Dynex Capital(DX) - 2019 Q3 - Quarterly Report

FORM 10-Q Cover Page Registrant Information This section provides basic identification details for Dynex Capital, Inc., including its incorporation state, address, contact, and SEC filing status as an accelerated filer for the quarter ended September 30, 2019 - The registrant is DYNEX CAPITAL, INC., incorporated in Virginia, with Commission File Number: 1-9819[2] Table: Securities Registered | Securities Registered | Trading Symbol(s) | Exchange | | :-------------------- | :---------------- | :------- | | Common Stock, $.01 par value | DX | New York Stock Exchange | | 8.50% Series A Cumulative Redeemable Preferred Stock, par value $0.01 per share | DXPRA | New York Stock Exchange | | 7.625% Series B Cumulative Redeemable Preferred Stock, par value $0.01 per share | DXPRB | New York Stock Exchange | - The registrant is an Accelerated filer and is not a shell company[4][5] - As of November 1, 2019, the registrant had 22,945,993 shares of common stock outstanding[5] INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements This section presents Dynex Capital, Inc.'s unaudited consolidated financial statements, including balance sheets, comprehensive income, shareholders' equity, and cash flows, for periods ending September 30, 2019, and December 31, 2018 Consolidated Balance Sheets Table: Consolidated Balance Sheets | Metric | Sep 30, 2019 (unaudited) ($ thousands) | Dec 31, 2018 ($ thousands) | | :----------------------------------------- | :----------------------------------- | :------------------------- | | Assets: | | | | Mortgage-backed securities | $5,302,926 | $3,749,464 | | Cash and cash equivalents | $41,781 | $34,598 | | Restricted cash | $97,154 | $54,106 | | Total assets | $5,487,401 | $3,886,089 | | Liabilities: | | | | Repurchase agreements | $4,872,869 | $3,267,984 | | Total liabilities | $4,902,954 | $3,358,936 | | Shareholders' Equity: | | | | Total shareholders' equity | $584,447 | $527,153 | | Total liabilities and shareholders' equity | $5,487,401 | $3,886,089 | - Total assets increased by $1,601,312 thousand (41.2%) from December 31, 2018, to September 30, 2019, primarily driven by an increase in mortgage-backed securities[8] - Total liabilities increased by $1,544,018 thousand (46.0%) over the same period, mainly due to higher repurchase agreements[10] - Total shareholders' equity increased by $57,294 thousand (10.9%) from December 31, 2018, to September 30, 2019[11] Consolidated Statements of Comprehensive Income (Loss) Table: Consolidated Statements of Comprehensive Income (Loss) | Metric | 3 Months Ended Sep 30, 2019 ($ thousands) | 3 Months Ended Sep 30, 2018 ($ thousands) | 9 Months Ended Sep 30, 2019 ($ thousands) | 9 Months Ended Sep 30, 2018 ($ thousands) | | :----------------------------------- | :---------------------------------------- | :---------------------------------------- | :---------------------------------------- | :---------------------------------------- | | Interest income | $44,502 | $26,925 | $128,207 | $78,037 | | Interest expense | $31,256 | $14,751 | $88,345 | $40,521 | | Net interest income | $13,246 | $12,174 | $39,862 | $37,516 | | Net (loss) income | $(36,604) | $25,586 | $(207,803) | $85,545 | | Net (loss) income to common shareholders | $(39,945) | $22,630 | $(217,409) | $76,707 | | Total other comprehensive income (loss) | $55,195 | $(21,914) | $252,789 | $(77,136) | | Comprehensive income (loss) to common shareholders | $15,250 | $716 | $35,380 | $(429) | | Net (loss) income per common share-basic and diluted | $(1.65) | $1.18 | $(9.12) | $4.06 | - Net interest income increased by $1,072 thousand (8.8%) for the three months ended September 30, 2019, compared to the same period in 2018, and by $2,346 thousand (6.3%) for the nine months ended September 30, 2019, compared to the same period in 2018[14] - The company reported a net loss to common shareholders of $(39,945) thousand for the three months ended September 30, 2019, a significant decrease from a net income of $22,630 thousand in the prior year period. For the nine months, the net loss was $(217,409) thousand, compared to a net income of $76,707 thousand in the prior year[14] - Total other comprehensive income (loss) significantly improved, showing a gain of $55,195 thousand for the three months ended September 30, 2019, compared to a loss of $(21,914) thousand in the prior year period, primarily due to unrealized gains on available-for-sale investments[13] Consolidated Statements of Shareholders' Equity Table: Consolidated Statements of Shareholders' Equity | Metric | Dec 31, 2018 ($ thousands) | Sep 30, 2019 ($ thousands) | | :----------------------------------- | :------------------------- | :------------------------- | | Preferred Stock Amount | $142,883 | $162,807 | | Common Stock Amount | $209 | $229 | | Additional Paid-in Capital | $818,861 | $858,050 | | Accumulated Other Comprehensive (Loss) Income | $(35,779) | $217,010 | | Accumulated Deficit | $(399,021) | $(653,649) | | Total Shareholders' Equity | $527,153 | $584,447 | - Total shareholders' equity increased from $527,153 thousand at December 31, 2018, to $584,447 thousand at September 30, 2019[17] - Accumulated other comprehensive income (loss) significantly improved from a deficit of $(35,779) thousand to an income of $217,010 thousand, reflecting substantial unrealized gains[17] - The company reported a net loss of $(207,803) thousand for the nine months ended September 30, 2019, contributing to an increased accumulated deficit[14][17] - Stock issuance activities contributed to increases in Preferred Stock, Common Stock, and Additional Paid-in Capital