Dynex Capital, Inc. — 2019 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2019. Dynex is an internally managed mortgage REIT investing primarily in Agency residential and commercial mortgage-backed securities (MBS), financed mainly through short-term repurchase agreements. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Financial performance and position
| Metric | 2019 | 2018 |
|---|---|---|
| Interest income | $170.2 | $110.1 |
| Interest expense | $114.1 | $59.6 |
| Net interest income | $56.1 | $50.5 |
| Net income (loss) attributable to common shareholders | $(165.6) | $(4.8) |
| Comprehensive income (loss) attributable to common shareholders | $44.0 | $(31.9) |
| Core net operating income, non-GAAP | $49.3; $2.09 per share | $42.3; $2.20 per share |
| Net interest spread | 0.98% | 1.22% |
| Adjusted net interest spread, non-GAAP | 1.30% | 1.48% |
| Operating cash flow | $175.3 | $180.6 |
2019 net loss principally reflected a $186.9 million net loss on derivatives, including large realized and fair-value losses on interest-rate swaps. This was more than offset in comprehensive income by $209.6 million of other comprehensive income, mainly unrealized MBS gains as longer-term rates declined and Agency CMBS spreads tightened. Core net operating income is a company-defined non-GAAP measure and excludes material market-value and realized items; it should not be treated as a substitute for GAAP results.
At December 31, 2019, total assets were $5.37 billion, including $5.19 billion of MBS; repurchase agreements were $4.75 billion, total liabilities $4.79 billion, and shareholders’ equity $583.0 million. Book value was $18.01 per common share versus $18.07 a year earlier. Reported leverage was 8.2 times equity, rising to 9.0 times including TBA long positions, compared with 6.4 and 8.0 times, respectively, in 2018. Unrestricted cash was $62.6 million and restricted cash was $71.6 million; the company reported $224.0 million of most-liquid assets, including unencumbered securities.
Repurchase-agreement balances increased from $3.27 billion to $4.75 billion year over year. The year-end weighted average borrowing rate declined to 2.01% from 2.69%; agreements were principally uncommitted and short term. The company had $4.76 billion of repurchase-agreement contractual payments due within one year, including estimated interest.
Material changes and fourth-quarter results
- Net interest income rose 11% year over year, largely as the average investment portfolio expanded. Higher average borrowings and financing costs absorbed most of the increase; the GAAP net interest spread narrowed 24 basis points.
- Core net operating income increased 17%, supported by higher net interest income and a $10.2 million increase in net periodic swap interest benefit. TBA drop income declined $8.5 million as the company reduced dollar-roll activity.
- Portfolio changes included a greater allocation to Agency CMBS, purchases of lower-coupon Agency RMBS, and sales of higher-coupon RMBS and adjustable-rate RMBS. Agency CMBS investments grew to about $2.00 billion fair value from $1.06 billion; Agency RMBS fair value rose to $2.69 billion from $2.16 billion.
- Fourth-quarter 2019 net interest income was $16.2 million, derivative gain $43.0 million, net income to common shareholders $51.8 million, other comprehensive loss $43.2 million, and comprehensive income to common shareholders $8.6 million. GAAP earnings per common share were $2.26 and the declared common dividend was $0.45. In fourth-quarter 2018, net interest income was $13.0 million, derivative loss $82.0 million, net loss to common shareholders $81.5 million, and comprehensive loss $31.4 million.
Common dividends declared totaled $2.01 per share for 2019, versus $2.16 in 2018. Monthly common dividends were reduced from $0.18 to $0.15 beginning with the August 2019 declaration. The company issued common and Series B preferred shares through offerings and at-the-market programs during 2019, and repurchased $25.0 million of common shares during the year.
Outlook, risks, and unusual items
- Management described the outlook for first-half 2020 net interest margin as favorable, citing 2019 portfolio and hedge repositioning, while noting that lower financing costs depended on economic conditions and stable short-term funding markets. It expected the 10-year U.S. Treasury rate to range from 1.50% to 2.50% in 2020 and planned to focus principally on Agency CMBS and RMBS. These are management expectations, not guarantees.
- Principal risks include high leverage; short-term, uncommitted repo financing and margin calls; interest-rate, spread, prepayment, reinvestment, credit and liquidity risks; hedge ineffectiveness; TBA settlement and margin exposure; and dependence on counterparties. Management said the September 2019 repo-market disruption had not materially affected its financing availability or cost as of the filing, but future effects were uncertain.
- LIBOR was scheduled to be phased out after 2021. The company had LIBOR-linked swaps and financing and was developing a transition plan; the impact of replacement benchmarks remained uncertain.
- The company reported a tax net operating loss carryforward of approximately $89.8 million, with most generated in 2000 and expected to expire in 2020. Management did not expect a 2019 income-tax liability after distributions and NOL use.
- Two DCI-related legal matters remained relevant. The company reported that claims seeking to hold it liable for a $46.5 million judgment against a former affiliate had been dismissed with prejudice, but plaintiffs appealed. In a separate cost-sharing-agreement case, the court found breaches by both sides; the receiver claimed $12.6 million while the company asserted offsetting damages, and the amount of any net loss was not reasonably estimable. Management considered loss remote in the first matter and not probable in the second, and recorded no contingency liability.
- Auditors issued unqualified opinions on the financial statements and internal controls. Management also concluded disclosure controls and internal control over financial reporting were effective at year-end.
Important facts for investors to verify
- Whether core operating income and cash generation support the current common dividend, particularly given the 2019 dividend reduction and REIT distribution requirements.
- How leverage, repo renewal terms, available liquidity, collateral haircuts and margin requirements evolve; confirm the 9.0-times leverage measure includes TBA long positions.
- Whether the widening gap between GAAP earnings and core operating income persists, and the realized and unrealized components of derivative results.
- How the portfolio’s Agency CMBS/RMBS mix, prepayment experience and net interest spread perform as rates and funding costs change.
- Progress and contractual exposure relating to LIBOR transition, the two DCI-related cases, and the NOL carryforward expiration.
- Subsequent events disclosed in the filing: issuance of $108.0 million net proceeds from Series C preferred stock and announced redemptions of Series A and a portion of Series B preferred stock in 2020.