Executive Summary / Key Takeaways

• Dynex Capital operates as a disciplined mortgage REIT focused on generating attractive, resilient returns primarily from Agency MBS, leveraging its experienced team and strategic flexibility in a complex, volatile market.
• The company's financial performance in Q1 2025 showed improving net interest income driven by higher-yielding assets and lower financing costs, although a net loss was reported due to mark-to-market movements, while comprehensive income remained positive.
• Management maintains a robust liquidity position and operates with generally lower leverage, viewing market volatility and dislocations (like recent tariff impacts) as opportunities to prudently deploy capital, as evidenced by recent accretive equity raises.
• The investment thesis is underpinned by historically wide Agency MBS spreads offering double-digit ROE potential, a steeper yield curve providing positive carry, and tactical hedging adjustments (including a shift towards swaps) aimed at enhancing returns and managing interest rate risk.
• Key risks include continued market volatility, potential GSE policy changes, intensifying prepayment risk from industry consolidation, and regulatory shifts, which the company addresses through disciplined risk management, scenario planning, and maintaining ample dry powder.

Harvesting Yields Amidst Global Complexity

Dynex Capital, Inc. (DX) is an internally managed mortgage real estate investment trust with a long history dating back to 1988. The company's core business revolves around investing on a leveraged basis primarily in Agency mortgage-backed securities (Agency MBS), including residential (RMBS) and commercial (CMBS), as well as to-be-announced (TBA) securities. This strategy places Dynex squarely at the intersection of global capital markets and the U.S. housing finance system, a space management believes offers sustained opportunity for compelling yields, supported by underlying demographic trends favoring residential real estate.

The company's strategic approach, particularly under the long-tenured leadership of Byron Boston and Smriti Popenoe, is characterized by a deep-seated discipline and a focus on navigating complex, rapidly changing macroeconomic environments. Rather than attempting to predict market movements, Dynex prepares for potential surprises and volatility, viewing market dislocations as opportunities to add assets prudently. This involves maintaining a nimble mindset, building a strong capital base, and prioritizing robust liquidity and flexibility across the portfolio and financing structures.

In the competitive landscape of mortgage REITs, Dynex operates alongside larger players like AGNC Investment Corp. (AGNC) and Annaly Capital Management, Inc. (NLY), as well as others like Two Harbors Investment Corp. (TWO). While AGNC and NLY command larger market shares and benefit from greater scale, potentially leading to lower operating costs per unit and faster portfolio adjustments through advanced analytics, Dynex differentiates itself through its experienced team's tactical expertise, disciplined capital management, and a willingness to diversify across the MBS coupon stack and into areas like CMBS for diversification benefits. Although precise, directly comparable market share figures for all niche competitors are not publicly detailed, Dynex's performance track record, including leading total shareholder return among agency-focused peers over various periods through late 2024, suggests its strategy has been effective in generating value despite lacking the scale advantages of the largest players.

Dynex's operational framework relies on sophisticated systems for trading, portfolio management, and risk reporting. While the company does not detail proprietary technological differentiators in the same way a manufacturing company might, the company emphasizes its investment in human capital and technology to enhance its analytical capabilities and compete effectively. The recent hiring of a Chief Technology Officer with experience in financial technology underscores the commitment to leveraging tech-driven analytics. This focus on analytical rigor and infrastructure is crucial for managing the embedded risks in MBS and executing tactical portfolio adjustments, aiming to generate alpha from relative value opportunities and dollar rolls within the Agency RMBS market.

Financial Performance and Portfolio Dynamics

The company's financial performance in the first quarter of 2025 reflected the ongoing trends of adding higher-yielding assets and benefiting from declining financing costs, contributing to improved net interest income. For the three months ended March 31, 2025, net interest income rose to $17.1 million, a significant increase from $6.9 million in the prior quarter and $3.2 million in the same period last year. This improvement was driven by a larger portfolio of Agency RMBS with higher effective yields (4.66% in Q1 2025 vs. 4.59% in Q4 2024 and 4.33% in Q1 2024) and a notable decline in repurchase agreement financing costs (4.56% in Q1 2025 vs. 4.97% in Q4 2024 and 5.51% in Q1 2024).

Despite the positive trend in net interest income, the company reported a net loss of $3.1 million for the first quarter of 2025, compared to net income of $49.2 million and $40.1 million in the comparable prior periods. This shift was primarily attributable to mark-to-market movements on investments and derivative instruments. While the fair value of the investment portfolio increased by $171.6 million, largely due to lower long-term Treasury rates, these gains were mostly offset by net losses on the hedging portfolio totaling $171.1 million (excluding net periodic interest earned from swaps), reflecting the impact of declining rates on hedge valuations.

Comprehensive income to common shareholders, which includes unrealized gains/losses on available-for-sale investments, stood at $14.4 million for Q1 2025, following $12.6 million in Q4 2024 and $20.9 million in Q1 2024. The company's total assets increased to $9.04 billion as of March 31, 2025, from $8.18 billion at year-end 2024, reflecting portfolio growth. Total shareholders' equity also grew to $1.40 billion from $1.18 billion over the same period, boosted by capital raising activities.