during the period[17] Consolidated Statements of Cash Flows Table: Consolidated Statements of Cash Flows | Cash Flow Activity | 9 Months Ended Sep 30, 2019 ($ thousands) | 9 Months Ended Sep 30, 2018 ($ thousands) | | :--------------------------------------------------- | :---------------------------------------- | :---------------------------------------- | | Net cash and cash equivalents provided by operating activities | $122,144 | $138,560 | | Net cash and cash equivalents used in investing activities | $(1,680,224) | $(216,302) | | Net cash and cash equivalents provided by financing activities | $1,608,311 | $104,127 | | Net increase in cash, cash equivalents, and restricted cash | $50,231 | $26,385 | | Cash, cash equivalents, and restricted cash at end of period | $138,935 | $113,585 | - Net cash provided by operating activities decreased by $16,416 thousand (11.8%) for the nine months ended September 30, 2019, compared to the same period in 2018[22] - Net cash used in investing activities significantly increased to $(1,680,224) thousand in 2019 from $(216,302) thousand in 2018, primarily due to higher purchases of investments[22] - Net cash provided by financing activities substantially increased to $1,608,311 thousand in 2019 from $104,127 thousand in 2018, driven by increased borrowings under repurchase agreements and proceeds from stock issuances[22] - Cash, cash equivalents, and restricted cash at the end of the period increased by $25,350 thousand (22.3%) from September 30, 2018, to September 30, 2019[22] Notes to the Unaudited Consolidated Financial Statements NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This note outlines the company's organization as a mortgage REIT, its primary investment strategy in MBS, and significant accounting policies including basis of presentation, investments, and derivatives - Dynex Capital, Inc. is a mortgage REIT primarily investing in leveraged debt securities, mainly Agency and non-Agency mortgage-backed securities (MBS)[24] - The company has elected to be taxed as a REIT, requiring distribution of at least 90% of its annual REIT taxable income to stockholders[34] - A 1-for-3 reverse stock split of common stock was effected on June 20, 2019, and all common share amounts have been restated to reflect this[26][39] - Investments in debt securities are designated as available-for-sale (AFS) and recorded at fair value, with unrealized gains/losses reported in other comprehensive income (OCI)[45] - Derivative instruments, including interest rate swaps and TBA securities, are accounted for at fair value, with changes recorded in 'gain (loss) on derivative instruments, net'[56] - The FASB issued ASU No. 2016-13 and ASU No. 2019-05 regarding credit losses, which the Company does not expect to have a material impact due to its majority investment in Agency MBS[67][68] NOTE 2 – INVESTMENTS IN DEBT SECURITIES This note details the company's debt securities portfolio, primarily Agency and non-Agency RMBS, CMBS, and CMBS IO, categorized by type and maturity, and discusses sales and impairment evaluation Table: Investments in Debt Securities by Type | Investment Type | Sep 30, 2019 Fair Value ($ thousands) | Dec 31, 2018 Fair Value ($ thousands) | | :---------------- | :------------------------------------ | :------------------------------------ | | Agency RMBS | $2,736,372 | $2,158,021 | | Non-Agency RMBS | $725 | $858 | | Agency CMBS | $2,075,203 | $1,057,015 | | Non-Agency CMBS | $1,083 | $1,416 | | Agency CMBS IO | $282,043 | $291,104 | | Non-Agency CMBS IO | $207,500 | $241,050 | | Total AFS securities | $5,302,926 | $3,749,464 | - Total AFS securities increased by $1,553,462 thousand (41.4%) from December 31, 2018, to September 30, 2019, with significant growth in Agency RMBS and CMBS[71][72] Table: Investments in Debt Securities by Maturity | Maturity | Sep 30, 2019 Fair Value ($ thousands) | Dec 31, 2018 Fair Value ($ thousands) | | :--------------- | :------------------------------------ | :------------------------------------ | | Less than 1 year | $8,450 | $39,808 | | >1 and <5 years | $136,599 | $152,917 | | >5 and <10 years | $987,657 | $806,015 | | >10 years | $4,170,220 | $2,750,724 | | Total | $5,302,926 | $3,749,464 | - The company does not consider unrealized losses on Agency MBS to be credit related due to government guarantees and has determined them to be temporary[78] NOTE 3 – REPURCHASE AGREEMENTS This note details the company's repurchase agreements used to finance debt securities, including balances, collateral, rates, maturity terms, and covenant compliance Table: Repurchase Agreements by Collateral Type | Collateral Type | Sep 30, 2019 Balance ($ thousands) | Sep 30, 2019 WAVG Rate | Dec 31, 2018 Balance ($ thousands) | Dec 31, 2018 WAVG Rate | | :---------------------- | :------------------------------- | :--------------------- | :------------------------------- | :--------------------- | | Agency RMBS | $2,561,276 | 2.26% | $1,887,878 | 2.66% | | Agency CMBS | $1,884,697 | 2.29% | $919,833 | 2.51% | | Agency CMBS IO | $249,929 | 2.64% | $253,258 | 2.96% | | Non-Agency CMBS IO | $176,967 | 2.94% | $207,015 | 3.38% | | Total repurchase agreements | $4,872,869 | 2.32% | $3,267,984 | 2.69% | - Total repurchase agreements increased by $1,604,885 thousand (49.1%) from December 31, 2018, to September 30, 2019, with a decrease in the weighted average rate from 2.69% to 2.32%[80] Table: Repurchase Agreements by Remaining Term to Maturity | Remaining Term to Maturity | Sep 30, 2019 Balance ($ thousands) | Sep 30, 2019 WAVG Rate | Dec 31, 2018 Balance ($ thousands) | Dec 31, 2018 WAVG Rate | | :------------------------- | :------------------------------- | :--------------------- | :------------------------------- | :--------------------- | | Less than 30 days | $2,751,900 | 2.39% | $2,319,911 | 2.74% | | 30 to 90 days | $2,120,969 | 2.22% | $948,073 | 2.55% | | Total | $4,872,869 | 2.32% | $3,267,984 | 2.69% | - The company was in full compliance with all covenants in master repurchase agreements as of September 30, 2019[84] NOTE 4 – DERIVATIVES This note details the company's use of derivative instruments, including interest rate swaps and TBA securities, for hedging and trading, providing fair value, gain/loss, and notional amounts - The company uses interest rate swaps, futures, options, and TBA securities as derivative instruments for economic hedging and trading[89][90] Table: Derivative Fair Values | Derivative Type | Sep 30, 2019 Fair Value ($ thousands) | Dec 31, 2018 Fair Value ($ thousands) | | :---------------------------- | :------------------------------------ | :------------------------------------ | | Interest rate swaptions | $1,851 | $0 | | Eurodollar futures | $928 | $0 | | TBA securities - net long position | $2,066 | $6,239 | | Total Derivative Assets | $4,845 | $6,563 | | TBA securities - net short position | $(439) | $0 | | U.S. Treasury futures | $0 | $(1,218) | | Total Derivative Liabilities | $(439) | $(1,218) | Table: (Loss) Gain on Derivative Instruments, Net | Derivative Type | 3 Months Ended Sep 30, 2019 ($ thousands) | 3 Months Ended Sep 30, 2018 ($ thousands) | 9 Months Ended Sep 30, 2019 ($ thousands) | 9 Months Ended Sep 30, 2018 ($ thousands) | | :---------------------------- | :---------------------------------------- | :---------------------------------------- | :---------------------------------------- | :---------------------------------------- | | Interest rate swaps | $(52,908) | $25,019 | $(248,886) | $93,833 | | Interest rate swaptions | $(4,329) | $0 | $(4,329) | $0 | | Eurodollar futures | $1,712 | $(189) | $1,610 | $1,886 | | TBA securities - net long position | $4,652 | $(5,204) | $21,609 | $(18,256) | | Total (Loss) Gain on Derivative Instruments, Net | $(50,709) | $19,499 | $(229,941) | $78,520 | - Notional balance of interest rate swaps decreased from $4,515,000 thousand at December 31, 2018, to $3,880,000 thousand at September 30, 2019, with a decrease in weighted-average pay rate from 2.35% to 1.65%[97] NOTE 5 – FAIR VALUE OF FINANCIAL INSTRUMENTS This note details fair value measurements of financial instruments, categorized by ASC Topic 820 hierarchy, explaining valuation methodologies for MBS and derivatives, and reconciling Level 3 non-Agency MBS activity - Fair value measurements are categorized into Level 1 (quoted prices in active markets), Level 2 (observable inputs other than Level 1), and Level 3 (unobservable inputs)[111] Table: Fair Value Measurements by Level | Financial Instrument | Sep 30, 2019 Fair Value ($ thousands) | Level 1 ($ thousands) | Level 2 ($ thousands) | Level 3 ($ thousands) | | :-------------------------------- | :------------------------------------ | :-------------------- | :-------------------- | :-------------------- | | MBS | $5,302,926 | $0 | $5,301,118 | $1,808 | | Derivative assets | $4,845 | $928 | $3,917 | $0 | | Derivative liabilities | $439 | $0 | $439 | $0 | - The majority of MBS are classified as Level 2, valued using third-party pricing services and broker quotes, while certain non-Agency MBS are Level 3 due to insufficient recent trades[116][117] Table: Level 3 Non-Agency MBS Activity | Level 3 Non-Agency MBS Activity | 2019 ($ thousands) | 2018 ($ thousands) | | :------------------------------ | :----------------- | :----------------- | | Balance as of beginning of period | $2,274 | $7,243 | | Unrealized gain included in OCI | $225 | $(862) | | Principal payments | $(1,853) | $(1,031) | | Accretion | $1,162 | $886 | | Balance as of end of period | $1,808 | $6,236 | NOTE 6 – SHAREHOLDERS' EQUITY AND SHARE-BASED COMPENSATION This note outlines preferred and common stock details, including a reverse stock split's impact, share-based compensation, restricted stock activity, and dividend declarations - The company has 8.50% Series A and 7.625% Series B Cumulative Redeemable Preferred Stock outstanding, classified as equity[122][123] - A 1-for-3 reverse stock split of common stock was effected on June 20, 2019, reducing outstanding shares and authorized shares[124] Table: Common Stock Dividends Declared | Declaration Date | Amount Declared (per share) | | :--------------- | :-------------------------- | | January 7, 2019 | $0.18 | | January 28, 2019 | $0.18 | | March 12, 2019 | $0.18 | | April 10, 2019 | $0.18 | | May 16, 2019 | $0.18 | | June 6, 2019 | $0.18 | | July 8, 2019 | $0.18 | | August 12, 2019 | $0.15 | | September 11, 2019 | $0.15 | Table: Restricted Stock Activity | Restricted Stock Activity | 2019 Shares | 2018 Shares | | :------------------------ | :---------- | :---------- | | Outstanding as of beginning of period | 113,904 | 117,701 | | Granted | 67,997 | 71,051 | | Vested | (62,688) | (74,849) | | Outstanding as of end of period | 119,213 | 113,904 | NOTE 7 – SUBSEQUENT EVENTS This note discloses a subsequent event where the Board of Directors declared a monthly cash dividend of $0.15 per common share, payable November 1, 2019 - On October 11, 2019, the Board of Directors declared a monthly cash dividend of $0.15 per common share, payable on November 1, 2019[130] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on financial condition and results, discussing investment strategies, market conditions, performance highlights, outlook, non-GAAP measures, and critical accounting policies EXECUTIVE