Dynex Capital (DX) Q3 2026 earnings call transcript

Thank you, operator, and thank you to everyone joining us today for DYNEX's third quarter 2026 earnings conference call. Joining me on today's conference call are Smirthy Papano, co-chief executive officer and president, Byron Boston, chairman and co-chief executive officer, Mike Sartori, chief financial officer, and TJ Connelly, chief investment officer. Before we begin, I'd like to remind you that today's discussion may include forward-looking statements. These statements are based on current expectations, forecasts, and assumptions, and are subject to risks, uncertainties, and other factors that could cause actual results to differ materially. For additional information regarding these risks and factors, please refer to our filings with the SEC available in the Investor section of our website as well as on the SEC's website.

DYNEX undertakes no obligation to update or revise any forward-looking statements. Our earnings press release was issued and filed with the SEC earlier today and is available on the investor section of our website at dynexcapital. com, as well as on the SEC's website. We may also reference our earnings presentation today, which is also available on our investor page. And with that, I'll turn the call over to Smarthi for opening remarks.

Thank you, Kate. Good morning, everyone, and thank you for joining us today. This was a pivotal quarter in the markets, and DYNEX was prepared for this moment. We had a strong liquidity position, our experienced team maintained our position in our highest conviction trade, and we have retained the capacity to invest as spreads have moved wider. In the third quarter, book value declined 15.4% to $10.91 per share for a total economic return of negative 11.4%. Our portfolio operated as designed. The liquidity position absorbed the book value movement. Our financing remained deep and reliable, and our hedging limited our downside as 10-year Treasury yields rose above 5%.

During the quarter, we took another step in the evolution of our capital structure with the issuance of our Series D preferred stock, our first preferred equity offering in more than six years. The transaction added an accretive source of permanent capital and further diversified our capital base.

The quarter's results reflect higher volatility and higher yields in the overall bond markets and wider spreads in the agency and BS markets. These moves were driven by fundamental shifts in the macroeconomic system. The U. S. economy is in the midst of a significant positive investment cycle, driven by AI and the infrastructure required to support it. During the third quarter, we experienced a simultaneous and significant risk and price re-rating of several crucial factors related to AI investment. The significant demand for capital in this sector, the price of that capital, the impacts of that capital investment on the price of commodities, and the follow-on impacts of all of this on inflation are all higher, pushing yields up.

At the same time, due political uncertainty and rising government borrowing needs, both in the U. S. and globally, have reinforced upward pressure on yields. Against this backdrop, agency MBS have actually been a sideshow, not the main act. And while flows were choppy and illiquid at times, the sector has not been the origin of market stress. In fact, the fundamentals and technicals behind agency MBS are highly constructive. After the significant and rapid repricing, we find ourselves once again facing a highly attractive investment opportunity. Absolute real yields are compelling. At current levels, mortgage spreads are still historically wide and provide significant compensation at a time when the value of the borrower's prepayment option is substantially lower.

Refinancing incentives is extremely limited, and much of the mortgage universe has already extended substantially. As a result, the duration and expected cash flows of these assets are more stable, and most importantly, the convexity profile of the mortgage market has improved dramatically. As a result, and as long-term investors in agency MBS, we are being paid a widespread while assuming considerably less cash flow uncertainty than is typically associated with mortgages. This combination underpins our confidence around strong forward returns. Yes, the cost of capital has temporarily adjusted higher, and prospective returns have adjusted materially higher. This is an important moment for DYNEX and our shareholders. We've been building a more scaled and resilient DYNEX with the liquidity and flexibility to navigate market and operating shocks.

As we grow, our investment platform becomes increasingly durable with greater capacity to deploy capital and opportunistically capture attractive returns. I'd now like to turn the call over to Mike and TJ to discuss our financial results and portfolio positioning in greater detail.

