Dynex Capital, Inc. — 2015 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2015. This is an annual filing; quarterly information is unaudited. Amounts are in U.S. dollars unless stated otherwise.
Business context
Dynex is an internally managed mortgage REIT investing primarily in Agency and non-Agency residential and commercial mortgage-backed securities, including commercial mortgage interest-only securities. It finances investments mainly with short-term, generally uncommitted repurchase agreements and uses derivatives to manage interest-rate risk. Its stated objective is long-term risk-adjusted returns with capital preservation, primarily through quarterly dividends.
Financial and operating performance
| Metric | 2015 | 2014 |
|---|---|---|
| Interest income | $100.2 million | $105.6 million |
| Net interest income | $77.6 million | $79.7 million |
| Net income to common shareholders | $7.4 million; $0.14 per share | $18.6 million; $0.34 per share |
| Comprehensive income (loss) to common shareholders | $(26.7) million | $73.8 million |
| Core net operating income (non-GAAP) | $49.2 million; $0.93 per share | $54.2 million; $0.99 per share |
| Weighted average asset yield / cost of funds | 2.71% / 0.68% | 2.76% / 0.76% |
| Net interest spread / adjusted net interest spread (non-GAAP) | 2.03% / 1.96% | 2.00% / 1.95% |
Net income to common shareholders included a $43.1 million net loss on derivatives, $17.7 million of general and administrative expenses, and $9.2 million of preferred dividends. Other comprehensive loss was $34.1 million, principally reflecting unrealized MBS losses amid wider credit spreads and higher interest rates. Management’s non-GAAP core net operating income excludes, among other items, changes in derivative fair value and investment-sale gains or losses; it should not be treated as a substitute for GAAP results.
Operating cash flow was $217.0 million, investing cash outflow was $209.4 million, and financing cash outflow was $17.6 million. Cash and cash equivalents ended the year at $33.9 million. Available liquid assets, including unencumbered Agency MBS, were $150.3 million, down from $215.8 million.
At year-end, total assets were $3.67 billion, shareholders’ equity $492.0 million, and book value per common share $7.71, down from $9.02. Repurchase agreements were $2.589 billion and FHLB advances were $520.0 million. The company reported a liabilities-to-equity leverage measure of 6.5x, compared with 5.1x a year earlier. Common dividends declared were $0.96 per share for 2015, including $0.12 characterized as return of capital; Series A and B preferred dividends were $2.125 and $1.906 per share, respectively.
Material changes versus 2014
- Common-shareholder net income fell to $7.4 million from $18.6 million; comprehensive results shifted from $73.8 million income to a $26.7 million loss.
- Book value per common share declined 14.5%, from $9.02 to $7.71. Management reported a negative 3.9% total economic return for 2015, combining $0.96 of common dividends with the $1.31 book-value decrease per share.
- The portfolio shifted toward commercial mortgage securities: CMBS and CMBS IO rose to 52% of the investment portfolio from 36%. Agency and AAA-rated investments were favored, while Agency RMBS exposure was reduced.
- Repurchase-agreement borrowings fell to $2.589 billion from $3.013 billion, while $520 million of FHLB advances were added. Total available liquid assets decreased by $65.5 million.
- Dynex repurchased 5.91 million common shares during the year for approximately $41.2 million. Common shares outstanding fell to 49.0 million from 54.7 million.
- Net interest income declined by $2.1 million. Lower asset yields and interest income outweighed lower reported financing costs; derivative losses remained substantial.
Outlook, risks and unusual items
- Outlook: Management expected continued market volatility and uncertainty in 2016, while describing newer investment opportunities as more attractive after spread widening. It planned to be cautious deploying capital and provided no quantified earnings or dividend guidance.
- Hedging: At year-end, Dynex had $2.1 billion of forward-starting pay-fixed swaps, mostly effective in the first half of 2016, at an approximately 1.37% weighted-average rate. Management said hedge positioning could change and hedging costs could pressure earnings and book value.
- Rate and spread sensitivity: The company’s model estimated that a parallel 100-basis-point rate increase would reduce adjusted net interest income by 10.93% and market value of investments and derivatives by 0.83%. A 50-basis-point widening in market credit spreads was estimated to reduce investment market value by 2.1%. These are model estimates, not forecasts.
- FHLB funding change: A January 2016 FHFA rule requires the captive insurance subsidiary to terminate FHLB membership and prohibits new advances or renewals. The $520 million outstanding at year-end must be repaid at maturity during 2016. Management expected replacement financing to be available through existing repurchase counterparties; this remains a funding and execution risk.
- Financing and liquidity: Most repurchase financing is short-term and renewable at lenders’ discretion. Declines in collateral values can trigger margin calls, while reduced financing availability could force asset sales. Repurchase agreements had a 22-day weighted-average remaining term at year-end; the $300 million committed Wells Fargo facility was scheduled to expire August 6, 2016.
- Other principal risks: Interest-rate and yield-curve movements, credit-spread volatility, prepayments and reinvestment risk, collateral and counterparty risk, commercial-property credit performance, regulatory changes affecting lenders and mortgage REITs, and maintaining REIT and Investment Company Act exemptions.
- Legal contingency: In a garnishment action, plaintiffs allege Dynex is the successor to former affiliate DCI and seek to garnish a judgment against DCI. Dynex moved to dismiss; the motion was pending. The filing says proceedings were not expected to materially affect consolidated financial condition or liquidity, but could affect results or cash flows in a future period.
Most important facts for investors to verify
- Whether Dynex repaid or replaced the FHLB advances on acceptable terms and maintained sufficient liquidity and covenant headroom.
- Subsequent book value, credit-spread exposure, derivative results, and the realized effectiveness and cost of the forward-starting swaps.
- Whether recurring earnings and cash generation support common dividends, particularly given 2015 GAAP earnings and the return-of-capital portion of the common dividend.
- The status and potential exposure from the garnishment litigation, including any developments affecting Dynex rather than former affiliate DCI.
- Changes in portfolio mix, collateral credit performance, prepayment assumptions, and the assumptions underlying fair-value estimates and modeled sensitivities.