Dynex Capital, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Dynex is an internally managed mortgage REIT investing primarily in leveraged Agency and non-Agency mortgage-backed securities (MBS), financed mainly through repurchase agreements. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Key financial results and position
| Metric | Q1 2020 / March 31, 2020 | Comparable period / prior date |
|---|---|---|
| Interest income | $39.8 | $40.0 in Q1 2019 |
| Net interest income | $17.7; 1.32% net interest spread | $13.7; 0.84% in Q1 2019 |
| Net loss attributable to common shareholders | $(106.2); $(4.63) per share | $(55.3); $(2.42) per share in Q1 2019 |
| Comprehensive loss attributable to common shareholders | $(33.3) | Comprehensive income of $31.2 in Q1 2019 |
| Core net operating income (non-GAAP) | $11.6; $0.51 per share | $15.0; $0.66 per share in Q4 2019 |
| Cash flow from operations | $44.0 provided | $40.3 provided in Q1 2019 |
| Cash, cash equivalents and restricted cash | $110.6 | $134.2 at December 31, 2019 |
| Total assets / shareholders’ equity | $5,374.2 / $550.6 | $5,370.6 / $583.0 at December 31, 2019 |
| Repurchase agreements | $4,408.1; weighted average rate 1.71% | $4,752.3; 2.01% at December 31, 2019 |
Q1 net loss included a $195.6 million net loss on derivatives, partly offset by $84.8 million of realized investment-sale gains. Other comprehensive income was $73.0 million, primarily reflecting unrealized gains on MBS, less the gain reclassified on securities sold. Management reported a $1.94 decline in book value per common share and an 8.3% quarterly economic loss to common shareholders, including the $0.45 common dividend.
Net interest income improved year over year as lower funding costs more than offset reduced asset yields and prepayment-related effects. Management expects net interest income and adjusted net interest income to decline in future periods as the portfolio has shrunk and most interest rate swaps were terminated. No conventional operating margin was reported.
Material changes and management actions
- In early March, Dynex sold a significant portion of Agency RMBS, realizing gains and reducing exposure and leverage. Q1 MBS-sale proceeds were $1,991.0 million, including unsettled sales recorded as a $1,503.6 million receivable at quarter-end.
- The company reduced interest-rate swap notional from $4,225 million at year-end to $230 million at March 31, recognizing substantial termination losses. It shifted toward short U.S. Treasury futures and Treasury futures options, citing liquidity and more favorable margin requirements.
- After quarter-end, Dynex sold Agency CMBS with March 31 fair value of $1,468.9 million and amortized cost of $1,301.8 million. Together with settlement of earlier sales, these transactions materially reduced leverage from 8.8 times equity at March 31 to approximately 4 times equity after settlement.
- Q1 liquidity, defined by management as unrestricted cash and unencumbered assets, was $155.4 million, down from $224.0 million at year-end, principally due to margin calls. Management reported approximately $225 million of cash and unencumbered assets as of April 30.
- The company issued 4.46 million Series C preferred shares for net proceeds of $108.0 million and used proceeds to redeem all Series A preferred shares and part of its Series B preferred shares. The redemptions generated a $3.9 million charge to common shareholders.
Outlook, risks and contingencies
Management said its near-term priorities were book value and capital preservation, with a measured approach to reinvestment because market conditions, policy responses and future returns remained uncertain. The company did not anticipate changing its May common dividend; dividends beyond May would depend on capital deployment, financing conditions and risk. Management expects lower future interest income from the smaller portfolio and lower yields on replacement assets.
COVID-19-related market disruption caused sharp spread widening, falling asset prices and increased margin calls. The Federal Reserve’s Agency MBS and CMBS purchase announcements helped market liquidity, but the company warned that the effects of the pandemic, government relief and mortgage forbearance on its assets could range from immaterial to significant. Principal risks include further spread or rate volatility, short-term uncommitted repo financing and renewal risk, margin calls and haircuts, commercial property defaults affecting CMBS IO, reinvestment risk, and the uncertain LIBOR transition. The company said it met its debt covenants at March 31.
Two related DCI matters remained in litigation. Management assessed the likelihood of loss as remote for the DCI litigation and not probable for the receiver claim; it recorded no liability, citing potential offsets and inability to reasonably estimate possible loss. The filing cautions that an adverse outcome could materially affect a future reporting period.
Most important facts for investors to verify
- Post-quarter settlement of the MBS sales, resulting cash and leverage, and the amount and timing of reinvestment.
- Book value per common share and subsequent effects of spread movements, asset sales and hedging changes.
- Repo availability, collateral haircuts, margin requirements and liquidity under renewed market stress.
- Future common and preferred dividends, including the earnings and taxable-income basis for distributions.
- COVID-19 effects on underlying mortgage performance, especially commercial loans and non-Agency CMBS IO, and developments in the DCI litigation.