousands to millions.
Financial performance and position
| Metric | Q2 2012 / June 30, 2012 | Comparable period / prior date |
|---|---|---|
| Interest income | $27.1 million | $21.1 million, Q2 2011 |
| Net interest income | $19.0 million | $15.0 million, Q2 2011 |
| Net income | $18.8 million; $0.35 per diluted share | $13.6 million; $0.34 per diluted share, Q2 2011 |
| Dividends declared | $0.29 per common share | $0.27, Q2 2011 |
| Net interest spread | 2.18% | 2.45%, Q2 2011; 2.41%, Q1 2012 |
| Total assets | $3.729 billion | $2.582 billion, December 31, 2011 |
| Shareholders’ equity | $525.1 million; $9.66 per common share, as reported by management | $371.3 million; $9.20 per common share, December 31, 2011 |
| Repurchase agreements | $3.112 billion; weighted-average rate 0.62% | $2.094 billion; 0.61%, December 31, 2011 |
| Cash and cash equivalents | $53.8 million | $48.8 million, December 31, 2011 |
For the six months ended June 30, net income was $35.3 million versus $23.9 million in 2011; diluted EPS was $0.68 versus $0.65. Net interest income was $38.2 million versus $27.8 million. Operating cash flow was $58.8 million; investing activities used $1.130 billion and financing activities provided $1.076 billion. Cash increased $5.0 million to $53.8 million. The company also reported $180.4 million of unencumbered cash and unpledged Agency MBS available as a liquidity resource.
Material changes and notable items
- The investment portfolio expanded: Agency MBS rose to $2.979 billion from $1.965 billion, and non-Agency MBS to $559.0 million from $421.1 million since year-end 2011. At June 30, Agency MBS represented 82% of asset allocation, above the company’s 60%–80% target range.
- Common shares outstanding increased to 54.4 million from 40.4 million. A public offering and other issuances raised $123.8 million net during the first half. Management attributed much of the increase in equity to these issuances and higher investment values.
- Accumulated other comprehensive income improved to $21.5 million from a $3.3 million deficit at year-end, reflecting $35.8 million of higher available-for-sale investment values, partly offset by an $11.0 million decline in swap values.
- Q2 gains on sales of investments were $2.6 million, including a $1.9 million gain from liquidation of a delinquent securitized commercial mortgage loan and a $0.7 million securities-sale gain. First-half gains were $2.9 million.
- Net interest income declined from $19.1 million in Q1 2012 to $19.0 million in Q2. Management cited higher investment-premium amortization, including increased prepayment forecasts. Q2 amortization was $20.6 million versus $12.6 million in Q1 and $6.6 million in Q2 2011.
Outlook, risks, and contingencies
- Management expected to reduce Agency exposure toward its target allocation and continue adding selected CMBS and CMBS interest-only securities, subject to market conditions and investment availability. It described the outlook as favorable but noted uncertainty from government policy and European markets.
- Management expected Agency RMBS prepayments to increase during the remainder of 2012, potentially accelerating premium amortization and reducing yields. It also reported declining net interest spreads on new purchases amid a flattening yield curve and tighter credit spreads.
- The company relies heavily on short-term, generally uncommitted repurchase financing. Renewal, collateral haircuts, margin calls, counterparty concentration, and market disruption could constrain liquidity or force asset sales. The company reported compliance with financing covenants at June 30; one counterparty represented approximately 11% of shareholders’ equity at risk.
- Interest-rate swaps had a $39.3 million net liability fair value and $1.512 billion notional at June 30. The company estimated $15.1 million of existing hedge losses in accumulated other comprehensive income would be reclassified to interest expense over the next 12 months. Reported interest-rate sensitivity modeling showed that a 100-basis-point rise corresponded to a 0.5% decrease in projected net interest income and a 1.2% decrease in projected market value; these are model estimates under stated assumptions.
- The February 2012 common-stock offering triggered a Section 382 ownership change. Management estimated annual use of pre-change net operating losses would be capped at $13.4 million; the NOL carryforward was estimated at $143.0 million at year-end 2011 and substantially begins to expire in 2019.
- Subsequent to quarter-end, the company issued 2.3 million 8.50% Series A preferred shares, receiving $55.7 million net before expenses, and entered into a committed two-year $200 million repurchase facility with Wells Fargo.
- Legal matters include a new putative class action concerning delinquent property-tax collection practices and an appeal in a long-running dispute. Management believed resolution would not materially affect consolidated financial condition or liquidity, but stated that a proceeding could affect results or cash flows in a future period.
Important facts for investors to verify
- Whether portfolio growth and additional financing maintain adequate liquidity under repo renewals, collateral calls, and adverse market conditions.
- Actual prepayment speeds, premium amortization, and net interest spreads relative to management’s forecasts, especially for Agency RMBS and IO securities.
- Asset mix, credit quality, valuation assumptions for Level 3 securities, and the durability of reported book value and unrealized gains.
- The effect of common and preferred stock issuance on per-share earnings, dividends, leverage, and the Section 382 limitation on NOL usage.
- Developments in the disclosed litigation and any resulting financial exposure.