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Text: Joining me on the call is Byron Boston, Chief Executive Officer and Co-Chief Investment Officer; Smriti Popenoe, President and Co-Chief Investment Officer; and Steve Benedetti, Executive Vice President, Chief Financial Officer and Chief Operating Officer.
As many of you know, who have followed us for a long time, we manage our shareholders' capital for the long term.
One of our core strengths is understanding the environment in which we operate, positioning board and adjusting that position as the environment changes.
We believe the beginning of this decade marked a major change in the global economy and capital markets environment.
It has been a great environment for Dynex to build on our solid track record of industry-leading performance as you can see on Slide 12, including the 21% cumulative shareholder total return since December 2019.
As we finished the third quarter, we continue to be excited about how we have performed during this period and how we have positioned our balance sheet for the future.
We're in a unique moment in history, and we believe every asset management team around the globe will be challenged by unforeseen surprises as we have already continually witnessed over the past 22 months.
At Dynex, we believe this environment calls for patience, discipline, and flexibility.
We also believe this is a great environment for our stakeholders as we expect to see attractive opportunities to deploy capital.
Our experienced management team has proven time and again that they have a flexible mindset to successfully navigate any operating environment and to generate above-average cash dividends and a solid economic return for our shareholders.
For the third quarter, we reported comprehensive income of $0.09 per common share and a total economic return of $0.06 per common share or 0.3% for the quarter.
We also reported earnings available for distribution of $0.54 per common share, a 6% increase over last quarter and well in excess of our $0.39 quarterly common stock dividend.
On a year-to-date basis, through the third quarter, we have paid $1.17 in dividends.
Book value per common share declined modestly to $18.42 from $18.75 or 1.8%, primarily from economic losses on the investment portfolio, principally in lower coupons relative to our hedge position.
As Smriti will discuss later in her comments, we've recovered this decline post quarter end with the curve steepening, which has occurred since then.
Beginning this quarter, consistent with others in our industry, we have renamed our non-GAAP earnings measure to earnings available for distribution from coordinate operating income.
All prior quarters have been relabelled to earnings available for distribution.
There have been no changes to the calculation of the non-GAAP measures and the adjustments made to reconcile the comprehensive income, the earnings available for distribution are identical to those previously used to reconcile the coordinate operating income.
We believe that the caption earnings available for distribution more accurately reflects the principle purpose of the measure and will serve as a useful indicator, but not the only indicator in evaluating the Company's performance and its ability to pay dividends to common shareholders.
Other factors that are considered in the dividends to common shareholders include our taxable income, total economic return, gains and losses including carry-forwards for tax purposes, and our outlook for future performance.
Turning back to the discussion of the performance, the increase in earnings available for distribution was driven by multiple factors.
First, our earning asset yields improved 3 basis points while overall repo borrowing costs were down another 3 basis points.
The improvement in asset yields was largely attributable to slower prepayment speeds during the quarter, as we benefited from adjustments to the overall prepayment profile of the pass-through portfolios or asset purchases.
Agency RMBS prepayment fees were 11.3 CPR versus 19 flat CPR in the second quarter.
Secondly, TBA dropped income contribution improved by 5 basis points primarily from continued dollar roll specialness during the quarter.
The funding cost benefit on dollar rolls versus repo and RMBS was approximately 60 basis points during the third quarter versus 49 basis points last quarter.
And third, average earning assets increased as we deployed equity capital proceeds raised in both -- raised in both second and third quarters.
Together, these items drove 4 basis point increase in our adjusted net interest spread to 2.1% for the quarter.
Offsetting these items was an increase in G&A expense of approximately $800,000.
The majority of the increase related to legal fees related to a contingent matter that we have previously disclosed in our SEC filings and which is now has been fully briefed for the court.
We do not expect these costs to repeat going forward.
From a portfolio perspective, from quarter to quarter, we reduced our investment portfolio, including TBAs by approximately $500 million, mostly through reducing our investment in TBA, 2.5 [Phonetic].
This occurred toward the end of the quarter and resulted in adjusted leverage declining by nearly a full turn to 5.9 times at the end of the quarter.
As noted on Slide 23, our investment portfolio is approximately $4.8 billion at September 30, with $4.3 billion invested in agency RMBS and TBAs.
From a hedging perspective, we reduced the notional balance of our hedges by a similar amount.
