Dynex Capital, Inc. Third Quarter Earnings Conference Call - DYNEX CAPITAL INC

Financial Performance:

• Book value per share declined 15.4% to $10.91 (Q3 2026) from $12.90 (Q2 2026); total economic return was negative 11.5% including the $0.51 common dividend.
• Reported comprehensive loss of $1.49 per share compared to $0.80 income in Q2.
• Raised $384 million of accretive capital: $268 million via ATM common equity and $116 million from a Series D preferred stock offering (first preferred offering since 2020).
• Expanded equity capital base by 24% year-over-year to $3.1 billion; preferred equity increased from 3% to 7% of the total capital stack.
• Asset yields rose from 4.94% to 5.0%, while financing costs increased modestly from 3.79% to 3.82%, maintaining a stable economic net interest spread of approximately 1.18%.
• Liquidity remains robust at $1.3 billion (42% of total equity), derived from cash and unencumbered securities.
• Maintained $24 billion of repo financing across 25+ counterparties; G&A expenses represented 2% of total equity on an annualized basis, down 40% year-over-year.

Guidance and Future Outlook:

• Management projects long-term static ROE of 20% to 25% on new investments (approx. 20% for lower coupons, 25% for current coupons).
• Views current market conditions as a "highly attractive investment opportunity" driven by wide mortgage spreads, compelling real yields, and limited prepayment risk.
• Anticipates further structural support for funding markets via central clearing, potential bank capital requirement changes, and Fed standing liquidity facilities.
• Expects continued demand from money market funds (balances up ~60% to $8 trillion) and GSEs acting as value-sensitive buyers to support mortgage spreads.
• Confidence in forward returns is underpinned by an improved convexity profile where mortgage durations are stable, limiting downside from rate hikes.

Business Segments and Product Lines:

• Portfolio focus remains exclusively on Agency Mortgage-Backed Securities (Agency MBS).
• Strategic shift involves letting spread exposure grow; portfolio spread sensitivity increased to 5.7% of common equity per 10bps spread (up from 4.6%).
• New product initiative launched with "Dynex Angle," a macro and market perspective report accompanying earnings.
• Investment strategy prioritizes lower coupon pools (below par) over current coupon, citing a 1% universe with refinance incentives >25bps.
• Leveraged position maintained at 9.0x shareholders' equity to capture spread compression gains without de-levering during volatility.

Market and Competitive Landscape:

• 10-year Treasury yields rose >80bps above 5%; current coupon mortgage yields increased nearly 100bps, while spreads widened ~20bps to 162bps over 7-year swaps.
• Market dynamics driven by AI capital demand, inflation pressures, and geopolitical uncertainty rather than Agency MBS fundamentals.
• Agency MBS sector described as a "sideshow" to broader macro shifts, with orderly market function despite volatility.
• Convexity selling pressure has largely run its course, reducing the risk of duration extension if yields rise further.
• GSE buying and foreign demand (e.g., Norges Bank potential entry) identified as key marginal demand sources.

Risks and Challenges:

• Primary risk factor is macroeconomic volatility leading to repricing; 15.4% book value decline attributed to spread widening and yield increases.
• Implied interest rate volatility remains elevated relative to realized volatility, pricing in significant macro risk.
• Financing market stability is critical; however, funding costs and repo spreads to SOFR remain resilient (12-15bps range).
• Political uncertainty and rising government borrowing continue to exert upward pressure on yields.

Management Commentary and Tone:

• Tone is highly confident and resilient, framing the quarter as a "pivotal moment" where Dynex was prepared to capture value.
• Emphasizes discipline in not deleveraging to preserve earnings power, viewing the current price drop as a reflection of mark-to-market rather than a deterioration in fundamentals.
• Management highlights the "construction of a more scaled and resilient Dynex" with a flexible capital structure capable of navigating shocks.
• Expresses strong conviction that current wide spreads offer superior compensation for risk compared to historical averages.

Analyst Questions and Answers:

• Leverage & Risk: TJ Connolly confirmed that the robust money market liquidity environment ($8 trillion) provides confidence to carry current leverage levels despite volatility.
• ROE Calculation: Confirmed 20-25% ROE models assume ~10x leverage; current 9x leverage still allows for strong dividend coverage given preserved earnings power.
• Expense Ratios: Clarified G&A is running at a 2% annualized rate, down 40% YoY, driven primarily by reduced compensation expenses aligned with performance.
• Hedging Strategy: Described adding hedges "in lockstep" with rising rates to mitigate downside, resulting in a 50bps rate rise scenario causing only a 0.5% equity drop (vs. 3.5% previously).
• Market Outlook: Reiterated that duration extension is limited (90% already realized); future returns are driven by spread tightening rather than rate direction.
• Capital Structure: Indicated room to increase preferred equity beyond the current 7% threshold opportunistically, citing the recent deal as accretive.

Other Key Points:

• Estimated book value as of early October (post-quarter end) reached $10.95 (net of accrued dividend).
• No dividend cuts were implemented; management asserts dividend coverage remains robust despite the mark-to-market decline.
• The company avoided deleveraging during the quarter, retaining full portfolio exposure to capture the anticipated spread tightening.
• Future investment focus is on capturing "carry" in an environment where prepayment risk is minimal and cash flows are stable.