Dynex Capital Now Offers A Consistent High Yield Dividend Paid Monthly From Real Estate Mortgage Assets

seekingalpha10-22

As a retired income investor, I focus on high-yield distributions, particularly from REITs, which offer diversification and inflation hedging but are sensitive to interest rates.Despite the real ...

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One asset class that offers a high-yield income distribution for investors like me is the real estate sector. In particular, REITs (real estate investment trusts) due to their tax structure typically offer higher yielding dividends than other common equities. In addition, REITs can offer diversification in an income portfolio and support inflation hedging. However, REITs are subject to interest rate risk and broader implications in the overall real estate market such as property values, geographic demand, etc. Due in large part to rising inflation and higher interest rates, the real estate sector (XLRE) has been the worst-performing US equity sector over the past 3 years. However, it has slowly been making a recovery over the past year, and now that interest rates are coming down that recovery looks like it will continue into 2025, although in October, the real estate sector appears to be pulling back due to ongoing inflationary pressure and mortgage rates back on the rise. Seeking Alpha As a result of this poor 3-year performance relative to other market sectors, REITs are now inexpensive compared to the S&P 500 as illustrated in this chart from Hoya Capital. Hoya Capital Back in early January, when investors and market pundits were speculating that the Fed would reduce the base rate multiple times in 2024, I wrote about a mortgage REIT that, I felt, would outperform this year due to lower rates on the horizon. That REIT is Dynex Capital, Inc. (NYSE:DX), and I suggested that income investors might want to consider DX for its consistent, monthly distributions that were yielding about 12% at that time. This was how I summarized my thesis: Dynex Capital is well positioned to benefit from the strong US economy, a potential recovery in the housing market in 2024, and the potential for lower interest rates. I rated DX a Hold back in January, and it turns out that it was a good call because lower rates did not materialize until much later in the year than I had anticipated at the time. Now in October, DX has just reported Q3 2024 earnings, and I wanted to revisit this REIT to see if it still looks like a good investment. DX Q324 Earnings Presentation At today's market price of about $12.60 and the new monthly dividend of $0.15, raised from the previous amount of $0.13, the common stock looks like an even better income investment with a yield now above 14% at the current price. In addition, book value increased by $0.50 to $13.00, so the stock now trades at a discount to BV. I am upgrading my rating to a Buy given the solid Q3 earnings report and the increased dividend and book value, both exhibiting confidence in the company's forward earnings potential. Dynex Capital Q3 Results Review After the company reported Q2 2024 results back in June it was apparent that ongoing higher interest rates had impacted performance as the company reported a comprehensive loss of ($0.18) per common share. However, the company stated at the time that they were continuing to execute their strategic plan and were expecting more positive results for the remainder of the year. \"Dynex continued to execute its strategic plan to deliver consistent dividend income with disciplined capital management. We raised capital at attractive levels and are ready to take advantage of the generationally wide spreads in the mortgage market,\" said Byron L. Boston, Chairman and Co-Chief Executive Officer. Based on what was reported in Q3 it has become obvious that the performance has improved dramatically due to the positioning earlier this year to take advantage of those wide spreads. From the Q324 earnings presentation, the comparison of Q3 to Q2 results summarized the substantial across-the-board improvement in metrics, including an increase in book value, reduction of leverage, increase in average earning assets, and a substantial increase in comprehensive income. DX Q324 Earnings Presentation Further elaborating on the company's solid execution of the strategic plan alluded to on the Q2 earnings call, Chairman Boston explained that the strong performance in Q3 was in large part due to that strategy. This decade, we have been strategically focused on our investment strategy and capital allocation, simplifying and enhancing our capital structure. We embarked on a strategy to grow the company to drive operating leverage and to improve our common stocks' liquidity while balancing our equity capital. Our highest priorities are to be reliable stewards of capital, transparent in our actions, and good corporate citizens. Dynex is a strong, diverse organization building on a 30-year vision to create a multi-generational organization that can stand the test of time. Further confidence in the company's positioning for the future and their ability to support the increased dividend was given by CFO/COO Rob Colligan, in his remarks. We raised $56 million of new capital, and we continue to keep ample levels of liquidity to deploy if spreads widen or volatility increases between now and the end of the year. Interest income was up from the second quarter from the active addition of higher-yielding assets into the portfolio, while older, lower-yielding assets continue to pay down. Borrowing rates on repurchase agreements are beginning to trend down as a result of the Fed's first interest rate cut in September. Compelling Opportunity in Agency MBS One aspect of this flexible strategy toward mortgage-related asses is the balance of different investment