The overall notional balance of our hedges at September 30 was $4.3 billion as indicated on Slide 19 with the bulk of the hedges protecting book value from increases in rates in the long end of the curve.
Overall, total shareholders capital grew approximately $18 million during the quarter, which includes approximately $28 million in new common equity raise at the market offerings in the quarter.
Year-to-date, we have raised approximately $224 million in new capital at a gross price before commissions of $18.80.
Our market capitalization adjusted for all shares outstanding is $650 million today versus $420 million at the beginning of the year, substantially increasing the liquidity of our stock for our shareholders while at the same time, unlocking the operating leverage in our business.
Our stock price is virtually unchanged year-to-date and our total shareholder return for 2021 is 6.9% through yesterday.
That concludes my remarks.
I'll briefly discuss performance drivers for the quarter and then turn to our macroeconomic outlook and portfolio construction.
We communicated last quarter that the risk of a whipsaw in rates was substantial.
During the quarter, the 10-year treasury yield touched a low of 1.13% twice and ended the quarter virtually unchanged at 1.46% with a 44 basis point intra-quarter trading range.
We also indicated during the quarter that we had maintained a portfolio structure, a hedge with the long end of the yield curve through July and we continue to hold that hedge position through today.
Book value on September 30 was at $18.42 and thus far as of October 22nd, book value is up between 2% to 2.5%.
Our trading discipline and top-down macroeconomic-centric approach continue to serve us well and remain the cornerstone of our decision-making framework.
Leverage at the end of the quarter stood at 5.9 times, down from 6.4 times at the beginning of the quarter.
As Steve mentioned, we decreased our exposure to convexity by selling TBA [Indecipherable], and to add to dry powder, to make future investments.
With the recovery in book value quarter to date, leverage stands at 5.6 times and the liquidity position is over $500 million.
At this current level of the balance sheet, we expect earnings available for distribution to continue to meet or modestly exceed the current level of the dividend in the fourth quarter with any excess returns providing a cushion to capital.
Book value will continue to fluctuate with the level of interest rates and mortgage spreads.
Future book value volatility is mitigated by our low leverage, substantial levels of liquidity, and the dry powder that we have to deploy capital opportunistically.
Turning now to our macroeconomic outlook that is the foundation for our positioning.
The global economy is in a period of transition to a post-pandemic environment.
And as such, we expect to see new risks and new opportunities develop over the next few quarters.
In the very short term, we are focused on specific risk events on the horizon, including the announcement of the taper, resolution of the debt ceiling, passage of any fiscal stimulus, a possible leadership transition at the fed, the composition of the new fed and international risks such as the Japanese elections and spiking fuel prices to name a few factors.
In the intermediate-term, the speed of reopening adjusting to living with COVID, inflation pressures from supply imbalances, labor shortages, fuel costs spikes are all having different impacts across economies.
Global central banks are adjusting their post-pandemic strategies as inflation and growth trajectories are uneven and disparate across the globe.
While most global bank policy remains highly accommodated, several have begun raising interest rates and have moved to hawkish language as inflation has accelerated.
In the near tone, US data points to stronger growth, higher inflation, and a tighter labor market, but the durability of these trends remains very difficult to parse out.
On the strength of this information, it is very clear that the fed is planning to taper later this month, that looks very likely to happen.
In our assessment, it is still too early to arrive at conclusions on long-term trends for inflation, labor market, and growth.
And for this reason, the timing, the pace, and the number of fed hikes is less clear.
I must point out that the levels of inflation that we are experiencing and inflation expectations are among the highest in the last 20 years.
And we are truly entering uncharted territory as global central banks attempt to exit their emergency interventions in the financial markets, trying to balance growth and maintain their inflation-fighting credibility.
Our team at Dynex is navigating the coming months by preparing for elevated uncertainty, higher volatility, and the increased probability of surprise factors.
We are also preparing for the impact of a more complex, turbulent, and evolving domestic and international political situation.
These factors lead us to maintain an up and credit up and liquidity position to position most of our hedges on the long end of the yield curve and to hold significant amounts of dry powder for investment during bouts of volatility and most importantly, to hold a very flexible portfolio and to have a flexible mindset to respond to evolving conditions.
Let me now discuss our market outlook and portfolio construction.
The portfolio today is constructed with lower leverage that reflects the uncharted territory we are in.