Thank you, Smurthy. I'll now review our financial results for the third quarter. We reported book value per common share of $10.91 at September 30th, compared with $12.90 at June 30th. Including the $0.51 common dividend, total economic return was negative 11.5%. Comprehensive loss was $1.49 per common share, compared with comprehensive income of $0.80 per share in the second quarter. We raised $384 million of accretive capital during the third quarter, net of fees, including $268 million of common equity through our ATM program, while maintaining an opportunistic approach to capital raising. We also completed our first preferred equity offering since 2020, raising $116 million of net proceeds in late September. However, the transaction was an important step in creating strategic flexibility in our capital structure.

The offering increased preferred equity as a percentage of our capital stacks from approximately 3% to 7% of our total equity base, diversifying our sources of capital as we continued to grow the business. The transaction was accretive and priced at an attractive cost of capital, particularly relative to the current yield on our common equity. Importantly, funding markets remain deep and supportive. We maintain more than $24 billion of repo financing across over 25 counterparties. The breadth of our counterparty relationships, combined with the high quality and liquidity of our agency collateral, provide substantial capacity to support additional investment opportunities. Asset yields increased from 4.94% to 5%, outpacing the modest increase in our effective financing costs from 3.79% to 3.82%.

As a result, our economic net interest spread remained stable at approximately 1.18%. Liquidity remains a key strength with 1.3 billion of cash and unencumbered securities at quarter end, representing over 42% of total equity, down approximately 9% from the prior quarter. As designed liquidity levels have buffered the book value declines Maintaining ample liquidity remains a core element of our risk management framework and allows us to capitalize on market opportunities as they arise We ended the quarter with a 3 billion equity capital base an increase of 24 year Turning to operating expenses, G&A for the third quarter was 2% of total equity on an annualized basis, consistent with the run rate we discussed last quarter. As we have grown, we have continued to generate meaningful operating leverage across the platform.

G&A expenses have declined as a percentage of equity over time and was approximately 40% lower than the same period in 2025. As we execute on our business plan, we have continued to invest in talent, technology, and infrastructure to support a larger, more scalable platform. We remain committed to expense discipline and focused on further enhancing operating efficiency as we scale.

With that, I will turn it over to TJ to discuss our portfolio and outlook in greater detail.

Thanks, Mike. Current coupon mortgage yields moved nearly 100 basis points higher in the third quarter. The 10-year Treasury rose over 80 basis points, eclipsing 5% for the first time since 2007, and mortgage spreads widened nearly 20 basis points, much of it in the last two weeks of September. At quarter end, current coupon spreads to seven-year swaps for around 162 basis points, near the wide end of this year's range.

We managed our portfolio actively and with discipline. As rates rose, we added to our hedges in lockstep. As a result, we limited the impact of the rate move. Spread widening drove over 80% of the return in the quarter, and our liquidity continued to do its job. It covered margin in the normal course of business, and we held our exposures and their return potential. We did not delever.

As I turn to market dynamics, this quarter I'm excited to announce the release of the DYNEX Angle to accompany our earnings presentation. It gives you a deeper look into our market and macro perspectives. You can find it on our website under the DYNEX Perspective heading. I want to focus on what drove spreads wider, how orderly it was, and why it leaves us with one of the most compelling risk profiles we've seen in this market.

Realized rate volatility increased, and implied volatilities in the interest rate options market jumped even more, causing cheapening of mortgages as expected. Floaters with interest rate caps were particularly exposed. Hedge funds were then forced to quickly exit or hedge their floater positions by selling agency MDS. We also saw convectity selling from servicers and other mortgage hedgers as yields rose rapidly and durations extended. Outside of the activity I just mentioned, the market functioned in an orderly fashion. Money managers continued buying agency MBS into the wider spread, and that has continued into October. The GSEs also operated as we expected. As I said in July, they act as value-sensitive buyers, and there was anecdotal evidence of GSE buying in late September.

