Dynex Capital, Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; balance sheet compared with December 31, 2010. Amounts below are in U.S. dollars unless stated otherwise. Dynex is an internally managed mortgage REIT that invests in mortgage-backed securities and finances much of its portfolio with short-term repurchase agreements.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Interest income | $21.1m | $11.7m | $38.5m | $22.8m |
| Net interest income | $15.0m | $7.9m | $27.8m | $15.1m |
| Net income | $13.6m | $7.3m | $23.9m | $12.8m |
| Net income per common share, basic | $0.34 | $0.41 | $0.65 | $0.74 |
| Dividends declared per common share | $0.27 | $0.23 | $0.54 | $0.46 |
- Balance sheet at June 30: Total assets were $2.657bn, including investments of $2.591bn; total liabilities were $2.270bn and shareholders’ equity was $386.9m. At December 31, 2010, total assets were $1.650bn and equity was $292.4m.
- Funding and liquidity: Repurchase agreements were $2.133bn, up from $1.234bn at year-end, with a 0.33% weighted-average rate. Non-recourse collateralized financing was $106.0m. Cash and cash equivalents were $34.0m. Management reported $176.6m of unencumbered cash and unpledged Agency MBS and said the company was compliant with its financing covenants.
- Cash flows, six months: Operating activities provided $33.3m; investing activities used $991.8m, primarily reflecting investment purchases; financing activities provided $973.6m, including repo borrowing and equity proceeds. Cash increased $15.1m from year-end.
- Profitability: Q2 net interest spread on the total investment portfolio was 2.45%, down from 2.68% in Q1 2011 and 3.07% in Q4 2010. The filing does not provide a clear consolidated net profit margin.
Material changes versus comparable periods
- Investment portfolio growth—principally Agency MBS—drove higher interest income, net interest income, and net income. The portfolio rose from $1.614bn at year-end to $2.591bn at June 30.
- Common-share earnings per share declined despite higher net income: Q2 basic EPS was $0.34 versus $0.41 a year earlier, and first-half basic EPS was $0.65 versus $0.74. The share count increased substantially following a 9.2m-share public offering and additional equity issuance; 40.34m shares were outstanding at June 30 versus 30.34m at year-end.
- New Agency MBS purchases were made at higher prices and lower yields, increasing premium amortization and reducing asset yields. Management cited this as a principal reason for the lower portfolio spread.
- Agency MBS represented approximately 84% of the investment portfolio, above the company’s 50%–70% target. The company planned to increase non-Agency MBS investment over the remainder of 2011 to move toward its target mix.
- Other comprehensive income was a loss of $3.4m for the first half, despite net income of $23.9m, reflecting changes in available-for-sale securities and cash-flow hedges.
Outlook, risks, contingencies, and unusual items
- Management expected a steep yield curve and low short-term rates, but described the investment environment as challenging because of high asset prices, competition, and uncertainty about government and Federal Reserve actions. No specific full-year earnings or EPS guidance was provided.
- Management expected voluntary Agency RMBS prepayments to remain somewhat muted absent a government-induced refinancing wave, while warning that faster prepayments could accelerate premium amortization and reduce yields. Agency RMBS CPR was 23.2% in Q2, versus 21.9% in Q1.
- Key risks include rising short-term rates, interest-rate and spread movements, refinancing/prepayment changes, mortgage credit performance, repo-market access, collateral declines and margin calls, and the mismatch between short-term recourse funding and longer-term assets. Repo financing is uncommitted and lenders are not required to roll it over.
- The company had $1.007bn notional of interest-rate swaps at June 30. It estimated approximately $11.5m of hedge-related amounts would be reclassified as increased interest expense over the next 12 months. A breach of derivative covenants could trigger settlement; the filing reported $13.7m net derivative liabilities for covenant purposes, collateralized by Agency MBS.
- Legal proceedings include the Teamsters securities class action, then scheduled for trial in November 2011, and other matters. Management believed the proceedings would not materially adversely affect financial condition or liquidity, but acknowledged possible material effects on results or cash flows in a future period.
- The filing added a risk concerning a possible U.S. sovereign credit downgrade and potential effects on Agency MBS values, financing costs, and financing availability. GSE reform and implementation of financial regulation were also described as uncertain.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether portfolio growth and the planned shift away from Agency MBS can sustain net interest income and improve the declining portfolio spread.
- How earnings per share and per-share book value are affected by the substantial equity issuance and higher share count; the filing text does not provide a clear book value per share figure here.
- Whether repo funding remains available on acceptable terms and whether liquidity reserves are adequate for margin calls, refinancing, and derivative collateral requirements.
- Actual performance of mortgage prepayments, credit losses, and seriously delinquent securitized commercial loans, including the reported $20.1m seriously delinquent balance.
- Developments in the Teamsters litigation and other legal matters, as well as U.S. credit-rating, GSE-reform, and regulatory developments.