Dynex Capital, Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Filed November 12, 2013. Dollar amounts below are in millions unless stated otherwise. Dynex is a leveraged mortgage REIT investing primarily in Agency and non-Agency mortgage-backed securities (MBS).
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Interest income | $31.7 | $28.6 | $98.5 | $82.0 |
| Net interest income | $22.9 | $19.1 | $67.9 | $57.3 |
| Net income (loss) | $(4.6) | $19.2 | $46.5 | $54.5 |
| Net income (loss) to common shareholders | $(6.9) | $18.4 | $40.9 | $53.7 |
| EPS to common shareholders | $(0.13) | $0.34 | $0.75 | $1.02 |
| Core net operating income to common shareholders (non-GAAP) | $14.9; $0.27/share | $14.7; $0.27/share | $48.2; $0.88/share | $46.9; $0.89/share |
- Q3 GAAP net loss included a $24.0 million net loss on derivatives, primarily from Eurodollar futures and adverse fair-value movements. Management introduced non-GAAP core income to aid period comparisons after ending hedge accounting; it is supplemental, not a substitute for GAAP results.
- GAAP net interest spread was 1.94% in Q3 (2.00% in Q3 2012) and 1.93% for the nine months (2.19% in 2012). Adjusted net interest spread, a non-GAAP measure including derivative costs, was 1.65% and 1.83%, respectively, versus 1.98% and 2.13% in the comparable 2012 periods.
- Total assets were $4.32 billion at September 30, versus $4.28 billion at December 31, 2012. MBS at fair value were $4.14 billion; shareholders’ equity was $581.0 million, down from $616.7 million. Accumulated other comprehensive income moved from $52.5 million to a loss of $34.4 million, principally reflecting MBS and hedge valuation changes.
- Repurchase agreements, the principal secured financing, totaled $3.675 billion, up from $3.564 billion at year-end. Non-recourse collateralized financing was $21.1 million. Total liabilities were $3.739 billion; enterprise liabilities were 6.4 times shareholders’ equity, within the stated 7-times limit.
- Cash and cash equivalents were $39.6 million, with a further $15.8 million restricted. Management reported $178.2 million of available liquid assets, including $125.7 million of unencumbered Agency MBS and $12.9 million of unrestricted cash collateral.
- For the first nine months, operating cash flow was $158.0 million, investing cash flow was $(262.0) million, and financing cash flow was $87.8 million. Cash declined by $16.2 million to $39.6 million.
- Common dividends declared were $0.27 per share in Q3, versus $0.29 a year earlier; nine-month declarations were $0.85 versus $0.86. Preferred dividends were $5.6 million for the nine-month period.
Material changes and management commentary
- Book value per common share declined $0.35, or 4%, during Q3 to $8.59. Management attributed estimated declines of $0.21 per share to wider credit spreads and $0.27 to higher interest rates, with hedges added during the quarter contributing to losses as rates retreated late in the period.
- Effective June 30, Dynex discontinued hedge accounting on its interest-rate swaps to allow greater flexibility to extend repurchase-agreement maturities. Derivative fair-value changes thereafter flowed through GAAP earnings rather than accumulated other comprehensive income. The company also began using Eurodollar futures.
- Management reduced portfolio risk during volatile markets by selling investments and not reinvesting principal repayments; repurchase agreements fell about $396.5 million during Q3. It began extending financing maturities, with the weighted-average original term at 91 days at quarter-end versus 57 days at year-end.
- Management expected to keep enterprise leverage at 6.5 times or lower in Q4, assuming no additional asset-price volatility. It anticipated continued market volatility around Federal Reserve asset-purchase tapering and near-term credit spreads remaining wide. Management expected very low short-term policy rates to persist for an extended period; the filing provides no specific earnings or dividend guidance.
Risks, contingencies and subsequent events
- Key exposures include interest-rate and spread volatility, prepayments and reinvestment, leverage, margin calls, and reliance on short-term, uncommitted repurchase financing. A rise in rates can increase funding costs faster than asset yields; falling collateral values can trigger additional collateral demands or asset sales. The company’s modeled rate sensitivity estimated a 5.4% decrease in projected 24-month net interest margin cash flows for a parallel 100-basis-point rate increase; modeled market value fell 0.7% under that scenario. These are assumptions-based estimates, not forecasts.
- Repurchase agreements had a 0.59% weighted-average borrowing rate at quarter-end; 21 of 31 available counterparties provided financing. One Wells Fargo counterparty group represented about 17% of shareholders’ equity at risk. The company reported compliance with financing covenants.
- Management cited uncertainty over Federal Reserve policy, U.S. fiscal and debt-ceiling issues, potential GSE reform, and Basel III and other regulatory changes as risks to MBS values, financing availability, costs, and liquidity.
- The company reported ongoing litigation, including a Texas matter with a reinstated $25.6 million award against former affiliate DCI. Management said it believed Dynex would not be obligated for DCI’s liability. A separate Allegheny County class action remained pending; the company said claims were without merit and would be defended. Management believed the proceedings would not materially affect consolidated financial condition or liquidity, but acknowledged possible effects on results or cash flows in a future period.
- After quarter-end, Wells Fargo amended a repurchase agreement effective October 1, extending its termination date to August 6, 2015 and increasing maximum borrowing capacity to $250 million. Dynex also terminated swaps with $902 million combined notional after September 30.
Important facts for investors to verify
- Reconcile the Q3 GAAP loss with core income and assess the recurring economic cost and valuation volatility of the new derivative strategy.
- Track book value, MBS fair values, accumulated other comprehensive loss, and the effect of interest rates and credit spreads.
- Assess available liquidity, repo renewals and maturities, counterparty concentration, collateral haircuts, and compliance with leverage and financing covenants.
- Compare GAAP and adjusted net interest spreads, asset yields, and effective borrowing costs; review the assumptions behind non-GAAP measures.
- Monitor dividend coverage, the company’s leverage target, and developments in the disclosed litigation and regulatory risks.