The investment portfolio composition as of March 31, 2025, remained relatively consistent, with 74% in Agency RMBS, 24% in TBA securities, and 2% in Agency CMBS and CMBS IO. The company actively purchased approximately $895.1 million of Agency RMBS and increased TBA positions by $430 million notional during the quarter. Purchases of $54.6 million in Agency CMBS were made to add diversification benefits due to their different convexity profile. Management highlighted that Agency CMBS IO from Freddie Mac Series K deals continue to perform well, with 99.6% of underlying loans current as of February 2025.

Capital Management, Liquidity, and Risk

A cornerstone of Dynex's strategy is disciplined capital management and maintaining robust liquidity, particularly in the current volatile environment. The company views liquidity as essential for withstanding market shocks and capitalizing on opportunistic investments. As of March 31, 2025, liquidity totaled $789.9 million, comprising $327.4 million in unrestricted cash, $450.3 million in unencumbered Agency MBS, and $12.2 million in noncash collateral pledged by counterparties. This represented a significant increase from $658.3 million at the end of 2024.

The company actively utilizes its at-the-market (ATM) program to raise capital, issuing 17.60 million shares for $239.7 million net proceeds in Q1 2025, and an additional $38.7 million through April 24, 2025. Raising capital at a premium to book value, as achieved in Q1 2025, is viewed as accretive to shareholders. Proceeds are partially deployed into the portfolio and used to support margin requirements for a larger hedge book, while a portion is intentionally held as "dry powder" to maintain flexibility.

Repurchase agreements are the primary financing source, increasing to $7.2 billion as of March 31, 2025, from $6.6 billion at year-end 2024 to fund asset purchases. Leverage, calculated as total liabilities plus TBA long cost basis relative to shareholders' equity, stood at 7.40x at quarter-end. While repurchase facilities are uncommitted and typically short-term, Dynex has not experienced difficulty in securing financing and was in full compliance with all debt covenants as of March 31, 2025. The company manages counterparty risk by maintaining relationships with multiple lenders and ensuring equity at risk does not exceed 10% with any single counterparty.

Risk management is central to Dynex's operations. The company is exposed to interest rate risk, spread risk, prepayment risk, credit risk, liquidity risk, and reinvestment risk. Interest rate risk is managed through a dynamic hedging strategy utilizing derivative instruments like U.S. Treasury futures, interest rate swaps, and interest rate swaptions. The company recently shifted a significant portion of its hedge book from futures to interest rate swaps, viewing swaps as a more natural hedge for the mortgage portfolio and offering potentially enhanced ROE. Spread risk, which is not hedged due to cost and liquidity constraints, remains a key sensitivity. Prepayment risk is actively monitored and managed through security selection, favoring specified pools with stronger prepayment protection and shifting exposures towards lower coupon mortgages, particularly in light of potential acceleration from industry consolidation.

Outlook and Strategic Positioning

Management views the current environment, characterized by a steeper yield curve, historically wide Agency RMBS spreads (ranging from 145 to 160 basis points over Treasuries, or nearly 200 basis points over swaps in April 2025), and lower financing costs, as favorable for generating attractive returns. They believe these spreads offer double-digit ROE potential, positioning the company to earn solid returns even without further spread tightening. The outlook anticipates continued market volatility, influenced by factors such as tariff news, potential GSE policy changes, Federal Reserve actions, and geopolitical events.

Dynex is preparing for a wider distribution of interest rates and positioning its portfolio for potential pockets of volatility, which could present opportunities to deploy capital at even wider spreads. The company expects expenses to level out and trend down over the course of 2025, aiming for a lower expense ratio compared to 2024, benefiting from scale achieved through capital growth. While the near-term book value has experienced some decline quarter-to-date (estimated between $11.55 and $11.65 per share as of April 18, 2025), management remains confident in the long-term ability to generate attractive returns and support the dividend, which was recently increased in February.

The strategic focus remains on disciplined risk management, maintaining a robust liquidity position, and operating with flexibility. The bar to add incremental risk, including increasing leverage, is currently viewed as quite high given the uncertain environment. The company continues to explore opportunities in the Agency CMBS market for diversification and more certain durations. Management emphasizes that their balance sheet is transparent and easily valued, with no held-to-maturity investments or hidden unrealized losses, reinforcing their commitment to being reliable stewards of shareholder capital.

Conclusion

Dynex Capital is navigating a complex and volatile macroeconomic landscape by adhering to its long-standing strategy of disciplined investment in Agency MBS, prioritizing risk management, and maintaining significant liquidity. The company's recent financial performance highlights the benefits of its portfolio positioning in a favorable yield curve environment with declining financing costs, contributing to improved net interest income. While mark-to-market fluctuations can impact reported net income, the focus remains on generating strong total economic returns over the long term.

The investment thesis for Dynex is compelling, rooted in the attractive return potential offered by historically wide Agency MBS spreads and the company's proven ability to tactically manage its portfolio and hedging strategy. The commitment to accretive capital raising, even opportunistically above book value, supports growth and scale benefits that enhance shareholder value. Although risks such as market volatility, policy uncertainty, and prepayment dynamics persist, Dynex's proactive approach, experienced team, and robust liquidity position it to withstand potential shocks and capitalize on future investment opportunities, underpinning the confidence in its ability to deliver compelling long-term returns and sustain its dividend.