Our hedges remain focused on the 7-year to 10-year part of the curve, reflecting the interest rate risk on our longer-duration asset portfolio.
We have selectively added hedges through the year and the five-year part of the curve and options remain a core holding.
From a financing perspective, we expect that front-end rates will remain low, close to zero through most of 2022, providing a solid base from which to generate returns.
However, we're not taking this for granted.
We are selectively and strategically locking in lower financing levels by taking longer-term repo.
On Slide 20, our weighted average contractual days to maturity of our repo book was about 169 days at September 30, as we targeted longer tenure for our roles between three months and 12 months.
Roughly 50% of the book had a contractual maturity that fell in the six to 12-month range.
We continue to target longer-term roles at opportunistic levels.
Turning now to agency MBS spreads, it's really a mixed story between fundamentals and technicals, and we believe spread volatility will be driven by macroeconomic events versus factors specific to the MBS market.
The fundamentals for agency RMBS are still challenging as we see many factors that will keep refinancing levels higher and net supply elevated.
The structure of the mortgage finance industry is drastically different today.
There are more public non-bank mortgage companies, subject to quarterly profit metrics now than any other time in the last 20 years.
This will be a major factor in driving competition to keep mortgage rates low, despite higher nominal treasury yields.
And this will keep the pressure up on net supply.
Government policy also favors broader access to refinancing with potential modifications from the GSEs to loan level pricing adjustments, therefore lowering the mortgage rate that's available to consumers once again, meaning that higher coupons remain vulnerable to prepayments and lower coupons susceptible to supply.
The technicals for RMBS are also challenging as the fed begins to exit and it is unclear whether bank demand will continue at the same level as early on 2021.
Market psychology and agency MBS spreads is bearish with many investors holding underweights and strategists recommending neutral or underweight positioning.
With this backdrop, we believe agency RMBS spreads could wipe up to 10 basis points to 20 basis points as the taper begins to be implemented, but we think this is more likely to happen during bouts of volatility.
We also expect agency RMBS spreads to be more volatile and directional widening and rallies and tightening and sell offs.
We do expect to increase leverage in these situations, and we are always looking for a good window to make this adjustment.
We expect to make an initial adjustment in leverage back up to eight times and when appropriate up to 10 times.
Longer term, we believe there will be good support for MBS spreads.
The Fed's balance sheet will create a powerful stock effect that will limit spread widening.
Demand from money managers as MBS becomes a high-quality alternative to corporate bonds and lower net supply from potentially higher rates will also provide an additional buffer against wider spreads.
We believe that holding a flexible liquid high credit quality position, even as spreads widen, we can manage both sides of our balance sheet to position for solid long-term return generation.
So to wrap up, the steep yield curve and low financing costs support our opportunities to generate solid returns for our business.
We expect this to continue well into 2022.
Book value is higher versus quarter end by 2% to 2.5%.
The portfolio is well-positioned for returns to cover or exceed the current level of the dividend today.
The low leverage that cushions book value and dry powder to drive forward earnings growth provide a solid foundation for return generation.
Specifically, we are entering the next few months with over $500 million in liquidity, almost an all-time high for Dynex relatively low leverage of 5.6 times that puts us in a solid position to navigate the environment and limits the risk to the existing portfolio.
We have dry powder for at least three turns and up to five turns of leverage each turn of leverage invested at 11% return adds roughly 1% or $0.24 per share incremental return annually.
This is a significant upside to the 9% dividend yield on our common shares that are trading somewhere between 94% and 95% of book value today.
The most important principles for the environment we're in right now, and this is how we're operating our discipline and patience while continuously assessing the environment as it will take time for the economic picture to become clear.
We stand prepared for the risks and we're ready for investment opportunities as they arise.
Let me wrap up with a couple of comments.
Dynex Capital is the oldest REIT focused solely on financing real estate assets in the United States.
We've encountered and navigated every market environment for 33 years.
Today, we are building a resilient organization to last the next 33 years and beyond.
We're making investments in people, processes, and technology that will allow us to rapidly adjust to a world that is destined to change.
We're also focused intensely on maintaining your trust by how we manage our risk, how we treat our employees, and how we positively impact our community at large.
We are positioned for this environment and we're excited about our opportunities.
Through our years of experience, we have learned that the best opportunities can appear at the most uncertain moments in the capital markets.

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q3 earnings per share $0.09.

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