Dynex Capital, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Dynex is an internally managed mortgage REIT investing on a leveraged basis in Agency and non-Agency mortgage-backed securities (MBS) and legacy securitized mortgage loans. Financial statements are unaudited.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Interest income | $28.6m | $21.1m | $82.0m | $59.7m |
| Net interest income | $19.1m | $14.6m | $57.3m | $42.3m |
| Net income | $19.2m | $1.5m | $54.5m | $25.4m |
| Net income to common shareholders | $18.4m | $1.5m | $53.7m | $25.4m |
| Diluted earnings per common share | $0.34 | $0.04 | $1.02 | $0.67 |
| Common dividends declared per share | $0.29 | $0.27 | $0.86 | $0.81 |
- Q3 net interest spread was 2.00%, down from 2.18% in Q2 2012; management cited purchases of lower-spread assets and Agency ARM rate resets. The spread table compares Q3 with Q2, not Q3 year over year.
- Q3 net income included $3.48m in net gains on investment sales. Q3 2011 included $8.24m in litigation settlement costs and a $1.97m loss on non-recourse financing.
- Nine-month operating cash flow was $96.3m; investing activities used $1.785bn and financing activities provided $1.675bn. Cash ended the period at $34.7m.
Financial position and material changes
- Total assets were $4.405bn at September 30, up from $2.582bn at December 31, 2011. Agency MBS were $3.651bn and non-Agency MBS $586.9m.
- Repurchase agreement borrowings were $3.671bn, versus $2.094bn at year-end; non-recourse collateralized financing was $31.3m, down from $70.9m after repayment of TALF financing. Repurchase agreements are recourse, short-term and uncommitted.
- Shareholders’ equity was $617.9m, compared with $371.3m at year-end. Management reported equity of $10.31 per common share. The increase reflected equity issuance and higher unrealized investment gains, partly offset by derivative fair-value losses.
- During 2012, common shares outstanding increased from 40.4m to 54.4m, principally following a February public offering of 13.33m shares. In August, the company issued 2.3m preferred shares at an 8.50% dividend rate, raising approximately $55.7m net.
- Reported liquidity was $178.8m, comprising $34.7m cash and $144.1m of unencumbered Agency MBS. The company had $3.7bn of repo borrowings across 21 counterparties; one counterparty accounted for about 18% of shareholders’ equity at risk.
- The portfolio was 84% Agency MBS, above the stated 60%–80% target range, reflecting Agency CMBS IO opportunities. Nine-month unrealized gains on available-for-sale investments contributed to accumulated other comprehensive income rising to $55.9m from a $3.3m loss at year-end.
Outlook, risks and contingencies
- Management expected somewhat elevated Agency MBS prepayments for the balance of 2012, citing low rates, HARP changes and Federal Reserve purchases under QE3. Faster prepayments can accelerate premium amortization and reduce yields.
- Management described the business outlook as favorable but noted uncertainty around QE3, housing policy, Europe and credit markets. It expected to increase its overall leverage target from approximately 6x to 6.5x invested equity in coming quarters. These are expectations, not guarantees.
- The company’s modeled interest-rate sensitivity for a static portfolio showed that a 100-basis-point increase could reduce projected 24-month net interest income by 7.0% and portfolio market value by 1.7%; a 100-basis-point decrease could increase them by 7.2% and 1.5%, respectively. Actual outcomes may differ materially.
- Key risks include repo renewal and margin-call exposure, rising financing costs, interest-rate and prepayment changes, credit and market-value volatility, and regulatory uncertainty involving REIT status, GSE reform and derivatives. The company reported compliance with financing and derivative covenants at quarter-end.
- A February common-stock offering triggered a Section 382 ownership change. Management estimated this limits annual use of tax NOLs to $13.4m; NOLs substantially begin expiring in 2019.
- Legal matters include an appeal in an Allegheny County tax-collection class action, a new putative class action, and a Texas appeal involving a former affiliate. Management did not expect these matters to materially affect financial condition or liquidity, but said resolutions could affect results or cash flows in a future period.
Most important facts for investors to verify
- Whether portfolio growth and the planned leverage increase can sustain earnings as net interest spreads compress.
- Actual Agency MBS prepayment speeds and the effect on premium amortization and investment yields.
- Repo funding availability, collateral haircuts, margin calls and exposure to major counterparties.
- Common-share dilution, preferred dividends and the capacity to maintain common dividends.
- The realized limits on NOL usage under Section 382 and developments in the disclosed litigation and regulatory matters.