Dynex Capital(US:DX)2021-08-01 16:00PART I. FINANCIAL INFORMATION Item 1. Financial Statements The company presents its unaudited consolidated balance sheets, income statements, and cash flow statements for the period ended June 30, 2021 Consolidated Balance Sheets Total assets grew to $3.47 billion, driven by an increase in mortgage-backed securities and supported by a rise in shareholders' equity | Financial Metric | June 30, 2021 (unaudited, $s in thousands) | December 31, 2020 ($s in thousands) | | :--- | :--- | :--- | | Total Assets | $3,474,295 | $3,095,435 | | Mortgage-backed securities, at fair value | $2,995,502 | $2,596,255 | | Total Liabilities | $2,718,666 | $2,461,982 | | Repurchase agreements | $2,321,043 | $2,437,163 | | Payable for purchases pending settlement | $350,854 | $5 | | Total Shareholders' Equity | $755,629 | $633,453 | Consolidated Statements of Comprehensive Income (Loss) The company reported a net loss of $45.7 million for Q2 2021, a significant reversal from the prior year due to losses on derivative instruments | Metric ($s in thousands except per share data) | Three Months Ended June 30, 2021 | Three Months Ended June 30, 2020 | Six Months Ended June 30, 2021 | Six Months Ended June 30, 2020 | | :--- | :--- | :--- | :--- | :--- | | Net interest income | $12,118 | $15,003 | $24,377 | $32,724 | | (Loss) gain on derivative instruments, net | $(52,940) | $(8,563) | $54,861 | $(204,130) | | Net (loss) income to common shareholders | $(45,682) | $191,585 | $66,701 | $85,351 | | Comprehensive (loss) income to common shareholders | $(31,412) | $26,538 | $15,815 | $(6,724) | | Net (loss) income per common share-basic | $(1.43) | $8.31 | $2.27 | $3.71 | | Dividends declared per common share | $0.39 | $0.43 | $0.78 | $0.88 | Consolidated Statements of Cash Flows Net cash increased by $124.4 million in the first half of 2021, with positive cash flows from both operating and investing activities | Cash Flow Activity ($s in thousands) | Six Months Ended June 30, 2021 | Six Months Ended June 30, 2020 | | :--- | :--- | :--- | | Net cash provided by operating activities | $67,854 | $83,469 | | Net cash provided by investing activities | $74,578 | $1,448,425 | | Net cash used in financing activities | $(18,069) | $(1,459,337) | | Net increase in cash | $124,363 | $72,557 | Notes to the Consolidated Financial Statements The notes detail the company's accounting policies, MBS portfolio composition, and extensive use of derivatives for hedging purposes - The company is an internally managed mortgage REIT that primarily invests on a leveraged basis in Agency mortgage-backed securities (MBS), including residential (RMBS), commercial (CMBS), and interest-only (IO) securities19 - Effective January 1, 2021, the company elected the fair value option for all newly purchased MBS, with changes in fair value reported in net income40 | MBS Portfolio Summary (June 30, 2021) | Fair Value ($s in thousands) | | :--- | :--- | | MBS designated as AFS | $1,947,316 | | MBS measured at fair value through net income | $1,048,186 | | Total MBS | $2,995,502 | | Repurchase Agreements (June 30, 2021) | Amount ($s in thousands) | | :--- | :--- | | Balance Outstanding | $2,321,043 | | Weighted Average Rate | 0.21% | | WAVG Original Term to Maturity (days) | 106 | - The company uses U.S. Treasury futures, options on U.S. Treasury futures, swaptions, and TBA securities to mitigate interest rate risk on its book value5090 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the impact of a flattening yield curve and wider MBS spreads on the company's financial performance and hedging strategy Executive Overview A flattening yield curve and wider credit spreads led to a decline in book value, prompting strategic portfolio adjustments during the quarter - Market conditions in Q2 2021 were characterized by a flattening yield curve and widening credit spreads for Agency RMBS, driven by discussions of potential tapering by the Federal Reserve126 - The company's book value declined by $(1.32) per common share during Q2, primarily due to hedge losses of $(93.8) million as the yield curve flattened133 - Strategically, the company reduced its investment portfolio early in the quarter when spreads were tight, then re-leveraged later by investing $68.3 million from ATM issuances into lower coupon Agency RMBS131 - The company's outlook is for rates to remain range-bound in the near term, but for the 10-year UST rate to move higher over the next 6-12 months136 Financial Condition The company's $5.4 billion investment portfolio is heavily concentrated in Agency RMBS and is approximately 86% hedged against interest rate risk | Investment Portfolio Composition | June 30, 2021 | December 31, 2020 | | :--- | :--- | :--- | | Agency RMBS | 89% | 84% | | Agency CMBS | 4% | 7% | | CMBS IO | 7% | 9% | - The Agency RMBS portfolio, including TBAs, totaled $4.8 billion in fair value, with a focus on lower coupon (2.0% and 2.5%) securities to mitigate prepayment risk148149 - The CMBS IO portfolio is primarily composed of investment-grade securities, with the largest underlying