Updated on May 19th, 2021 by Bob Ciura
Dynex Capital (DX) is a mortgage Real Estate Investment Trust (mREIT) that offers a an appealing 8% yield, making it a potentially attractive high yield stock.
Dynex Capital also pays its dividends on a monthly basis, which is rare in a world where the vast majority of companies that pay a dividend, pay them quarterly.
There are currently only 55 companies with monthly dividend payments. You can see the full list of monthly dividend stocks (along with relevant financial metrics such as dividend yields, payout ratios, and more) by clicking on the link below:
Dynex Capital’s high dividend yield and monthly dividend payments make it an intriguing stock for dividend investors, even though its dividend payment has been declining in recent years.
However, as with many high-dividend stocks, the sustainability of the dividend is an important consideration. This article will analyze the investment prospects of Dynex Capital.
Dynex Capital is a mortgage Real Estate Investment Trust. As a mortgage REIT, Dynex Capital invests in mortgage-backed securities (MBS) on a leveraged basis in the United States. It invests in agency and non-agency MBS consisting of residential MBS, commercial MBS (CMBS), and CMBS interest-only securities.
Agency MBS have a guaranty of principal payment by an agency of the U.S. government or a U.S. government-sponsored entity, such as Fannie Mae and Freddie Mac. Non-Agency MBS have no such guaranty of payment. Dynex Capital, Inc. was founded in 1987 and is headquartered in Glen Allen, Virginia.
The company is structured to have internal management, which is generally positive because it can reduce conflicts of interest. Additionally, when they increase total equity, there is no material impact on operating expenses. Over time, Dynex’s management team has built a strong track record of generating attractive total returns for shareholders:
Source: Investor presentation
Dynex’s portfolio is structured to be widely diversified across residential and commercial agency securities. This diversified approach creates an attractive risk-to-reward balance that has benefited the company for many years. Over time, the mix of CMBS and RMBS investments has reduced the negative impacts of prepayments on portfolio returns. Furthermore, agency CMBS acts as a cushion in the event of unexpected volatility in interest rates.
Finally, the high-quality CMBS IO are selected for shorter duration and higher yield, with the intended impact of limiting portfolio volatility. A significant portion of Dynex’s Agency 30-year RMBS fixed rate portfolio has prepayment protection via limits on incentives to refinance.
Management anticipates opportunistically increasing leverage in the high-quality asset portfolio while avoiding credit sensitive assets that are leveraged with short term financing. As a result, the company enjoys a highly flexible portfolio that frees management to rapidly pivot to other attractive opportunities as markets remain volatile.
The trust reported first–quarter results on April 28th, 2021. Core net operating income per share came in at $0.46, up from $0.45 sequentially. Net interest income fell from $14.4 million to $12.3 million quarter–over–quarter and adjusted net interest income fell to $20.8 million from $20.9 million sequentially.
The trust also reported 6.9x in leverage including TBA dollar as of March 31, 2021, compared to 6.3x as of December 31, 2020. Book value per common share stood at $20.70 as of March 31st, 2021 up from $19.08 on December 31st, 2020.
Given that interest rates are expected to remain in a narrower and lower range for a longer period than ever seen in recent history, returns will likely suffer substantially. This is because the economies of the world will continue to be weighed down by large pools of negative yielding debt, forcing central banks to remain accommodative in their monetary policy.
That being said, such a low-yield environment creates an opportunity in high quality real-asset backed loans. While numerous short-term headwinds remain (as we will discuss next), Dynex still benefits from several long-term factors that could enable them to continue growing.
First, an aging population in a low yield world should foster a growing demand for the cash flow that their business can generate, thereby boosting valuations and making attracting capital easier for mortgage REITs. Second, as the Federal Reserve attempts to reduce its investment in Agency RMBS and GSE reform opens new investment opportunities, demand for private capital in the US housing finance system should grow.
Third, the shortage of affordable housing means that there is a need for additional investment into the sector.
Source: Investor Presentation
Finally, Dynex brings to the table several competitive advantages which should enable it to generate strong returns for investors throughout business cycles on the back of these long-term tailwinds.
These include the company’s experienced management team with expertise in managing securitized real estate assets through multiple economic cycles. It also includes their emphasis on maintaining a diversified pool of highly liquid mortgage investments with minimal credit risk, and the attractive dividend yield.
While the long-term outlook is more promising, several challenges remain in the near term. First, this includes a shrinking spread between 3-month LIBOR and short-term repo rates as repo rates remain elevated due to the extremely low Fed Funds rate.
That being said, the trust’s normalized diluted earnings per share were actually quite stable through the last recession, though shares still sold off very heavily, losing about 40% of their market value. All in all, there’s little margin of safety here due largely to the payout ratio being so high, combined with highly volatile earnings–per–share.
Another risk is that prepayment speeds could rise due to seasonal factors. Additionally, the drop in mortgage rates could increase refinancing activity, further cutting into profits.
While some cash-out refinancing is already factored into the company’s prepayment expectations and their portfolio has been structured to hedge against some of this, there will still likely be some lost profits. This explains the company’s recent pattern of dividend reductions since 2019.
The latest earnings results revealed a dividend that appears covered by earnings, as the company paid a $0.39 per share dividend in the quarter. At the same time, Dynex delivered core net operating income per share came of $0.46.
Including dividends distributed thus far in 2021, as well as those expected for the rest of the year, Dynex will pay out $1.56 of dividends this year. Based off of the recent closing price of $19.70, shares have a yield of 7.9% today. On the surface, Dynex appears to be an attractive high-yield dividend stock.
Importantly, the dividend appears covered. We expect Dynex to produce $1.87 of core operating EPS in 2021. This puts the expected payout ratio at 83%, making it possible that the dividend can be maintained, barring a significant decline in operating EPS.
Dynex Capital’s high dividend yield and monthly dividend payments make it stand out to high-yield dividend investors. However, we remain extremely cautious on the stock.
The company is covering its dividend for the time being. But the riskiness of the business model sets up Dynex for potentially steep losses if the economy slips into recession and defaults rise. We also find shares to be overvalued, with a 2021 P/E of 10.5 compared with our fair value P/E of 8.
This makes the stock fairly risky. Despite the high dividend yield, investors looking for monthly income have better choices with more favorable growth prospects, and safer dividends.