OVERVIEW This overview introduces Dynex Capital, Inc. as an internally managed mortgage REIT, detailing its MBS investment strategy, financing, hedging, market factors, Federal Reserve actions, and Q3 2019 financial highlights Company Overview - Dynex Capital, Inc. is an internally managed mortgage REIT, primarily investing in residential and commercial mortgage-backed securities (MBS) on a leveraged basis[135] - The company's objective is to provide attractive risk-adjusted returns to shareholders through regular dividends and potential capital appreciation, focusing on capital preservation[135] - Investments primarily consist of Agency MBS (RMBS, CMBS, CMBS IO) and non-Agency CMBS IO, with Agency securities guaranteed by U.S. government-sponsored entities[137] - The company uses repurchase agreements for financing and derivative instruments (primarily interest rate swaps) for hedging against interest rate changes[143][144] Factors that Affect Our Results of Operations and Financial Condition - Financial performance is influenced by interest rates, prepayment rates, investment supply/competition, economic conditions, and market spreads, all impacted by macroeconomic and geopolitical factors[146] - During Q3 2019, the Federal Reserve reduced the Fed Funds Target Rate by 50 basis points, but repurchase agreement borrowing rates lagged due to market issues like excess collateral supply and balance sheet constraints[147] - The New York Federal Reserve's operations to provide liquidity to the repurchase agreement markets are expected to help stabilize short-term borrowing rates[147] Market Conditions and Recent Activity - U.S. Treasury and swap rates continued to decline in Q3 2019 due to weakening global GDP, trade uncertainty, and benign inflation[149] - The Federal Reserve reduced the Fed Funds rate by 50 basis points and resumed Treasury bill purchases at $60 billion monthly[149] - Treasury and swap rates experienced significant volatility during the quarter, with the 10-year part of the curve ranging by as much as 68 and 75 basis points, respectively[150] Highlights of Third Quarter 2019 Results - Comprehensive income to common shareholders improved to $15.3 million in Q3 2019, up from a loss of $(11.1) million in the prior quarter[157] - Net loss to common shareholders improved due to increased net interest income, a lower net loss on derivative instruments, a net gain on sale of investments, and decreased general and administrative expenses[157][159] - Core net operating income to common shareholders (non-GAAP) increased to $11.5 million in Q3 2019 from $10.6 million in Q2 2019[160] - Book value per common share increased by $0.39 to $18.07 at September 30, 2019, from $17.68 at June 30, 2019. Common stock repurchases contributed $0.24 to this increase[161] - Quarterly total economic return on book value per common share was 4.9%, and year-to-date total economic return was 8.6%[161] Management Outlook - Management anticipates global debt, demographic trends, technological advances, human conflict, and climate change will continue to drag global growth and inflation[162] - The 10-year U.S. Treasury bond is expected to remain within a 1.5%-2.5% range, with a rapid decline below 1.5% being a major risk due to potential increases in RMBS prepayments[162] - The FOMC reduced the Fed Funds Rate by an additional 25 basis points on October 30, 2019, totaling a 75 basis point reduction since June[163] - While Fed Funds Rate reductions generally lower borrowing costs and increase net interest spread, pressure in funding markets may keep borrowing rates somewhat elevated[163] Non-GAAP Financial Measures - The company uses non-GAAP measures like core net operating income to common shareholders, adjusted interest expense, and adjusted net interest income for internal analysis and investor transparency[165] - Core net operating income to common shareholders is an estimate of financial performance based on effective yield of investments, net of financing costs and recurring operating income/expense[168] - TBA drop income and periodic interest benefit/cost from interest rate swaps are included in core net operating income and adjusted net interest income, as they are viewed as economic equivalents of net interest income or total financing cost[168] Table: Core Net Operating Income to Common Shareholders (Non-GAAP) | Metric | 3 Months Ended Sep 30, 2019 ($ thousands) | 3 Months Ended Jun 30, 2019 ($ thousands) | | :----------------------------------- | :---------------------------------------- | :---------------------------------------- | | GAAP net loss to common shareholders | $(39,945) | $(122,191) | | Less: Change in fair value of derivative instruments, net | $56,079 | $122,370 | | Less: (Gain) loss on sale of investments, net | $(4,605) | $10,360 | | Less: Fair value adjustments, net | $13 | $16 | | Core net operating income to common shareholders | $11,542 | $10,555 | | Core net operating income per common share | $0.48 | $0.43 | Table: Adjusted Net Interest Income (Non-GAAP) | Metric | 3 Months Ended Sep 30, 2019 Amount ($ thousands) | 3 Months Ended Sep 30, 2019 Rate | 3 Months Ended Jun 30, 2019 Amount ($ thousands) | 3 Months Ended Jun 30, 2019 Rate | | :--------------------------- | :--------------------------------------- | :----------------- | :--------------------------------------- | :----------------- | | Net interest income | $13,246 | 0.82% | $12,935 | 0.76% | | Add: TBA drop income | $1,404 | —% | $1,282 | (0.04)% | | Add: net periodic interest benefit | $3,966 | 0.32% | $3,553 | 0.31% | | Adjusted net interest income | $18,616 | 1.14% | $17,770 | 1.03% | CRITICAL ACCOUNTING