property type exposures being Retail (28.1%) and Office (21.7%)155160 - As of June 30, 2021, approximately 86% of the MBS portfolio (including TBAs) was hedged using instruments like U.S. Treasury futures and interest rate swaptions, an increase from 62% at year-end 2020162 Results of Operations Derivative losses drove a comprehensive loss in Q2 2021, though adjusted net interest income increased due to favorable TBA dollar roll economics | Metric ($s in thousands) | Q2 2021 | Q1 2021 | | :--- | :--- | :--- | | Net interest income | $12,118 | $12,259 | | (Loss) gain on derivative instruments, net | $(52,940) | $107,801 | | Comprehensive (loss) income to common shareholders | $(31,412) | $47,227 | - Adjusted net interest income increased in Q2 2021 due to a 29% increase in the average investment in TBA securities, which benefited from favorable implied financing costs174 | Metric ($s in thousands) | Six Months Ended June 30, 2021 | Six Months Ended June 30, 2020 | | :--- | :--- | :--- | | Net interest income | $24,377 | $32,724 | | Gain (loss) on derivative instruments, net | $54,861 | $(204,130) | | Realized gain on sale of investments, net | $6,705 | $277,882 | Liquidity and Capital Resources Liquid assets increased to $517.9 million and leverage rose to 6.7x, with the company remaining in full compliance with all debt covenants - Liquid assets, including unrestricted cash and unencumbered Agency securities, increased to $517.9 million as of June 30, 2021, from $415.3 million as of December 31, 2020202 - Leverage (total liabilities plus TBA cost basis to shareholders' equity) increased to 6.7x as of June 30, 2021, compared to 6.3x at year-end 2020202 - The company maintained repurchase agreements with 23 counterparties and had no more than 5% of its equity at risk with any single counterparty as of June 30, 2021205 - The company was in full compliance with all financial and operating covenants in its repurchase agreements as of June 30, 2021205 Item 3. Quantitative and Qualitative Disclosures About Market Risk The company details its exposure to interest rate, spread, prepayment, and credit risks, along with its corresponding mitigation strategies Interest Rate Risk The company's portfolio is positioned for a steeper yield curve, with a 50 basis point rate increase projected to decrease equity by 0.5% | Scenario (Instantaneous Parallel Shift) | Projected % Change in Shareholders' Equity (June 30, 2021) | | :--- | :--- | | -100 Basis Points | -13.5% | | -50 Basis Points | -2.4% | | +50 Basis Points | -0.5% | | +100 Basis Points | -1.8% | Spread Risk A 10 basis point widening in market spreads is projected to decrease common equity by approximately 5.2%, a risk managed via asset selection | Scenario (Change in Market Spreads) | Projected % Change in Common Equity (June 30, 2021) | | :--- | :--- | | +10 Basis Points | -5.2% | | -10 Basis Points | +5.2% | Prepayment, Credit, and Liquidity Risk The company mitigates risks by focusing on low-coupon RMBS, Agency-guaranteed securities, and maintaining diverse counterparty relationships - To manage prepayment risk, approximately 85% of the company's capital in RMBS is invested in securities with a coupon of 2.5% or lower236 - Credit risk is mitigated by investing in Agency MBS with government-sponsored entity guarantees and primarily AAA-rated senior tranches of CMBS IO238 - Liquidity risk from repurchase agreements and TBA contracts is managed by maintaining diverse counterparty relationships and ensuring sufficient liquidity240242 Item 4. Controls and Procedures Management concluded that disclosure controls and internal controls over financial reporting were effective as of the end of the quarter - Management concluded that disclosure controls and procedures were effective as of June 30, 2021245 - No material changes were made to the internal control over financial reporting during the three months ended June 30, 2021246 PART II. OTHER INFORMATION Item 1. Legal Proceedings The company reports no material developments in ongoing litigation and has not recorded any contingent liability - There were no material developments in the ongoing Receiver Litigation during the quarter248 - Management has determined that the likelihood of loss is not probable, and no contingent liability has been recorded248 Item 1A. Risk Factors No material changes were reported to the risk factors disclosed in the company's 2020 Annual Report on Form 10-K - No material changes from the risk factors discussed in the 2020 Form 10-K were reported249 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The company has an active stock repurchase program but made no repurchases during the quarter under the publicly announced plan - The company has a stock repurchase authorization of up to $40 million for common stock and $40 million for Series C Preferred Stock, valid through March 31, 2022250 - No shares were repurchased under the plan during the three months ended June 30, 2021252254 Item 6. Exhibits This section lists all exhibits filed with the Form 10-Q, including officer certifications and governance document amendments