Dynex Capital, Inc. — Q1 2021 Form 10-Q
Reporting period: Three months ended March 31, 2021. Dynex is an internally managed mortgage REIT investing primarily in residential and commercial mortgage-backed securities (MBS), financed largely through repurchase agreements.
Financial results and position
| Metric | Q1 2021 | Comparable period / balance |
|---|---|---|
| Interest income | $13.9 million | $39.8 million in Q1 2020 |
| Net interest income | $12.3 million; 1.87% net interest spread | $17.7 million and 1.32% in Q1 2020; $14.4 million and 1.94% in Q4 2020 |
| Net income (loss) | $117.9 million | $(98.5) million in Q1 2020 |
| Net income (loss) to common shareholders | $112.4 million; $4.20 per diluted share | $(106.2) million; $(4.63) per share in Q1 2020 |
| Comprehensive income to common shareholders | $47.2 million; $1.76 per share | $(33.3) million in Q1 2020 |
| Core net operating income (non-GAAP) | $12.4 million; $0.46 per share | $10.5 million; $0.45 per share in Q4 2020 |
Q1 earnings included $107.8 million of net derivative gains, substantially reflecting gains on Treasury futures and swaptions. These were partly offset in comprehensive income by $65.2 million of other comprehensive losses, primarily unrealized MBS valuation declines. Adjusted net interest income, a non-GAAP measure, was $20.8 million, broadly unchanged from Q4 2020 as increased TBA dollar-roll income offset lower GAAP net interest income.
Cash flow: Operating activities provided $30.2 million; investing activities provided $398.3 million; financing activities used $360.8 million. Cash and cash posted to counterparties increased $67.8 million to $378.1 million. Cash flow includes substantial investment sales, principal receipts, derivative settlements and repurchase borrowing activity.
Balance sheet and funding, March 31, 2021: Total assets were $2.90 billion, including $2.38 billion of MBS; total liabilities were $2.17 billion, including $2.03 billion of repurchase agreements. Shareholders’ equity was $731.3 million. Reported leverage, including the cost basis of TBA long positions, was 6.9x equity, up from 6.3x at year-end. Repo weighted-average rate was 0.26%, versus 0.34% at year-end. Unrestricted cash and unencumbered securities totaled $528.6 million, compared with $415.3 million at year-end.
Material changes versus comparable periods
- Versus Q1 2020, net interest income fell by $5.5 million, mainly because the average investment balance and asset yields were lower. Net income nevertheless swung to a profit, primarily due to the reversal from large derivative losses to derivative gains.
- Versus Q4 2020, net interest income declined $2.2 million, while core net operating income rose $1.9 million. Higher TBA dollar-roll income largely offset lower net interest income.
- During Q1, Dynex issued 7,187,500 common shares for $128.2 million and redeemed its remaining 2,788,330 Series B preferred shares for approximately $69.7 million, including the redemption charge. Common shares outstanding increased to 30,879,569 from 23,697,970 at year-end; Series C preferred shares outstanding were 4,460,000.
- Leverage rose primarily as TBA investment cost basis increased 82%; equity increased 15%, primarily due to the capital raises. The Company increased its hedge coverage to approximately 72% of MBS including TBAs, from 62% at year-end.
- Effective January 1, 2021, Dynex elected the fair value option for newly purchased MBS, with fair-value changes recognized in net income rather than OCI.
Outlook, risks and contingencies
- Management described market conditions as favorable, expecting near-term rates to remain relatively range-bound and financing costs low, while noting longer-term pressure from Treasury supply and possible inflation. It expects Q2 results to benefit from TBA securities, but does not expect dollar-roll specialness to persist at its recent level.
- The stated target for leverage, including TBAs, is 6–9x equity; management expects leverage to increase modestly over the next six months, subject to market conditions and risk-adjusted returns. This is a target, not earnings guidance.
- Key risks include interest-rate and spread movements, prepayments, reinvestment at lower yields, repo renewal and margin-call exposure, TBA settlement liquidity, and COVID-19 effects on commercial-property loans. Management noted increased delinquencies in some retail and hotel loans underlying non-Agency CMBS IO, but said these had nominally affected cash flows to date and the ultimate impact remained uncertain.
- Repo funding is principally short-term and uncommitted. A Wells Fargo committed facility had $114.3 million outstanding against $250 million capacity and matured June 11, 2021; management expected renewal. The Company reported compliance with repo covenants and no counterparty represented more than 5% of equity at risk.
- A Receiver Litigation claim relates to an alleged breach of a litigation cost-sharing agreement. Dynex reported no material quarterly developments, assessed loss as not probable, and recorded no liability because the possible loss could not be reasonably estimated. The filing warns an unfavorable outcome could materially affect a future period.
- Management stated that no material changes had occurred in the risk factors from the 2020 Form 10-K. It also cautioned that estimates and outlook remain uncertain, including due to COVID-19 and government and GSE actions.
Important facts for investors to verify
- How much of Q1 GAAP earnings and book-value performance depended on derivative gains, and whether hedge results offset portfolio valuation movements over time.
- Whether TBA dollar-roll income and favorable implied financing rates persist, and the resulting effect on adjusted net interest income and liquidity.
- Repo facility renewal, lender haircuts, margin requirements and the company’s ability to meet collateral calls, especially at 6.9x reported leverage.
- Performance and credit developments in non-Agency CMBS IO collateral, particularly retail and hotel loans affected by the pandemic.
- Developments in the Receiver Litigation and the potential offset claims; no contingent liability was recorded.
- Dividend sustainability relative to recurring cash earnings, REIT distribution requirements, and the effect of the common and preferred share changes on per-share results.