POLICIES This section states that critical accounting policies, involving significant management estimates and judgments, have not materially changed during the three and nine months ended September 30, 2019 - No significant changes in critical accounting policies occurred during the three and nine months ended September 30, 2019[174] FINANCIAL CONDITION This section details the company's investment portfolio, primarily Agency fixed-rate MBS, strategies to mitigate prepayment risk, and the status of repurchase agreements and derivative assets/liabilities Investment Portfolio - The investment portfolio is mostly Agency fixed-rate investments, with diversification across residential and commercial Agency MBS to mitigate prepayment risk in a declining interest rate environment[177] Table: Investment Portfolio Composition | Investment Type | Sep 30, 2019 Fair Value ($ thousands) | Dec 31, 2018 Fair Value ($ thousands) | | :------------------------------------------ | :------------------------------------ | :------------------------------------ | | Agency RMBS, fixed-rate | $2,736,372 | $2,124,810 | | TBAs, fixed-rate | $(123,208) | $888,469 | | Agency CMBS, fixed-rate | $2,075,203 | $1,057,015 | | CMBS IO | $489,543 | $532,154 | | Non-Agency other | $1,808 | $2,274 | | Total investment portfolio including TBA dollar roll positions | $5,186,497 | $4,646,499 | - Total investment portfolio increased by $540,000 thousand (11.6%) from December 31, 2018, to September 30, 2019[179] - The company sold a portion of higher coupon fixed-rate Agency RMBS and adjustable-rate Agency RMBS due to increased prepayment risk and lower return profiles, replacing them with lower coupon Agency RMBS[223] Repurchase Agreements - The majority of repurchase agreement borrowings are collateralized with Agency MBS, which have lower liquidity risk[191] Derivative Assets and Liabilities - The company regularly monitors and adjusts its hedging portfolio based on investment portfolio changes, yield curve shifts, and expectations of interest rates and volatility[192] - As of September 30, 2019, the notional balance of interest rate swaps decreased by $0.6 billion, and the weighted average net pay-fixed rate decreased by 70 basis points to 1.65% since December 31, 2018[194] - The company also held swaptions on pay-fixed interest rate swaps with an aggregate notional balance of $750.0 million and Eurodollar futures with an aggregate notional balance of $6.0 billion[197] RESULTS OF OPERATIONS This section analyzes the company's financial performance, focusing on net interest income, adjusted net interest income, investment gains/losses, derivative performance, and general and administrative expenses for the three and nine months ended September 30, 2019 Net Interest Income for the Three Months Ended September 30, 2019 Compared to the Three Months Ended September 30, 2018 - Net interest income increased by $1.1 million for the three months ended September 30, 2019, compared to the same period in 2018[201] - Interest income increased by $17.6 million due to a larger and higher-yielding portfolio, but was largely offset by a $16.5 million increase in interest expense from higher average borrowings at higher financing rates[201][206] - Net interest spread declined by 26 basis points for Q3 2019 compared to Q3 2018, as interest expense growth outpaced interest income growth[201] Table: Net Interest Income Analysis (3 Months) | Metric | 3 Months Ended Sep 30, 2019 | 3 Months Ended Sep 30, 2018 | | :----------------------------------- | :-------------------------- | :-------------------------- | | Total Interest-earning assets (Avg Balance) | $5,195,909 | $3,031,388 | | Total Interest-bearing liabilities (Avg Balance) | $4,958,857 | $2,569,123 | | Effective Yield (Assets) | 3.29% | 3.33% | | Cost of Funds (Liabilities) | 2.47% | 2.25% | | Net Interest Spread | 0.82% | 1.08% | Adjusted Net Interest Income for the Three Months Ended September 30, 2019 Compared to the Three Months Ended September 30, 2018 - Adjusted net interest income increased by $0.5 million for the three months ended September 30, 2019, compared to the same period in 2018[209] - This increase was driven by higher net interest income and net periodic interest benefit from interest rate swaps, partially offset by a decline in drop income from TBA dollar roll positions[209] - The net yield on TBA dollar roll positions decreased to 1.08% in Q3 2019 from 1.61% in Q3 2018 due to higher expected prepayment speeds impacting TBA contract pricing[209] Table: Adjusted Net Interest Income Analysis (3 Months) | Metric | 3 Months Ended Sep 30, 2019 Amount ($ thousands) | 3 Months Ended Sep 30, 2019 Rate | 3 Months Ended Sep 30, 2018 Amount ($ thousands) | 3 Months Ended Sep 30, 2018 Rate | | :----------------------------------- | :---------------------------------------- | :----------------- | :---------------------------------------- | :----------------- | | Net interest income | $13,246 | 0.82% | $12,174 | 1.08% | | Add: TBA drop income | $1,404 | —% | $4,262 | 0.06% | | Add: net periodic interest benefit | $3,966 | 0.32% | $1,777 | 0.28% | | Adjusted net interest income | $18,616 | 1.14% | $18,147 | 1.41% | Net Interest Income for the Nine Months Ended September 30, 2019 Compared to the Nine Months Ended September 30, 2018 - Net interest income increased by $1.7 million for the nine months ended September 30, 2019, compared to the same period in 2018[212] - Interest income increased by $49.6 million due to a larger and higher-yielding portfolio, but was mostly offset by a $47.8 million increase in interest expense from higher average borrowings at higher financing