Dynex Capital, Inc. — Q1 2012 Form 10-Q
Business context and period. Unaudited results for the three months ended March 31, 2012. Dynex is an internally managed mortgage REIT investing on a leveraged basis in Agency and non-Agency mortgage-backed securities (MBS) and legacy securitized mortgage loans. Its principal earnings source is net interest income.
Financial results and position
Unless stated otherwise, dollar amounts are in millions.
| Metric | Q1 2012 / March 31, 2012 | Comparable period / prior quarter-end |
|---|---|---|
| Interest income | $26.3 | $17.5 in Q1 2011 |
| Net interest income | $19.1 | $12.7 in Q1 2011 |
| Net income | $16.5; $0.33 per diluted share | $10.3; $0.31 per diluted share in Q1 2011 |
| Dividends declared per common share | $0.28 | $0.27 in Q1 2011 |
| Total assets | $3,349.1 | $2,582.2 at December 31, 2011 |
| Shareholders’ equity | $522.9; $9.62 per share | $371.3; $9.20 per share at December 31, 2011 |
| Repurchase agreements | $2,686.2; weighted average rate 0.59% | $2,093.8; 0.61% at December 31, 2011 |
| Non-recourse collateralized financing | $32.2 | $70.9 at December 31, 2011 |
| Cash and cash equivalents | $41.7 | $48.8 at December 31, 2011 |
| Cash flows | Operating +$24.3; investing −$697.4; financing +$666.1 | Net cash decreased $7.1 in the quarter |
Net interest spread on the investment portfolio was 2.41%, down from 2.56% in Q4 2011, principally because newly added Agency MBS yielded less. Management reported a 21.4% average CPR for Agency RMBS, versus 25.4% in Q4 2011. Agency MBS represented 81% of the portfolio at quarter-end, compared with 79% at year-end; the stated target range is 60%–80%.
Material changes and unusual items
- Dynex issued approximately 14.0 million shares and raised $123.7 million net during the quarter, including a 13.33 million-share public offering. Average weighted shares rose to 49.48 million from 33.15 million a year earlier; net income per share increased to $0.33 from $0.31.
- Investments expanded substantially: Agency MBS fair value rose to $2,656.2 million from $1,965.2 million at year-end, and non-Agency MBS to $465.7 million from $421.1 million. Purchases were funded partly with increased repo borrowings and equity proceeds.
- Other comprehensive income was $26.2 million, largely reflecting higher fair values of available-for-sale investments; total comprehensive income was $42.7 million. Accumulated other comprehensive income improved to $22.9 million from a $3.3 million deficit.
- The company paid off $37.6 million of TALF financing during Q1, replacing it with repo financing. It also sold $48.8 million of Freddie Mac unsecured notes and recorded a $0.4 million gain; the remaining notes were sold in Q2.
- The $7.5 million Teamsters securities class-action settlement was approved, with escrow to be distributed to class members. A separate Allegheny County class action was dismissed on April 23, 2012, subject to a possible appeal.
Outlook, risks and contingencies
Management described the business outlook as favorable but noted uncertainty around government policy and U.S. and European credit markets. It expected to reduce Agency MBS exposure during the remainder of 2012 toward its 60%–80% target. Dynex anticipated higher Agency RMBS prepayments during 2012, which could accelerate premium amortization and reduce yields. No specific earnings or dividend guidance was provided.
- Funding and liquidity: Repo financing is short-term, uncommitted, and subject to renewal, collateral haircuts and margin calls. Repo borrowings had a 48-day weighted-average term at quarter-end. Management reported $241.1 million of unencumbered cash and unpledged Agency MBS, and said it was compliant with financing covenants.
- Interest-rate exposure: A modeled instantaneous 100-basis-point rate increase would reduce projected 24-month net interest income by 6.5% and portfolio market value by 1.5%; a 100-basis-point decrease would increase them by 2.0% and 1.1%, respectively. These are model estimates based on stated assumptions, not forecasts.
- Other market risks: Rising short-term rates may raise funding costs faster than asset yields adjust. Prepayments, reinvestment at lower yields, credit losses, spread movements, GSE reform, regulatory changes and weaker repo availability could affect earnings, asset values and liquidity. Non-Agency securities carry greater credit, financing and valuation risk; some are valued using Level 3 models.
- Contingencies: Management said pending proceedings were not expected to materially affect consolidated financial condition or liquidity, but outcomes could materially affect results or cash flows in a future period. A potential Section 382 ownership shift following the share offering could limit use of tax net operating losses and affect REIT distribution requirements; whether a shift occurred was not yet determinable.
Most important facts for investors to verify
- Whether the planned portfolio rebalancing and targeted leverage are achieved, and how changes affect net interest spread and book value.
- Repo renewal terms, counterparty concentration, collateral haircuts, margin-call capacity and available liquidity as the portfolio grows.
- Actual Agency RMBS prepayment speeds and premium amortization relative to management’s expectations.
- Credit performance and valuation assumptions for non-Agency CMBS and CMBS IO, including Level 3 inputs.
- Any Section 382 ownership shift, resulting NOL limitations and implications for REIT qualification and dividends.
- Developments in the remaining legal matters and any appeals following the Allegheny County dismissal.