Dynex Capital, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Dynex is an internally managed mortgage REIT investing primarily in leveraged Agency and non-Agency mortgage-backed securities (MBS). Unless stated otherwise, amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions.
Financial performance and condition
| Metric | Q3 2020 / Sep. 30, 2020 | Comparable period / prior date |
|---|---|---|
| Interest income | $20.1 million | $44.5 million in Q3 2019 |
| Interest expense | $3.4 million | $31.3 million in Q3 2019 |
| Net interest income; net interest spread | $16.7 million; 1.96% | $13.2 million; 0.82% in Q3 2019 |
| Net income (loss) | $40.7 million; $1.62 per common share | $(36.6) million; $(1.65) per share in Q3 2019 |
| Core net operating income (non-GAAP) | $14.2 million; $0.61 per common share | $8.4 million; $0.36 per share in Q2 2020 |
| Comprehensive income to common shareholders | $44.5 million | $15.3 million in Q3 2019 |
| Nine-month net income (loss) | $137.1 million; $5.33 per common share | $(207.8) million; $(9.12) per share in 2019 |
| Cash flows, nine months | $130.0 million operating cash provided; $2.11 billion investing cash provided; $2.19 billion financing cash used | Operating cash provided was $122.1 million in 2019 |
| Total assets; shareholders’ equity | $3.22 billion; $603.6 million | $5.37 billion; $583.0 million at Dec. 31, 2019 |
| Repurchase agreements | $2.59 billion; weighted-average rate 0.36% | $4.75 billion; 2.01% at Dec. 31, 2019 |
| Cash and cash equivalents; restricted cash | $158.9 million; $26.0 million | $62.6 million; $71.6 million at Dec. 31, 2019 |
| Liquidity and leverage | $378.0 million of unrestricted cash and unencumbered securities; leverage including TBAs was 6.2x equity | Liquidity was $224.0 million at Dec. 31, 2019 |
Management reported a $1.56 increase in book value per common share during Q3 and total economic returns to common shareholders of 11.7% for the quarter and 8.4% year to date. The filing does not provide a clear ending book value per common share in the supplied text.
Material changes and drivers
- Q3 net income benefited from $20.8 million of realized investment-sale gains and an $8.0 million net derivative gain. The prior-year quarter included a $50.7 million derivative loss.
- For the first nine months, investment-sale gains were $298.7 million versus a $5.8 million loss in 2019; derivative losses were $196.2 million versus $229.9 million. The company attributed much of the 2020 derivative loss to the rapid interest-rate decline in Q1.
- Interest expense fell substantially as financing rates and average borrowings declined. Management said Q3 net interest spread was flat versus Q2, while lower funding costs, larger average interest-earning assets, and increased TBA drop income lifted core net operating income.
- The investment portfolio, including TBA securities, was approximately $4.2 billion at September 30, down from $5.1 billion at year-end 2019. Sales of Agency CMBS shifted the portfolio toward Agency RMBS.
- In Q1, Dynex issued $108.0 million of Series C preferred stock net of issuance costs, redeemed all Series A preferred stock, and partially redeemed Series B. The nine-month common-shareholder result includes a $3.9 million preferred-stock redemption charge.
- Monthly common dividends were reduced from $0.15 to $0.13 per share beginning in June 2020. Q3 declarations were $0.13 monthly.
Outlook, risks, and contingencies
- Management’s leverage target, including TBA securities, is 6–9x shareholders’ equity. It expected leverage to increase near term through TBA investments but had not increased leverage in Q4 as of the filing, citing caution ahead of the U.S. presidential election.
- Management favored maintaining liquidity and investing in Agency MBS, citing Federal Reserve support and low funding costs. It described the global economy as fragile and policy outcomes as uncertain; the filing provides no earnings or dividend guidance.
- COVID-19 market disruption in March generated substantial margin calls, which Dynex says it met without forced asset sales. Management warned that a renewed pandemic impact could disrupt real-estate cash flows. Delinquencies in loans underlying non-Agency CMBS IO, particularly retail and hotel, had increased, with nominal effects on cash flows and yields to date.
- Key exposures include interest-rate and spread movements, prepayments, credit performance, short-term uncommitted repo financing, margin calls, and TBA settlement or roll risk. The company reported $26.0 million of cash posted as collateral and compliance with financing covenants at quarter-end. Repo maturities were short, and lenders were not obligated to renew them.
- Dynex significantly reduced interest-rate swaps and shifted hedging toward Treasury futures, options, and swaptions. Its modeled net-interest-income sensitivity to a 50-basis-point rate increase was negative 11.6%; modeled market-value sensitivity to a 100-basis-point increase was approximately neutral overall, but these are estimates and exclude spread changes.
- A receiver’s litigation-cost-sharing claim remains unresolved. The company recorded no liability, assessing loss as not probable and the possible amount as not reasonably estimable. Separately, an appeals court affirmed dismissal of plaintiffs’ claims; a further appeal to the U.S. Supreme Court remained possible. The company cautioned that litigation outcomes cannot be predicted with certainty.
- The company is planning for the LIBOR transition and said reduced swap exposure limits, but does not eliminate, the potential impact. Management also noted uncertainty around future COVID-19 effects and policy support.
Most important facts for investors to verify
- Whether reported earnings and book-value gains are repeatable, given the substantial realized gains on asset sales and volatile derivative results.
- How portfolio income, prepayments, and credit performance—especially for commercial real-estate-linked CMBS IO—evolve as pandemic effects continue.
- Whether repo counterparties renew short-term financing and how margin, haircut, and collateral requirements affect liquidity and leverage.
- Whether leverage remains within management’s 6–9x target and how actual results compare with modeled rate and spread sensitivities.
- The effect of the reduced common dividend, preferred dividends, and REIT distribution requirements on future capital and liquidity.
- Developments in the receiver litigation, including any change in estimated exposure or appeal status.