Dynex Capital, Inc. — 2011 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2011; fourth-quarter results are also summarized below. Dynex is an internally managed mortgage REIT investing in Agency and non-Agency mortgage-backed securities and legacy securitized mortgage loans, primarily using leverage. The filing’s financial statements received an unqualified audit opinion; management and the auditor reported effective internal controls.
Key financial metrics
| Metric | 2011 | 2010 |
|---|---|---|
| Interest income | $83.4 million | $48.8 million |
| Net interest income | $59.3 million | $34.4 million |
| Net income | $39.8 million | $29.5 million |
| Net income per diluted common share | $1.03 | $1.41 |
| Dividends declared per common share | $1.09 | $0.98 |
| Net interest spread | 2.45% | 3.17% |
| Operating cash flow | $70.6 million | $30.1 million |
Fourth-quarter 2011 net interest income was $17.0 million and net income was $14.4 million, or $0.36 per diluted share; the declared dividend was $0.28 per share. Full-year net interest income after loan-loss provision was $58.4 million. The filing does not present a conventional operating margin measure.
At year-end, total assets were $2.58 billion, investments $2.50 billion, repurchase agreements $2.09 billion, non-recourse collateralized financing $70.9 million, and shareholders’ equity $371.3 million. Book value was $9.20 per common share, down from $9.64. Overall leverage increased to 6.0 times equity from 4.6 times. Cash and cash equivalents were $48.8 million; cash plus unencumbered cash and unpledged Agency MBS totaled $134.1 million, or 6.4% of repurchase agreements.
Cash flows included $915.8 million used in investing and $875.1 million provided by financing; cash increased by $29.9 million to $48.8 million. The company raised $95.3 million net from common-stock issuance during 2011 and paid $40.9 million in dividends.
Material changes versus 2010
- Investments increased 54.9% to $2.50 billion; Agency MBS were 79% of the portfolio, versus 74% a year earlier. The company added Agency and non-Agency CMBS interest-only securities.
- Net income rose, but diluted EPS fell from $1.41 to $1.03, reflecting a substantially larger share count and expenses including litigation costs, higher premium amortization, swap costs, and financing-redemption charges.
- Net interest spread narrowed from 3.17% to 2.45%. Management attributed the decline mainly to lower yields on new purchases and increased premium amortization.
- Repurchase agreements grew by $859.6 million. Interest-rate swap notional increased to $1.092 billion from $345 million; year-end derivative liabilities were $28.0 million.
- Accumulated other comprehensive income declined by $13.3 million, principally due to a $22.6 million reduction in the fair value of cash-flow hedges, partly offset by gains on investments.
Outlook, risks, and unusual items
- Management expected the Federal Reserve to keep its federal funds target at 0%–0.25% through 2014, supporting low financing costs, while noting that the outlook depends on market conditions. The company forecast 2012 Agency RMBS prepayments of 28% CPR, above the 24.9% fourth-quarter 2011 rate, and expected higher prepayments could accelerate premium amortization and reduce income.
- After year-end, the company completed a public offering of 13.33 million shares for approximately $120.0 million net. Management expected to deploy the proceeds into investments, potentially adding approximately $700 million in assets and $600 million in repo borrowing. A possible Section 382 ownership change could limit use of the company’s tax-loss carryforwards; the filing said this could not yet be determined.
- In February 2012, Dynex repaid its remaining TALF financing and replaced it with $41.7 million of repurchase financing. Repo funding is short-term, uncommitted, subject to renewal and margin calls. The company cited heightened risks from leverage, non-Agency MBS price volatility and limited financing counterparties.
- The principal strategic and market risks include interest-rate and yield-curve movements, refinancing and prepayment activity, credit and liquidity risk, counterparty exposure, GSE reform, potential changes to the mortgage REIT exemption under the Investment Company Act, and REIT qualification and tax-loss carryforward limitations.
- Dynex recorded $8.2 million of litigation settlement and related costs in 2011, including a $7.5 million settlement funded into escrow, pending court approval. The company denied wrongdoing. Other disclosed legal matters remained unresolved; management did not expect them to materially affect financial condition or liquidity, though a future period’s results or cash flows could be affected.
- The company declared $1.09 per share in 2011 dividends. Management noted that tax-loss carryforwards may reduce required REIT distributions, and the board reviews the dividend quarterly; future distributions are not assured.
Important facts for investors to verify
- Whether the post-year-end share offering triggered a Section 382 ownership change and restricted use of the approximately $146.3 million REIT NOL carryforward.
- Whether the $7.5 million Teamsters settlement received final court approval and the status or exposure of other litigation.
- Current repo borrowing terms, collateral haircuts, counterparty concentration, margin-call capacity, and liquidity relative to leverage.
- Actual prepayment experience versus the 28% CPR forecast, and the resulting effect on asset yields, premium amortization, net interest income, and book value.
- Deployment and returns on post-year-end equity proceeds, and whether the dividend is supported by sustainable earnings and cash flows.