DYNEX CAPITAL INC quarterly report, Q1 FY2016

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Dynex Capital, Inc. — Q1 2016 Form 10-Q

Reporting period: Three months ended March 31, 2016; balance sheet compared with December 31, 2015. Dynex is a mortgage REIT investing on a leveraged basis in residential and commercial mortgage-backed securities (MBS). Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless stated otherwise.

Key financial results

MetricQ1 2016Comparable period
Interest income$25.1 million$24.1 million, Q1 2015
Interest expense$6.3 million$5.4 million, Q1 2015
Net interest income$18.8 million$18.7 million, Q1 2015
GAAP net loss$(37.4) million$(9.5) million, Q1 2015
Net loss to common shareholders / diluted EPS$(39.7) million / $(0.81)$(11.8) million / $(0.21), Q1 2015
Other comprehensive income$41.7 million$23.1 million, Q1 2015
Comprehensive income to common shareholders$2.0 million$11.3 million, Q1 2015
Operating cash flow$53.6 million provided$51.0 million provided, Q1 2015

GAAP net interest spread was 1.97%, up from 1.93% in Q1 2015. Adjusted net interest spread, a non-GAAP measure that includes periodic derivative interest costs, was 1.76%, versus 1.96%. Management-reported core net operating income to common shareholders was $10.8 million, or $0.22 per share, versus $12.4 million, or $0.23 per share, in Q1 2015.

The GAAP loss primarily reflected a $48.3 million net derivative loss and $3.9 million net loss on investment sales. Unrealized MBS gains reported in other comprehensive income substantially offset these items, producing positive comprehensive income.

Financial position and liquidity

  • Total assets were $3.58 billion, including $3.33 billion of MBS, compared with $3.67 billion and $3.49 billion, respectively, at year-end 2015.
  • Total liabilities were $3.10 billion; shareholders’ equity was $483.8 million, down from $492.0 million. Accumulated other comprehensive income improved to $29.0 million from a $12.8 million loss.
  • Repurchase agreements were $2.72 billion and FHLB advances were $263.0 million, for total secured borrowings of $2.99 billion. Total liabilities were 6.4 times shareholders’ equity, against a stated enterprise-level limit of 7 times.
  • Unrestricted cash and cash equivalents were $82.9 million; restricted cash was $86.9 million and was pledged for financing and derivative margin. Management reported available liquid assets of $145.1 million, comprising unrestricted cash and $62.2 million of unencumbered Agency MBS, versus $150.3 million at year-end.
  • Net cash provided by investing activities was $170.6 million; financing activities used $175.2 million. Cash and cash equivalents ended the quarter at $82.9 million, up $49.0 million from year-end.
  • Common dividend declared for Q1 was $0.21 per share, down from $0.24 for Q4 2015. The company also had Series A and B preferred stock with annual dividend rates of 8.50% and 7.625%.

Material changes versus prior periods

  • Compared with Q1 2015, GAAP net loss widened as derivative losses increased to $48.3 million from $25.3 million; net interest income was nearly unchanged. The loss on investment sales was $3.9 million, versus a $1.3 million gain.
  • Interest income benefited from shifting the portfolio toward higher-yielding CMBS and CMBS IO. Their share of the investment portfolio was 53% at March 31, versus 45% a year earlier; management cited $1.3 million of Q1 prepayment compensation.
  • Funding costs rose: cost of funds was 0.81%, compared with 0.69% in Q1 2015. The company cited higher repo rates following the December 2015 Federal Funds rate increase and higher periodic interest costs on derivatives.
  • During Q1 the company did not reinvest portfolio paydowns, instead using proceeds to repay borrowings and build liquidity. It sold lower-yielding Agency RMBS and non-Agency CMBS; MBS fair value declined from $3.49 billion at year-end to $3.33 billion.
  • Repurchase agreements increased from $2.59 billion at year-end, while FHLB advances declined from $520.0 million to $263.0 million. The remaining advances mature in October 2016.

Outlook, risks and other notable matters

  • Management said it expected intermittent market volatility to continue and considered a sustained near-term rise in interest rates unlikely. It described the environment as potentially supportive of net interest income but emphasized disciplined risk management and capital allocation. No numerical earnings or dividend guidance was provided.
  • Management maintained a long-duration portfolio position and said it could reduce hedging further and add duration if rates rise. It identified credit-spread widening and adverse relative movements between assets and hedges as factors that had contributed to book-value declines in recent quarters.
  • Key risks include interest-rate and yield-curve changes, MBS prepayments and reinvestment, credit and market-value losses, margin calls, and the short-term, generally uncommitted nature of repo financing. Financing access and pricing may be affected by market stress, regulation, and counterparty capacity.
  • An FHFA rule requires the captive insurance subsidiary to end FHLB membership by February 2017 and bars new advances or renewals; outstanding advances were expected to be repaid before year-end 2016. Management said it expected to replace this funding using available repo capacity.
  • In May 2016, after quarter-end, Dynex amended its Wells Fargo committed repo facility, increasing maximum capacity to $350 million and extending maturity to August 6, 2018.
  • The company reported compliance with financing covenants. Its motion to dismiss the garnishment action alleging it was a successor to former affiliate DCI was granted in March 2016. Dynex said other legal proceedings were not expected to materially affect consolidated financial condition or liquidity, though resolution could affect results or cash flows in a future period.

Important facts for investors to verify

  • Whether core net operating income, funding costs, and the common dividend remain sustainable as the portfolio contracts and financing rates change.
  • How derivative fair-value movements and credit-spread changes affect book value and whether hedges offset asset risks as intended.
  • Whether Dynex can refinance or repay the remaining $263 million of FHLB advances on schedule and maintain repo capacity and liquidity.
  • Whether margin requirements, collateral values, prepayments, or defaults—especially in non-Agency securities and CMBS IO—change materially.
  • The final effect of the Wells Fargo facility amendment, and any material developments in legal proceedings or financing covenants.