They added just enough demand when spreads were wide to support a healthy mortgage market. Funding markets remain very robust, and these conditions have continued in October, with strong demand from money market funds intermediated well by the dealer community. Mortgage repo spreads to SOFR held near the tights of the last several years in the 12 to 15 basis point range.

Moreover, for the first time in many years, quarter end came and went without any noticeable pressure. Looking ahead, we also see further structural support for financing from the expansion of central clearing and sponsor repo, potential changes to bank capital requirements, and the Fed's standing liquidity facilities, All of which should contribute to the depth and resilience of funding markets over time.

Smurthy described the improved mortgage convexity profile as an important part of today's opportunity. Let me put some numbers behind it and explain what it means for DYNEX's portfolio today. Only about 1% of the outstanding mortgage universe has more than a 25 basis point refinance incentive, and the vast majority of agency mortgages trade below par. The convexity selling that added to the push higher in yields has largely run its course, which means there's very little extension left, even if rates move higher still. You can see this in the interest rate sensitivity table at the top of page 23 of our presentation, where the modeled impact of rate movements on book value is now much more limited.

An instantaneous 50 basis point rise in rates as of September 30th is modeled to reduce common equity by only about 0.5% compared with 3.5% at June 30th. That means our shareholders have the potential to capture the attractive carry I mentioned without relying on a particular path for interest rates.

Given this setup, we deliberately let our spread exposure grow. Our portfolio spread sensitivity increased from about 4.6% of common equity per 10 basis points of spread at June 30th to about 5.7% at quarter end. What this means is if spreads tighten 20 basis points, which is roughly a retracement of the widening in the third quarter, you see the model shows approximately 11.5% of gains to book value, all else equal. Leverage ended the quarter at 9.0 times shareholders' equity, with the increase largely reflecting the decline in book value due to the spread widening and convexity.

Our leverage reflects the opportunity set, the risk characteristics of the portfolio, and the liquidity we want to maintain. Our confidence in our current positioning is rooted in the market backdrop. The yield spread available, favorable supply and demand technicals, the convexity profile driven by more stable mortgage duration, and a favorable financing environment. What matters is not simply that modeled ROEs are attractive.

With more stable durations and less hedge rebalancing, the portfolio is positioned to retain more of the carry embedded in those returns. We believe we are being well compensated for the risk we are taking, which underscores our willingness to operate at the current level of leverage. We maintained our positions through the pricing, kept our financing, and put new capital to work at wider spreads.

Today, we are earning attractive spreads on mortgages with more stable durations amid a funding market that remained resilient through the volatility. That is the opportunity in front of us, and we are positioned to capture it. At today's wider spread, static ROEs on new investments hedged with interest rate swaps are around 20% in lower coupons and 25% in current coupons. And as you see in the interest rate sensitivities, a 10-bip spread tightening adds almost 6% of incremental return.

I will now turn the call back over to Smurthy for some closing remarks.

Thank you, TJ. Periodic repricing is a normal occurrence in the markets, and the mark-to-market impact of the third quarter's repricing is already reflected in our assets, our balance sheet, our book value, and our share price. At this point, our focus, and we believe investors' focus, should be on the 20-plus percent ROEs that the portfolio could generate in the future. We have a strong conviction in our ability to earn these forward returns. We continue to manage DYNEX with a long-term shareholder perspective. That means staying disciplined through significant periods of repricing, managing risk while holding the positions where we have the greatest conviction, and preserving our ability to invest as opportunities emerge. Our focus extends beyond any single quarter We are building DYNEX of compound value across cycles with greater scale a flexible capital structure and the capacity to invest when shareholders are well compensated for risk As always we remain invested alongside you in what we believe is a powerful long opportunity for our shareholders With that I like to open up the call to questions Thank you.