types within the DX investment portfolio with a recent increase in agency assets due to the opportunity for compelling risk-adjusted returns from Agency MBS as illustrated on the slide in the Q3 presentation. DX Q324 Earnings Presentation As the spreads between IG corporate bonds and agency RMBS are historically wider than ever, investors are likely to shift capital into more agency assets, driving up the price over time as interest rates continue coming down. This recent insight from Angel Oak Capital Advisors further explains the opportunity in both agency and non-agency MBS. With rate declines expected over the course of the next year, high-quality fixed-income portfolios of intermediate duration have the potential to generate total returns that are greater than current yields and to help mitigate reinvestment risk. Given current valuations, we believe there is an opportunity to add mortgage-backed securities at some of the most compelling spreads and yields seen in decades. Angel Oak Capital Advisors There are a lot of market dynamics around the potential for strong returns from Agency MBS that include the expectation of a soft landing, lower interest rates in the future, and more private credit entering the market as the Fed is expected to continue to sell off its MBS assets. Those dynamics and other portfolio strategy considerations are summarized on this slide from the Q3 presentation. DX Q324 Earnings Presentation Financing Costs Continue to Decline Another positive trend that was further described on the Q3 earnings call by SVP TJ Connelly is that the company's financing costs continue to decline as rates are cut. We expect financing costs to continue declining as the Fed delivers more rate cuts. As we often see during transitions to a new regime though, financing markets have experienced some volatility on the way to a new equilibrium. The Fed's quantitative tightening program and regulatory capital constraints have put upward pressure on mortgage repo rates relative to SOFR, especially at quarter end. We're planning for more periodic rate pressure in repo markets ahead. Connelly also explained that the company began adjusting its hedging position during the quarter to transfer to SOFR swap rates. We started to adjust our hedge book in the third quarter, shifting to SOFR swaps from treasury futures. For several years now, treasury hedges have been the best choice for managing interest rate duration, because we were effectively selling the asset that was being created the most. The government has been financing massive fiscal deficits. As you can see from slide 14 in our earnings deck, the spread between long-term treasury and SOFR rates is historically wide. Seven-year SOFR swap rates are 40 bps below the seven-year treasury yield. DX Q324 Earnings Presentation He further explained that the hedging position should also offer some additional protection from potential future increases in the federal deficit. You can also see on that slide that the spread has historically moved with the level of federal deficits. At today's spread levels, we think lowering the fixed rate yield on our hedges by 40 basis points offers highly accretive ROE for the incremental capital required for swaps versus futures. In our view, the spread now compensates us for the risks of the potential further increase in federal deficits over the long term. Further details regarding the positive decline in funding costs are illustrated on this slide from the Q3 presentation that shows a decline of 3 bps in the weighted average repo borrowing cost. DX Q324 Earnings Presentation Risks to Future Performance There are risks to investing in DX including ongoing uncertainty in the housing market, geopolitical risks and raging global conflicts, a possible reversal of interest rates if inflation begins to rise again or strong employment numbers derail the Federal Reserve's plans to further reduce rates, and other macro conditions that could change the market sentiment for REITs. Based on comments on the Q3 earnings call it appears that company management has a good handle on risk management and is taking proactive steps to position themselves for a range of potential outcomes. For the present quarter and looking to the near-term future, the outlook is mostly positive based on comments made by TJ Connelly on the earnings call. Overall, we expect the environment will be favorable for both the asset and hedge sides of our portfolio. The opportunities to earn carry and roll down with a steeper curve are significant and growing. We expect to be able to generate alpha within agency RMBS from dollar rolls and relative value. More compelling yields on our hedges will also gradually allow a greater mix of assets across the spectrum of residential and commercial mortgages to generate robust and resilient long-term returns to support our dividends. Summary: Buy DX Stock for the Consistent, Well Covered Monthly Income After reading and digesting Dynex Capital's Q3 2024 earnings results, and based on the increase in the monthly dividend, an increase in book value over the previous quarter, a reduction in financing costs, and strategic portfolio positioning to take advantage of the compelling investment potential in Agency RMBS, I rate DX a Buy at the current price of about $12.60 with an increased $0.15 dividend. The dividend is well-supported and is paid out monthly, which is a further benefit to income investors like me who use those monthly distributions to reinvest in more shares of this and other high-yield income securities.  I own some shares of DX in my own Income Compounder portfolio, and I recommend buying shares while they still trade at a discount to book value if you like the idea of a consistent, monthly, high-yield income stream.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2477366943"}