2023-03-29 07:48:07 ET
Summary
- Dynex Capital has struggled to generate returns as it faced multiple hurdles in 2022.
- The distribution has, of course, not been covered for a long time but continues unabated.
- The company's stock issuance has been rather unusual and changes the risk-reward in 2023.
When we last covered Dynex Capital Inc. ( DX ) we highlighted the strong potential for a dividend cut at some point in 2023. Specifically we said:
Our forecast is for another reduction to the dividend and we are likely looking at about 10 cents on a monthly basis or $1.20 annually. This would be on the low-side, if we see the historical correlation between book values and dividends paid for the trailing 12 months. But one that we think is highly likely in the rough environment ahead. We rate the shares a "hold" and think the preferred shares are relatively a better here.
Source: Dividend Likely To Be Cut To 10 Cents A Month
Investors who avoided the shares have not fared too badly, even though that cut is nowhere to be found.
Seeking Alpha
We look at the fundamentals and update our outlook.
Q4-2022
Q4-2022 had a lot for investors to chew on. The gyrating comprehensive income changes were first up as Dynex's heavily leveraged book value moved with MBS (Mortgage-backed-securities) spreads.
Dynex Q4-2022 Presentation
Earnings available for distribution collapsed to $0.03 from $0.24 in the previous quarter. The same slide showed the biggest problem facing mortgage REITs. An absolute collapse in the net interest spread.
Dynex Q4-2022 Presentation
Dynex's spread went to a negative 0.46% and the adjusted spread hit 0.07%, just barely above the breakeven mark. This is something we have been harping on for some time as we covered stocks like Annaly Capital Management ( NLY ), and AGNC ( AGNC ). The blogosphere has been filled with incorrect logic that this is the "best time" for mortgage REITs. That has been backed by the spread between the 10 year Treasuries and 30 year mortgage rates. What is lost in this weird analysis is that no mortgage REIT finances using the 10 year Treasury. They finance using shorter term borrowing rates. What is also lost is that the existing portfolio cannot be magically readjusted to the rates on new MBS. The end result of this is that Dynex and the rest are funding 3% coupon MBS with 5% short term interest rates. Now there are hedges to consider and they certainly appear to be doing some magic in Dynex's case.
Those hedges can of course go both ways.
That short position on 10 Year Treasuries is a solid loss since year end as rates move lower and prices move higher.
All while the 30 year mortgage rate has stayed flat since year end.
So you lose on the short side but not make money on the long side. There is more nuance to this but broadly you should expect a lower tangible book value at the end of Q1-2023.
Dilution And Leverage
One unusual facet of the Dynex slides was the extent to which they deleveraged in a single quarter. Sure, tangible book value had moved up so your debt to equity will move down. But that move was huge.
Dynex Q4-2022 Presentation
Did Dynex unload assets in a hurry? That would explain such a deleveraging event. Yes, assets were sold. Total assets were $4.05 billion on September 30, 2022.
Dynex Q3-2022 FS
This number dropped by 10%.
Before we proceed further, we want to pause here to highlight how quarter after quarter shows multiple mortgage REITs selling assets in this timeframe. Apparently, they have not got the memo that this is the best time to be a mortgage REIT and best time to buy MBS assets . So back to our deleveraging, yes Dynex did sell assets. But even that was not all there was to it. Dynex issued a boatload of shares.
That is 14% of common equity issuance in one quarter.
Chew on that for a while. Also chew on this chart while you are at it. That is Dynex's stock price. Notice that it nowhere in same postal code as the tangible book value per share.
So, Dynex issued an enormous number of shares under book value to deleverage. If that does not blow your mind, then the next chart should do it.
Outlook And Verdict
We wish we had some good news for mortgage REITs but that is unfortunately not in the cards at present. The borrowing costs are going only in one direction and they will keep moving up in Q1-2023 and Q2-2023. Since there is a 90 day (based on Dynex's average funding rollover), we are looking at some more steep increases and some solid decreases in net interest margin. Through it all, Dynex, could pay the dividend that they are not really earning. They have already diluted book value per share by issuing so much stock under book value and we think there will be more of that in 2023. They are also seeking to increase the number of shares they can issue, by a substantial amount as well.
As of our record date of March 9, 2023, we had 53,848,982 shares outstanding, which represented approximately 60% of the authorized shares of common stock under our Articles of Incorporation. On March 9, 2023, we had approximately 36.2 million unissued shares, of which approximately 11.8 million shares and 2.1 million shares were reserved for issuance upon redemption of our Series C Preferred Stock and for issuance under our equity plan, respectively. We believe the unissued and not otherwise reserved shares of approximately 22.3 million is inadequate to provide us with the flexibility necessary to respond to future needs and opportunities. The Board has determined that this amendment is in the best interest of the Company and its shareholders and recommends that the shareholders approve this amendment. If the amendment is approved, then the number of authorized but unissued shares of common stock would be increased to 126,151,018.
Source: Dynex SEC filing
Over the last 10 years, total returns including dividends has been 13.54% or about 1.28% annually.
Split History
If you consumed the dividends (why else would you even grapple with these REITs), then we made an awe-inspiring 0.63% a year. That of course fits in with this asset class, which has delivered total returns of 2.47% a year over the last two decades .
NAREIT
We exited Dynex some time back at $14.93, and managed to squeak out a small gain. With perfect hindsight, it was not remotely worth the effort. The current discount to tangible book value does look appealing but with the headwinds ahead and Dynex's lack of reluctance to issue huge amounts of stock under book value, we believe that advantage is irrelevant. We rate this a "hold/neutral" for now and might get interested if we see a 30% plus discount to our calculated NAV.
For further details see:
Dynex: A Lean, Mean, Stock Issuing Machine