rates[212][217] - Net interest spread declined by 36 basis points for the nine months ended September 30, 2019, compared to the same period in 2018[212] Table: Net Interest Income Analysis (9 Months) | Metric | 9 Months Ended Sep 30, 2019 | 9 Months Ended Sep 30, 2018 | | :----------------------------------- | :-------------------------- | :-------------------------- | | Total Interest-earning assets (Avg Balance) | $4,830,196 | $3,126,959 | | Total Interest-bearing liabilities (Avg Balance) | $4,490,334 | $2,646,808 | | Effective Yield (Assets) | 3.46% | 3.25% | | Cost of Funds (Liabilities) | 2.59% | 2.02% | | Net Interest Spread | 0.87% | 1.23% | Adjusted Net Interest Income for the Nine Months Ended September 30, 2019 Compared to the Nine Months Ended September 30, 2018 - Adjusted net interest income increased by $2.9 million for the nine months ended September 30, 2019, compared to the same period in 2018[219] - TBA drop income declined due to reduced volume of TBA dollar roll transactions and lower net spreads (0.97% in 2019 vs. 1.74% in 2018) caused by higher expected prepayment speeds[220] Table: Adjusted Net Interest Income Analysis (9 Months) | Metric | 9 Months Ended Sep 30, 2019 Amount ($ thousands) | 9 Months Ended Sep 30, 2019 Rate | 9 Months Ended Sep 30, 2018 Amount ($ thousands) | 9 Months Ended Sep 30, 2018 Rate | | :----------------------------------- | :---------------------------------------- | :----------------- | :---------------------------------------- | :----------------- | | Net interest income | $39,862 | 0.87% | $37,516 | 1.23% | | Add: TBA drop income | $4,649 | (0.03)% | $11,614 | 0.05% | | Add: net periodic interest benefit | $11,416 | 0.33% | $3,890 | 0.20% | | Adjusted net interest income | $56,092 | 1.17% | $53,182 | 1.49% | Gain (Loss) on Sale of Investments, Net - The company recorded a net gain on sale of investments of $4,605 thousand for the three months ended September 30, 2019, compared to a net loss of $(1,726) thousand in the prior year period[224] - For the nine months ended September 30, 2019, the company recorded a net loss on sale of investments of $(5,755) thousand, an improvement from a net loss of $(17,945) thousand in the prior year period[225] - Sales included fixed-rate Agency RMBS (4.0%-4.5% coupons) due to increased prepayment risk and the remainder of adjustable-rate Agency RMBS due to lower return profiles[223] Derivative Instruments (Results of Operations) - Total interest rate swap losses, net, were $(52,908) thousand for the three months ended September 30, 2019, compared to gains of $25,019 thousand in the prior year period[227] - For the nine months ended September 30, 2019, total interest rate swap losses, net, were $(248,886) thousand, compared to gains of $93,834 thousand in the prior year period[227] - Net periodic interest benefit from interest rate swaps increased for both the three and nine months ended September 30, 2019, due to an increase in the average net receive rate[227][229] Table: Average Interest Rate Swap Net Receive Rate | Metric | 3 Months Ended Sep 30, 2019 | 3 Months Ended Sep 30, 2018 | 9 Months Ended Sep 30, 2019 | 9 Months Ended Sep 30, 2018 | | :----------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Average interest rate swap net receive rate | 0.23% | 0.03% | 0.36% | 0.17% | General and Administrative Expenses - General and administrative expenses decreased by $(0.2) million for the three months ended September 30, 2019, primarily due to lower legal and professional fees[231] - General and administrative expenses increased by $0.4 million for the nine months ended September 30, 2019, primarily due to higher audit and consulting expenses[231] Other Comprehensive Income (Loss) - Other comprehensive income was $55.2 million for the three months and $252.8 million for the nine months ended September 30, 2019, primarily from net unrealized gains in Agency RMBS and CMBS due to declining longer-term interest rates[232] - In contrast, other comprehensive loss was $(21.9) million and $(77.1) million for the three and nine months ended September 30, 2018, respectively, due to net unrealized losses from increasing longer-term interest rates[232] LIQUIDITY AND CAPITAL RESOURCES This section discusses the company's liquidity management, sources and uses of funds, leverage ratios, sensitivity analysis, and the impact of contractual obligations and tax NOL carryforwards on liquidity - Primary liquidity sources include repurchase agreements and monthly principal/interest payments on investments, supplemented by asset sales, equity offerings, and derivative payments[234] - Most liquid assets (unrestricted cash, cash equivalents, unencumbered Agency MBS) were $198.4 million as of September 30, 2019, down from $210.8 million at December 31, 2018[235] - Leverage, including TBA net long positions, was 9.1 times shareholders' equity as of September 30, 2019, up from 8.0 times at December 31, 2018, increasing liquidity risk[238][307] Repurchase Agreements - Repurchase agreement borrowings are principally uncommitted and short-term, with $4,872,869 thousand outstanding with 22 counterparties at a weighted average rate of 2.32% as of September 30, 2019[240] - The company is required to post and maintain margin (haircut) on repurchase agreements, which can lead to margin calls if collateral fair value declines[241] Table: Weighted Average Minimum Haircut on Repurchase Agreements | Collateral Type | Sep 30, 2019 WAVG Minimum Haircut | Dec 31, 2018 WAVG Minimum Haircut | | :-------------------- | :-------------------------------- | :-------------------------------- | | Agency CMBS and RMBS | 4.7% | 4.9% | | CMBS IO | 13.0% | 13.4% | - The company monitors compliance with financial covenants (e.g., minimum net worth, maximum leverage) and believes it is not subject to material restrictions on financing flexibility[245][246] Derivative Instruments - Derivative instruments (interest rate swaps, Eurodollar futures, TBA positions) may require posting initial and daily variation margin, typically in cash or Agency MBS[248] - As of September 30, 2019, $97.2 million in cash was posted as collateral for derivative agreements[248] - TBA contracts expose the company to liquidity risk if unable to roll or terminate positions, potentially requiring physical delivery of securities and cash settlement[249] Dividends - As a REIT, the company must distribute at least 90% of its REIT taxable income, generally funded by operating cash flows[250] - The company has an estimated NOL carryforward of $89.8 million as of September 30, 2019, which will begin to expire in 2020[251] - Approximately 88% of common stock dividends declared during the nine months ended September 30, 2019, will represent a return of capital to shareholders due to tax hedge loss deductions[252] Table: Deferred Tax Hedge Losses | Year | Deferred Tax Hedge Losses ($ thousands) | | :--- | :-------------------------------------- | | 2019 | $33,543 | | 2020 | $38,080 | | 2021 - 2028 | $155,146 | | Total | $226,769 | Contractual Obligations and Other Matters - Repurchase agreement amounts outstanding as of September 30, 2019, are due within 90 days[253] - No material off-balance sheet arrangements or capital expenditure commitments are believed to exist as of September 30, 2019[256] RECENT ACCOUNTING PRONOUNCEMENTS This section states that no new accounting pronouncements issued during the nine months ended September 30, 2019, are expected to materially impact the company's financial condition or results - No recent accounting pronouncements are expected to have a material impact on the company's financial condition or results of operations[258] FORWARD-LOOKING STATEMENTS This section provides a cautionary statement regarding forward-looking statements, outlining inherent risks, uncertainties, and factors that could cause actual results to differ materially from projections, including economic conditions and regulatory policies - Forward-looking statements are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from historical results or implied projections[262] - Key factors include changes in domestic economic conditions, interest rates and spreads, investment portfolio performance, Federal Reserve monetary policy, financing costs, and regulatory changes[263] - The company cautions readers not to place undue reliance on forward-looking statements and is not obligated to update or revise them[260] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section details the company's exposure to market risks, including interest rate, spread, prepayment, reinvestment, credit, and liquidity risks, providing quantitative sensitivity analyses and mitigation strategies Interest Rate Risk - Interest rate risk arises from investing in fixed-coupon securities and the duration mismatch between assets, liabilities, and hedges[267] - The company uses interest rate swaps and other derivatives to manage interest rate risk, but calculated duration can be imprecise due to prepayment speed sensitivity[269] Table: Projected Change in Net Interest Income and Net Periodic Interest Benefit/Cost due to Interest Rate Shift | Interest Rate Shift | Sep 30, 2019 Projected Change in Net Interest Income and Net Periodic Interest Benefit/Cost | | :------------------ | :------------------------------------------------------------------------------------------ | | Decrease 100 Basis Points | 6.9% | | Decrease 50 Basis Points | 0.1% | | Increase 50 Basis Points | (4.4)% | | Increase 100 Basis Points | (12.3)% | - The projected sensitivity to interest rate changes reversed from December 31, 2018, to September 30, 2019, with lower projected earnings if rates increase and higher if rates decrease, due to portfolio mix and hedge positioning changes[274] Table: Total Percentage of Total Equity Change due to Interest Rate Shift | Interest Rate Shift | Sep 30, 2019 Total % of Total Equity Change | Dec 31, 2018 Total % of Total Equity Change | | :------------------ | :------------------------------------------ | :------------------------------------------ | | Decrease 100 Basis Points | 1.0% | (7.6)% | | Decrease 50 Basis Points | 2.3% | (1.4)% | | Increase 50 Basis Points | (4.7)% | (1.7)% | | Increase 100 Basis Points | (10.4)% | (7.3)% | Spread Risk - Spread risk is the risk of loss from an increase in the market spread between an investment's yield and its benchmark index, which reduces market value[287] - The company does not hedge spread risk due to its complexity and lack of liquid hedging instruments[287] Table: Percentage Change in Shareholders' Equity due to Market Spreads | Basis Point Change in Market Spreads | Sep 30, 2019 Percentage Change in Shareholders' Equity | Dec 31, 2018 Percentage Change in Shareholders' Equity | | :----------------------------------- | :----------------------------------------------------- | :----------------------------------------------------- | | +20/+50 | (11.0)% | (9.5)% | | +10 | (5.2)% | (4.5)% | | -10 | 5.4% | 5.0% | | -20/-50 | 11.4% | 11.0% | Prepayment and Reinvestment Risk - Prepayment risk is the risk of early principal return on investments, influenced by interest rates and other factors, impacting premium amortization and net interest income[292][295] - CMBS and CMBS IO typically have prepayment protection provisions (e.g., lock-outs, yield