Dynex Capital, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; balance-sheet comparisons are with December 31, 2022. Dynex is an internally managed mortgage REIT investing primarily in leveraged Agency mortgage-backed securities (MBS), with additional Agency and non-Agency commercial MBS interests. Financial statements are unaudited.
Financial performance and position
| Metric | Q1 2023 / March 31, 2023 | Comparison |
|---|---|---|
| Interest income / expense | $30.8 million / $31.3 million; net interest expense of $0.5 million | Q1 2022 net interest income was $15.7 million; Q4 2022 was $6.2 million |
| Net income (loss) to common shareholders | $(43.6) million; $(0.81) per diluted share | Q1 2022: $115.3 million; $3.11 diluted EPS |
| Comprehensive income (loss) to common shareholders | $(28.9) million | Q1 2022: $23.9 million; Q4 2022: $56.6 million |
| Economic return and common book value | Total economic return: $(0.54) per share, including $0.39 dividends; quarter-end book value: $13.80 per share | Book value was $14.73 per share at December 31, 2022 |
| Non-GAAP earnings available for distribution (EAD) | $(8.7) million, or $(0.16) per share | Q1 2022: $16.1 million, or $0.44 per share |
| Assets / shareholders’ equity | $3.87 billion / $854.8 million | $3.61 billion / $901.3 million at December 31, 2022 |
| Repurchase agreements | $2.94 billion outstanding; weighted-average rate 4.92% | $2.64 billion at 4.18% at December 31, 2022 |
| Liquidity and leverage | $554.2 million in most liquid assets; leverage was 7.8x equity including TBA cost basis and 3.4x based on repurchase borrowings | Most liquid assets were $632.3 million at year-end |
| Cash flows | Operating cash provided: $3.7 million; investing cash used: $332.3 million; financing cash provided: $272.3 million | Cash including cash posted to counterparties fell $56.3 million to $393.6 million |
Material changes and drivers
- Higher Federal Funds rates increased financing costs: the average repo cost rose to 4.62% from 0.25% in Q1 2022. Despite higher asset yields, GAAP net interest income turned negative.
- Including TBA drop income, adjusted net interest income was $1.0 million and adjusted net interest spread was negative 0.75%, versus $25.4 million and 2.08% in Q1 2022. Management attributed the deterioration to higher financing costs and sharply lower TBA drop income.
- Spread widening during banking-sector turmoil reduced MBS values. Management said this offset gains associated with lower Treasury yields; losses on interest-rate hedges exceeded net gains on investments by $18.7 million. The filing reports $57.1 million of unrealized investment gains in net income, $14.8 million of OCI gains, and $23.3 million of realized investment-sale losses.
- Dynex realized $89.0 million of gains when it rolled interest-rate hedges in February; falling rates in March drove a $199.7 million decline in the fair value of its interest-rate hedges. Most realized hedge gains are deferred for tax purposes and are not immediately distributable.
- The company shifted toward higher-coupon Agency RMBS and TBAs and sold some lower-coupon specified pools. MBS fair value increased to $3.30 billion from $3.11 billion at year-end.
Outlook, risks and unusual items
- Management expects near-term market volatility and spreads to remain volatile and range-bound while the Federal Reserve reduces its MBS holdings. It views spread widening as creating potentially attractive investment opportunities, and expects MBS values could recover if demand improves, rate volatility declines, or recession increases demand for risk-free assets. These are expectations, not formal earnings guidance; no numerical forecast was provided.
- Key exposures include interest-rate and spread movements, prepayments, leverage, counterparty financing and margin requirements, and liquidity. The company does not hedge spread risk; management notes that widening spreads can reduce asset values even when interest-rate hedges help mitigate rate risk.
- Most repo financing is uncommitted and renewable at lender discretion. A $250 million committed Wells Fargo facility had $41.2 million outstanding and matures June 8, 2023. Repo borrowing is recourse, and lenders may demand additional collateral. Dynex reported compliance with financing covenants and no material difficulty securing financing at quarter-end.
- Unsettled or unrollable long TBA positions could require physical delivery and cash funding. The company had $3.75 billion notional of long TBA positions at quarter-end and $114.6 million cash collateral posted to counterparties.
- Estimated net deferred tax hedge gains were $766.0 million at March 31, 2023, expected to be recognized as taxable income over future periods. Management said it cannot reasonably estimate the effect on 2023 or future dividends. As a REIT, Dynex generally must distribute at least 90% of annual REIT taxable income.
- No pending material litigation or material changes to previously disclosed risk factors were reported. Management concluded disclosure controls were effective; no material change in internal control was reported.
Important facts for investors to verify
- How spread changes, Federal Reserve policy and market volatility affect MBS valuations, hedge performance and book value.
- Whether higher repo costs, TBA financing costs and lower adjusted spreads continue to pressure earnings and dividends.
- Liquidity adequacy, margin-call capacity, access to uncommitted repo financing, and renewal or replacement of the Wells Fargo facility due June 8, 2023.
- The timing and tax treatment of deferred hedge gains, and their actual effect on REIT taxable income and dividend decisions.
- How the reported GAAP loss, non-GAAP EAD, dividends and share issuance translate into sustainable per-share returns; EAD is not equivalent to taxable income or distributable cash.