Dynex Capital, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Dynex is an internally managed mortgage REIT that invests primarily in leveraged Agency mortgage-backed securities (MBS), along with commercial MBS and related securities. Financial statement amounts below are in U.S. dollars; financial-statement figures are in millions unless stated otherwise.
Financial performance and position
- Q3 earnings: Interest income was $20.4 million and interest expense was $13.3 million, producing net interest income of $7.1 million. The company reported a net loss of $46.7 million and a loss to common shareholders of $48.6 million, or $1.07 per diluted share, versus net income to common shareholders of $12.1 million, or $0.35 per share, in Q3 2021.
- Comprehensive results and book value: Comprehensive loss to common shareholders was $99.7 million ($2.20 per share). Book value per common share declined from $16.79 at June 30 to $14.23 at September 30; including the $0.39 common dividend, Q3 total economic return was negative $2.17 per share, or negative 12.9% of beginning book value.
- Nine-month results: Net income was $99.9 million and net income to common shareholders was $94.1 million, or $2.33 per diluted share, compared with $78.8 million and $2.52 per share, respectively, in the first nine months of 2021. Nine-month comprehensive loss to common shareholders was $109.3 million.
- Interest spread: Q3 net interest spread was 0.23%, down from 1.50% in Q2 2022. Including TBA dollar-roll drop income, adjusted net interest spread, a non-GAAP measure, was 1.12%, down from 1.84%. Nine-month net interest income was $36.9 million versus $38.8 million a year earlier; adjusted net interest income was $74.0 million versus $72.8 million.
- Balance sheet and funding: Total assets were $4.05 billion and shareholders’ equity was $771.3 million at quarter-end. Repurchase agreements were $3.01 billion, at a 2.90% weighted-average rate, versus $2.85 billion at 0.23% at December 31, 2021. Company-calculated leverage, which includes the cost basis of long TBA positions, was 8.5x equity versus 5.7x year-end 2021.
- Cash and cash flow: Cash and equivalents were $260.4 million; cash collateral posted to counterparties was $246.2 million. The company reported $505.2 million of most liquid assets. For the first nine months, operating cash flow was $96.3 million, investing cash flow was negative $271.5 million and financing cash flow was positive $260.4 million. Cash including cash posted to counterparties ended at $506.6 million.
- Dividends and capital: Common dividends declared were $0.39 per share in Q3. During the quarter, Dynex issued 2.79 million shares through its at-the-market program for $45.0 million net of commissions and fees. Common shares outstanding increased to 46.35 million from 36.67 million at year-end 2021.
Material changes and unusual items
- Q3 MBS and loan fair-value changes were negative $191.3 million; TBA changes were negative $197.6 million. These losses exceeded gains on interest-rate hedges, including $281.8 million on U.S. Treasury futures.
- For the first nine months, investment and TBA value declines exceeded hedge gains by $114.9 million. The company recorded $245.6 million of unrealized investment losses and $89.5 million of realized investment-sale losses, compared with a $6.7 million realized gain in the comparable 2021 period.
- Net interest income fell approximately 50% from Q2, as higher Federal Funds rates increased financing costs. Q3 general and administrative costs included $2.7 million of non-recurring severance expense related to the CFO transition; management also cited implementation costs for a new investment accounting system.
- GAAP net income included substantial hedge gains, but most realized tax-hedge gains are deferred and amortized into REIT taxable income over time. Estimated deferred tax hedge gains were $512.9 million at September 30, compared with $27.0 million at year-end 2021. The company estimated a $9.4 million Q3 taxable-income benefit from amortization; this is not included in EAD.
Outlook, commentary and risks
- Management described extreme interest-rate volatility and historically wide MBS spreads, with further near-term spread widening possible. Subsequent to quarter-end, Dynex said it reduced portfolio size and added interest-rate hedges to prepare for multiple rate scenarios. It provided no specific earnings or book-value guidance.
- Management viewed Agency MBS as potentially attractive over the medium and long term and expected book value could recover as market conditions and MBS-market technicals improve. These are expectations, not assurances; the company does not hedge spread risk, and rate hedges do not protect against spread widening.
- Liquidity and financing risks include margin calls, collateral-value declines, and reliance on mostly uncommitted repurchase agreements that lenders may not renew. At quarter-end, $246.2 million of cash collateral was posted; most repo agreements had short remaining maturities. Dynex reported compliance with its financing covenants and no material concerns communicated by counterparties.
- Interest-rate, spread, prepayment, credit and reinvestment risks remain material. The company’s modeled results indicate substantial sensitivity of net interest income to rate changes; modeled sensitivities assume a static portfolio and may differ from actual outcomes. Management also cited Federal Reserve tightening, global central-bank policies, geopolitical uncertainty including the Russia-Ukraine war, and possible market-liquidity deterioration.
- The company reported no pending or threatened legal proceedings that management believes could materially adversely affect results or financial condition. Management concluded disclosure controls were effective as of September 30, 2022.
Important facts for investors to verify
- Whether the sharp increase in repo funding costs and the Q3 decline in net interest spread persist, and how they affect earnings and dividends.
- How book value and portfolio marks respond to continued spread volatility; separately assess interest-rate hedge effectiveness versus unhedged spread exposure.
- The sustainability of liquidity and financing access, including repo renewals, margin requirements and the effect of TBA positions on leverage and cash needs.
- How deferred hedge gains, capital-loss and NOL carryforwards affect future REIT taxable income and dividend requirements; management said it could not reasonably estimate the effect on future common dividends.
- The impact of continued share issuance on per-share book value and earnings, and any subsequent changes in portfolio size or hedging after September 30.