maintenance) that reduce prepayment risk, but these are not present if loans default[293][294] - Reinvestment risk arises from the need to reinvest capital from prepayments, repayments, and sales into new assets; lower yields on new investments could negatively impact results[299] - The company manages prepayment risk by diversifying investments and favoring securities with prepayment prohibitions or yield maintenance[296] Credit Risk - Credit risk is the risk of not receiving contractual amounts due to borrower default or collateral liquidation deficiency, potentially leading to lower or negative yields[301] - Agency RMBS and CMBS have low credit risk due to government guarantees, but Agency CMBS IO are exposed to loss of investment basis if underlying loans liquidate without yield maintenance[302] - Credit risk on non-Agency securities is mitigated through asset selection and purchasing higher-quality, typically investment-grade, securities[303] Liquidity Risk - Liquidity risk primarily stems from the use of recourse repurchase agreements, which are renewable at lenders' discretion and lack guaranteed roll-over terms[305] - Declines in investment market value can trigger margin calls, and failure to meet them could lead to lenders selling collateral[305] - TBA long positions also pose liquidity risk if the company cannot roll or terminate contracts, potentially requiring physical delivery and cash settlement[306] - Increased overall leverage (9.1x shareholders' equity as of Sep 30, 2019) heightens liquidity risk, reducing available assets for margin calls, despite being within Board authorized limits[307] Item 4. Controls and Procedures This section confirms the effectiveness of the company's disclosure controls and procedures as of September 30, 2019, with no material changes in internal control over financial reporting during the quarter - Disclosure controls and procedures were evaluated and deemed effective as of September 30, 2019[310] - No material changes in internal control over financial reporting occurred during the three months ended September 30, 2019[311] PART II. OTHER INFORMATION Item 1. Legal Proceedings This section updates ongoing legal proceedings, including the dismissal of certain claims in the DCI Plaintiffs' amended complaint and the status of the Cost Sharing Litigation, with the company expecting no material adverse effect - The U.S. District Court, Northern District of Texas, dismissed with prejudice the DCI Plaintiffs' fraudulent transfer and alter ego claims on October 28, 2019[312] - The Cost Sharing Litigation remains pending in the 68th District Court of Dallas County, Texas, with no further developments during the quarter[313] - The company believes these matters are baseless and expects resolution without a material adverse effect on its consolidated financial statements[314] Item 1A. Risk Factors This section refers to risks and uncertainties outlined in forward-looking statements and the 2018 Form 10-K, emphasizing their potential significant impact on the company's financial condition, results, and cash flows - Risks and uncertainties identified in forward-looking statements and the 2018 Form 10-K could significantly impact financial condition, results of operations, and cash flows[319] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds This section details the company's common stock repurchase program, authorized up to $40 million through December 31, 2020, and summarizes repurchases made during the three months ended September 30, 2019 - The Board of Directors authorized repurchases of up to $40 million of common stock through December 31, 2020[320] Table: Common Stock Repurchase Program Activity | Period | Total Number of Shares Purchased | Average Price Paid per Share | Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs ($ thousands) | | :--------------------------------- | :------------------------------- | :--------------------------- | :-------------------------------------------------------------------------------------------------------------------------- | | July 1, 2019 - July 31, 2019 | 0 | $0 | $40,000 | | August 1, 2019 - August 31, 2019 | 591,517 | $14.67 | $31,322 | | September 1, 2019 - September 30, 2019 | 1,117,754 | $14.63 | $14,969 | | Total | 1,709,271 | $14.65 | | Item 3. Defaults Upon Senior Securities This section states that no defaults upon senior securities occurred during the reporting period - No defaults upon senior securities occurred[323] Item 4. Mine Safety Disclosures This section states that no mine safety disclosures are to be reported - No mine safety disclosures are applicable[324] Item 5. Other Information This section indicates that no other information is to be reported - No other information is reported[325] Item 6. Exhibits This section lists exhibits filed as part of the Form 10-Q, including articles of incorporation, bylaws, stock certificates, certifications, and iXBRL financial statements - Exhibits include Restated Articles of Incorporation, Amended and Restated Bylaws, Specimen of Common Stock Certificate, Section 302 and 906 Certifications, and iXBRL formatted financial statements[327] SIGNATURES Signatures This section contains the signatures of the principal executive officer and principal financial officer, certifying the report's filing on behalf of Dynex Capital, Inc - The report is signed by Byron L. Boston, Chief Executive Officer, President, Co-Chief Investment Officer, and Director (Principal Executive Officer), and Stephen J. Benedetti, Executive Vice President, Chief Financial Officer and Chief Operating Officer (Principal Financial Officer) on November 5, 2019[329][330]