Dynex Capital, Inc. — 2013 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2013. Dynex is an internally managed mortgage REIT investing in Agency and non-Agency mortgage-backed securities (MBS) with leverage, primarily funded by repurchase agreements. Its stated objective is to earn long-term risk-adjusted returns while emphasizing capital preservation and regular dividends.
Financial performance and position
| Metric | FY 2013 | FY 2012 |
|---|---|---|
| Interest income | $127.1 million | $113.5 million |
| Net interest income | $88.1 million | $78.4 million |
| Net income to common shareholders | $60.2 million | $72.0 million |
| Net income per common share | $1.10 | $1.35 |
| Core net operating income per common share (non-GAAP) | $1.17 | $1.19 |
| Net interest spread | 1.95% | 2.13% |
| Adjusted net interest spread (non-GAAP) | 1.86% | 2.11% |
| Common dividends declared per share | $1.12 | $1.15 |
FY 2013 net cash provided by operating activities was $208.8 million; investing activities used $165.1 million and financing activities used $30.1 million. Cash and cash equivalents ended the year at $69.3 million. Management reported $208.7 million of available liquid assets, including cash, unencumbered Agency MBS, and unrestricted cash collateral.
At year-end, total assets were $4.22 billion, investments were $4.07 billion, repurchase agreements were $3.58 billion, and shareholders’ equity was $585.9 million. Book value per common share was $8.69, down from $10.30 a year earlier. Total liabilities were 6.2 times shareholders’ equity, versus a company policy ceiling of 7 times. Repurchase agreements had a weighted-average rate of 0.61% and original term to maturity of 114 days.
Fourth-quarter 2013 net interest income was $20.2 million, net income to common shareholders was $19.3 million, diluted EPS was $0.35, and the declared common dividend was $0.27 per share.
Changes versus the prior year
- Net interest income increased 12%, mainly because the average interest-earning asset base grew and borrowing costs were lower; lower investment yields partly offset this benefit.
- Common net income fell by $11.8 million. Higher preferred dividends, increased derivative losses, and lower gains on investment sales offset the increase in net interest income.
- Core net operating income, a non-GAAP measure, rose slightly to $63.8 million, but declined to $1.17 per share from $1.19, partly because average common shares outstanding increased.
- Book value declined as MBS fair values fell amid 2013 rate and spread volatility. Shareholders’ equity decreased $30.8 million; accumulated other comprehensive loss increased $86.3 million.
- Management reduced leverage after midyear volatility, selling approximately $170.2 million of assets since June 30 and not reinvesting a substantial portion of principal repayments.
Outlook, commentary, risks, and unusual items
- Management expected Federal Reserve asset purchases to continue tapering during 2014 and anticipated continued potential for asset-price volatility as rates and credit spreads adjusted. It expected the federal funds rate to remain low for an extended period, while noting that market participants were forecasting an eventual increase.
- The company continued to favor higher-quality, shorter-duration Agency and non-Agency assets. It increased its modeled duration gap in the fourth quarter, ending the year at the higher end of its 0.5-to-1.5-year target range, and extended some repo maturities.
- Key risks include rising rates reducing MBS values and increasing funding costs; spread widening, margin calls, and forced asset sales; reliance on short-term, generally uncommitted repo funding; counterparty and liquidity risk; prepayment and reinvestment risk; and credit exposure in non-Agency MBS and commercial real estate loans.
- Regulatory uncertainty may affect repo funding costs or availability. The future structure and guarantees of Fannie Mae and Freddie Mac also pose uncertainty for Agency MBS markets. Dynex relies on its REIT status and on an exemption from Investment Company Act registration.
- Effective June 30, 2013, Dynex discontinued cash flow hedge accounting for its interest-rate swaps. Derivative fair-value changes and subsequent periodic costs moved into current-period earnings presentation, increasing reported earnings volatility. Management’s non-GAAP core results and adjusted spread are intended to aid comparison, but should be considered alongside GAAP results.
- Estimated tax NOL carryforward was $142.3 million, with Section 382 limiting annual use to approximately $13.5 million; the NOL begins expiring principally in 2020–2024. Management expected no 2013 income tax liability.
- In litigation involving former affiliate DCI, a $25.6 million damages award was reinstated against DCI; the company stated it was not liable and DCI appealed. The company also disclosed a putative class action concerning delinquent property-tax collections. Management did not expect the proceedings to materially affect consolidated financial condition or liquidity, but acknowledged potential period-specific effects on results or cash flows. A separate $8.4 million balance due from DCI under a litigation cost-sharing agreement was fully reserved.
- Management reported effective disclosure controls and internal control over financial reporting; the independent auditor issued unqualified opinions on the financial statements and internal controls.
Most important facts for investors to verify
- Whether book value, MBS valuations, and common dividends remain sustainable under changing interest rates and credit spreads.
- Repo availability, refinancing terms, margin-call exposure, covenant headroom, and liquidity relative to the company’s leverage.
- The effect of hedge-accounting discontinuation on GAAP earnings, and the assumptions behind non-GAAP core income and adjusted spread.
- Actual portfolio prepayments, premium amortization, and credit performance—especially for CMBS IO and non-Agency holdings.
- Developments in GSE reform, financial regulation, REIT qualification, and the Section 382 limits on use of tax NOLs.
- Updates on the DCI appeal and Allegheny County litigation, including any change in the company’s assessment of potential exposure.