Dynex Capital, Inc. — Q2 2015 Form 10-Q
Business context and period. Dynex is an internally managed mortgage REIT investing on a leveraged basis in residential and commercial mortgage-backed securities (MBS). This unaudited report covers the quarter and six months ended June 30, 2015; balance-sheet comparisons are with December 31, 2014. Amounts below are in millions except per-share data.
Key financial results
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Interest income | $24.5 | $27.7 | $48.6 | $55.4 |
| Net interest income | $19.0 | $21.1 | $37.7 | $41.2 |
| Net income (loss) to common shareholders | $28.2 | $(8.3) | $16.4 | $(11.3) |
| Net income (loss) per common share | $0.52 | $(0.15) | $0.30 | $(0.21) |
| Comprehensive income (loss) to common shareholders | $(11.5) | $26.9 | $(0.2) | $53.4 |
| Core net operating income per share (non-GAAP) | $0.21 | $0.26 | $0.44 | $0.51 |
- Q2 GAAP net interest spread was 1.97%, versus 2.04% a year earlier; six-month spread was 1.96%, unchanged year over year. The Q2 adjusted spread, a non-GAAP measure incorporating derivatives, was 1.86%.
- At June 30, total assets were $4,169.0 million and shareholders’ equity was $575.3 million. MBS totaled $3,852.9 million.
- Repurchase agreements were $3,403.0 million and FHLB advances were $108.1 million. Total liabilities were $3,593.8 million. Reported leverage was 6.2 times shareholders’ equity, up from 5.0 times at year-end 2014.
- Cash and cash equivalents were $56.5 million; restricted cash was $57.9 million. Reported available liquid assets were $177.9 million, including $96.2 million receivable for securities sold and $25.3 million of unencumbered Agency MBS. A further $30.6 million of unencumbered non-Agency MBS was considered less liquid.
- Operating cash flow for the six months was $108.4 million; investing activities used $537.5 million and financing activities provided $441.6 million. Cash increased $12.5 million to $56.5 million.
Material changes versus comparable periods
- Q2 net income improved from a loss in Q2 2014, principally reflecting a $17.1 million derivative gain versus a $23.1 million derivative loss a year earlier. This did not prevent a comprehensive loss: unrealized MBS losses in OCI more than offset the derivative gain.
- For the first six months, net interest income declined to $37.7 million from $41.2 million. Management attributed the decline largely to a smaller average earning-asset base and lower asset yields. Core net operating income fell to $24.0 million from $27.9 million.
- Book value per common share was $8.53 at June 30, down $0.43 in Q2 and $0.49, or 5%, from year-end. Management cited rising rates and spread widening, which reduced unrealized MBS gains; derivative fair-value gains partially offset the Q2 impact.
- Portfolio mix shifted toward CMBS: the CMBS portfolio more than doubled from year-end, mainly through Agency CMBS purchases. RMBS declined as principal repayments and sales exceeded purchases. Agency RMBS CPR rose to 16.7% in Q2 from 12.4% in Q1, increasing premium amortization.
- Repurchase borrowings rose $389.9 million from year-end to finance investment purchases. Dynex began using FHLB financing in Q2; advances totaled $108.1 million at a 0.22% rate.
Outlook, commentary, and risks
- Management expected the Federal Reserve to begin raising rates in 2015, while noting that weak global conditions could constrain longer-term U.S. rates. It maintained a positive duration gap, leaving the portfolio more sensitive to rising than falling rates, and cited exposure to a steeper yield curve.
- Management warned that higher short-term rates could increase borrowing costs and reduce net interest income and spread, potentially leading to a lower common dividend. The filing provides no formal earnings or dividend guidance.
- Investment focus included multifamily Agency CMBS, Agency and non-Agency CMBS IO, and selective re-performing/non-performing loan securities. Management saw less value in hybrid ARMs. It expected to expand FHLB and private direct financing relationships.
- Risks include interest-rate and spread changes, prepayments and reinvestment at lower yields, credit performance, margin calls, short-term uncommitted repo funding, and potential reductions in market liquidity from regulation or market stress. The company’s sensitivity model estimated that a parallel +100 bp rate shift would reduce market value by 0.86% and adjusted net interest income by 22.35%; modeled results are not forecasts.
- A proposed FHFA rule could terminate captive-insurer FHLB memberships, including Mackinaw’s, and require prompt repayment of advances; inability to replace financing could force asset sales. Repo and derivative covenant compliance was reported at quarter-end.
- The company reported no contingency for which it believed a probable loss had been incurred. A Pennsylvania class action was dismissed in full, with the dismissal affirmed on May 14, 2015. Management did not expect the legal proceedings to materially affect consolidated financial condition or liquidity, though a future period’s results or cash flows could be affected.
Important facts for investors to verify
- Whether subsequent interest-rate and credit-spread movements, prepayment speeds, and hedge performance change book value, net interest income, or dividend capacity.
- Whether elevated leverage and the short maturity of repo funding remain manageable, including liquidity available for margin calls and refinancing.
- Whether FHLB membership and advances remain available under regulatory developments, and whether alternative financing can replace them if needed.
- How the shift into CMBS and CMBS IO, and investment in non-Agency loan securities, affects portfolio yields, credit risk, and fair-value volatility.
- Whether core net operating income and the $0.24-per-share common dividend declared for Q2 are sustainable; core income is a non-GAAP measure and is not a substitute for GAAP results.