Dynex Capital, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Dynex is an internally managed mortgage REIT that invests on a leveraged basis in Agency and non-Agency residential and commercial mortgage-backed securities (MBS).
Key financial results
| Metric | Q1 2015 | Q1 2014 / prior period |
|---|---|---|
| Interest income | $24.1 million | $27.6 million |
| Net interest income | $18.7 million | $20.0 million |
| GAAP net loss | $9.5 million | $0.7 million |
| Net loss to common shareholders | $11.8 million; $0.21 per share | $3.0 million; $0.06 per share |
| Comprehensive income to common shareholders | $11.3 million | $26.5 million |
| Core net operating income, non-GAAP | $12.4 million; $0.23 per share | $13.7 million; $0.25 per share |
| GAAP net interest spread | 1.93% | 1.87% |
| Adjusted net interest spread, non-GAAP | 1.96% | 1.88% |
At March 31, total assets were $4.08 billion, including $3.88 billion of MBS; shareholders’ equity was $605.5 million. Repurchase agreements totaled $3.19 billion, up from $3.01 billion at year-end 2014. The company reported total liabilities of 5.7 times shareholders’ equity, or 5.4 times excluding the payable for unsettled securities.
Cash and cash equivalents were $38.5 million, while restricted cash was $67.0 million. Management reported $182.5 million of available liquid assets, consisting of $38.5 million unrestricted cash and $144.0 million unencumbered Agency MBS. Operating activities provided $51.0 million of cash; investing activities used $187.2 million and financing activities provided $130.8 million. Cash and cash equivalents declined $5.4 million during the quarter.
Changes and notable items
- MBS fair value grew $363.5 million from December 31, 2014. The portfolio expansion primarily reflected $444.2 million of Agency CMBS purchases; purchases also included senior non-performing-loan securitization tranches.
- Despite a slightly higher GAAP net interest spread, net interest income declined year over year, as the average investment balance and total asset yield were lower. Interest expense fell, partly reflecting lower average borrowings and borrowing costs.
- Derivative losses increased to $25.3 million from $13.4 million, including a $5.7 million realized loss from terminating interest-rate swaps. This was the main driver of the GAAP net loss and the decline in comprehensive income.
- Other comprehensive income was $23.1 million, principally reflecting an increase in the fair value of available-for-sale investments. Management reported a $0.24 common dividend and an annualized economic return of 7.98%, based on the quarter’s dividend and a $0.06 decline in book value per common share.
Outlook, risks and contingencies
Management expected to continue opportunistic portfolio growth, with emphasis on multifamily Agency CMBS, CMBS interest-only securities, selected residential securities and Agency hybrid ARMs. It said it did not expect leverage to increase significantly for the rest of 2015. The company had applied for Federal Home Loan Bank membership for a subsidiary, which could provide an additional liquidity source if approved.
Management cited interest-rate and credit-spread volatility, prepayments and reinvestment yields, market liquidity, financing availability and costs, and regulatory constraints on lenders as important risks. Most repo financing is short-term and renewable at lenders’ discretion; declines in collateral values may trigger margin calls. The company was in compliance with its financing and derivative covenants at quarter-end. Its modeled +100-basis-point parallel rate shock indicated a 13.90% decline in adjusted net interest income and a 0.58% decline in the market value of investments and derivatives; these are model estimates, not forecasts.
After quarter-end, Dynex terminated Eurodollar futures with $2.0 billion aggregate notional and repurchased 92,600 common shares for $732,000, excluding commissions. Management reported no contingencies for which a probable loss had been incurred. Various legal proceedings remained pending; the company did not expect their resolution to materially harm financial condition or liquidity, though results or cash flows in a future period could be affected. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether portfolio expansion and settlement of pending MBS purchases support net interest income without materially increasing leverage or liquidity pressure.
- The drivers and potential persistence of derivative losses, including the effects of the post-quarter Eurodollar futures termination and the company’s hedge positioning.
- Repo renewal terms, counterparty exposure, margin-call needs, and whether additional liquidity from FHLB membership is approved and available.
- How interest rates, credit spreads, prepayments and financing costs affect book value, earnings, and the sustainability of common and preferred dividends.
- The distinction between GAAP results and management’s non-GAAP core net operating income and adjusted spread measures.