Assessing Dynex Capital's Performance For Q3 2024

seekingalpha11-22 12:11

Dynex Capital's Q3 2024 BV increase was modest and as expected, with minor portfolio adjustments and strategic derivative changes positively impacting core earnings/EAD.The company's hedging strategy ...

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Core Earnings/EAD: Modest Outperformance ($0.054 Variance).  An \"as-expected\" quarter regarding Dynex Capital's (NYSE:DX) BV, in my opinion. DX recorded a minor—modest quarterly BV increase, which was correctly anticipated. DX continued to modestly—notably increase the company's on-balance sheet fixed-rate agency MBS portfolio while modestly decreasing (proportionately speaking) its off-balance sheet net long TBA MBS position. The size of DX's investment portfolio increase basically matched what I anticipated, which directly led to a de minimis BV underperformance (see table below). However, DX altered the composition of the company's derivatives sub-portfolio during Q3 2024, which was a bit surprising. While this did not materially alter DX's BV performance when compared to my expectations (basically exchanged one type of derivative instrument for another; see table below), this strategic change positively impacted the company's core earnings/EAD performance (more on this in a bit). DX modestly—notably decreased the company's net (short) U.S. Treasury futures position (by $1.0 billion) and notably increased its previous extremely minor interest rate payer swaps position (by ($1.5) billion). DX's continued use of the company's \"at-the-market\" (\"ATM\") equity offering program directly led to some very minor BV dilution, which was correctly anticipated. DX's modest core earnings/EAD outperformance was a continued step in the right direction in my opinion. This was mainly due to a combination of the following during Q3 2024: 1) net interest income matched expectations (correctly anticipated MBS balance increase + slightly moving higher in coupon + relatively unchanged borrowing costs); 2) net dollar roll loss matched expectations; 3) larger-than-anticipated current period hedging income (directly due to the notably larger interest rate payer swaps sub-portfolio); and 4) operational expenses matched expectations. Per share variances of these 4 accounts/factors are provided in the table below. With that said, remember, I/we upgraded DX back in September 2024 due to improving macroeconomic conditions/changes to Federal Open Market Committee monetary policy (in particular for agency mREITs). I do not believe today's results outperformed my expectations enough to warrant another upgrade at this time. DX's core earnings/EAD outperformance was merely a derivative sub-portfolio \"reclassification\" partially out of U.S. Treasury futures and into interest rate payer swaps. The REIT Forum uses a number of metrics to assess these types of investments:  A risk/performance rating of 3.5 for DX remains appropriate in the current environment/over the foreseeable future. Remember, even though most agency mREITs have very little credit risk, these companies have to navigate the following risks: 1) spread/basis; 2) leverage; 3) prepayment/extension; and 4) interest rate (regarding derivatives). Also, as a reminder, my/our models are now projecting (150) basis points (\"bps\") of Federal (\"Fed\") Funds Rate cuts through June 2025. This equates to another (100) bps of cuts over the next ~8 months which is already \"baked\" into sector price targets.  BV Performance (Actual Vs. Estimated) The REIT Forum Change or Maintain (Layout Repeated)   BV/NAV Adjustment (BV/NAV Used Interchangeably): Our projection for current BV/NAV per share was adjusted: Unchanged (To Account for the ($0.05) Actual 9/30/2024 BV/NAV Vs. Prior Projection + $0.05 BV Outperformance Thus Far in October 2024). Price targets have already been adjusted to reflect the change in BV/NAV. The update is included in the card below and the subscriber spreadsheets.  Percentage Recommendation Range (Relative to CURRENT BV/NAV): No Change.  Risk/Performance Rating: No Change. Remains at 3.5.  Hedging  Hedging Coverage Ratio: Increase from 66% to 70%. The REIT Forum Earnings Results The REIT Forum Note: BV at the end of the quarter. Subscriber spreadsheets and targets use current estimates, not trailing values. Valuation The REIT Forum Ending Notes/Commentary As stated in prior DX earnings assessment articles, there is a notable caveat to the company's core earnings/EAD metric in the recent, current, and projected near-term environment. I would point out the company's current core earnings/EAD metric is \"flawed\" when trying to assess dividend sustainability. Simply put, the equivalent of DX's current period hedging income, through the use of U.S. Treasury futures, is not a part of the company's core earnings/EAD calculation/metric. Per GAAP, this income equivalent is part of DX's realized gains (losses) and is excluded from core earnings/EAD. In comparison, per GAAP, current period hedging income from interest rate payer (receiver) swaps is part of a company's core earnings/EAD calculation/metric. So, in a nutshell, a large portion of DX's \"true\" operational income/gains is excluded from core earnings/EAD. This is why DX experienced a very rapid decline in core earnings/EAD during 2022–2023. DX chose not to utilize interest rate payer (receiver) swaps in lieu of net (short) U.S. Treasuries. Very important to understand. I would continue to encourage DX to begin providing quarterly estimated REIT taxable income (\"ERTI\") per share metrics in the future (the actual total ERTI figure/amount; not just the amount assigned to U.S. Treasury futures as there are various/many reconciliations that make up ERTI versus core earnings/EAD). DX's projected BV decrease of (1%) during October 2024 (through 10/18/2024) was also basically an exact match versus my projection of a (1.5%) decrease. Finally, DX declared an increased monthly dividend of $0.15 per common share for November 2024 when compared to a monthly dividend of $0.13 per common share for October 2024. As noted in last quarter's sector comparison article, I actually projected DX could increase the company's monthly dividend at some point during Q4 2024. However, I projected an increase to $0.14 per common share. As such, DX's $0.02 per common share monthly dividend increase was slightly greater versus my projection of a $0.01 per common share increase. A bit of a larger increase, but not enough to warrant another percentage recommendation range upgrade at this time (again, already upgraded DX back in September 2024 [very recently]). Still, a positive event nonetheless.  Note: We use quite a few industry terms in the earnings articles. 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