Yeah, good morning, Doug. One of the most important factors in the market that I discussed a little bit, maybe need to even further emphasize, is the favorable financing environment. Over the last two to three years, we've seen money market balances grow by some 60%. $8 trillion sits in money market funds. And at the end of the day, that drives a lot of our ability to carry positions through volatility in markets. You know, it's really notable that while realized volatility jumped in the third quarter, the big jump was in implied volatility. There's a lot of macro risk priced into these mortgages, and we are able to continue to hold the financing through these periods of volatility.

So at the end of the day, it's all about the financing market for us, and that has been an extremely healthy part of the market. It gives us a lot of confidence in carrying the leverage that we're currently carrying.

Pleasure.

Yes, of course. Good morning. Bose, as of Friday, our estimated book value net of the accrued dividend was $10.95.

Yeah, both. That's right. You know, as we indicated, G&A is down about 40% since last year at this time. We remain focused on that 2% ratio. As we continue to grow, we will see operating leverage benefits from this. At the end of the day, it's about performance and returns and what creates shareholder value. And what-that decrease really comes from compensation expense. It's aligned with the company's performance, so-and shareholder value.

Well, as one of my colleagues mentioned, I may have cut out just slightly, as I said, the book value, $10.95.

$0.95.

Yep.

Yeah, good morning. Importantly, as I mentioned, GSEs were very likely in the market in September. However, they have been a backstop bid to mortgages, and I think that's something we've been talking about for several quarters now, ever since the January tweet and their active purchases in the first quarter. So that remains an important backdrop. What's really notable here is given the supply dynamics at these rate levels, you don't actually need all that much marginal demand. We have seen foreign buyers in Europe. For instance, there was the news of the Norges Bank and the possibility that they'd be selling global sovereigns to buy agency mortgages, and they specifically mentioned U. S. agency mortgages. That's notable. I think that's a long-term flow that will underpin and really shows the quality of these assets, right?

It's a yield that you can, at these real yield levels, is very compelling to global investors. So I do expect foreign investors to be active on the demand side of the equation. Of course, the mortgage rate community remains increasingly important to this.

Yeah, hi, Marissa. I'd also jump in and just talk about, you know, the view on forward returns being really solid here in the low to mid-20s. One of the other pieces to keep in mind is how we've been able to preserve our earnings power, even when book value has declined. So one of the key decisions that we made over the quarter was the decision to not delever. And by doing so, we've kept so much of the earnings power, in fact, all of it. And that's another big reason for having the level of confidence about the compelling opportunity and the forward returns.

Yeah, I mean, we're really happy with the issuance and the timing of that particular deal. It was really massively accretive to the common shareholder. You know, we think of ourselves as having a significant amount of capital structure flexibility here at this point. The total, I think Mike mentioned, preferred in the stack is about 7%. That number has room to go higher. As with all of our capital structure decisions, right, and capital raising decisions, it's opportunistic. It's, you know, thinking through the things like how creative it is to shareholders, you know, where we can put the capital to work relative to the cost of that capital. But suffice to say, I think we're really happy with one, reentering the market, the reception that we got and then the possibility that this could be something that we could continue to use in terms of you know a source of capital in the future Got it Thank you We'll go next to Merrill Ross with Compass Point.

Good morning, Merrill. Yeah, thanks for the question. The hedges were put – we added to the hedge book pretty much in lockstep as rates were moving. We came into the quarter with a very strategic mindset in terms of continuing to add to hedges as rates moved higher. So it was progressive over the course of the quarter. As we broke through 5%, there was a clear realization of the new profile that mortgages would offer in terms of the convexity that we discussed. So we had a very clear game plan to put in place there and continue to add to hedges. So you'll see a modest increase in some of the longer hedges, in particular on page 24, as you mentioned, on the swap side of the book, as well as on the Treasury futures side.

Yeah, let me first make a comment on the notion of a static mortgage rate over time is not something we spend a lot of time thinking about. We're thinking about a range of scenarios and preparing for a significant number of outcomes, Both higher and lower than that 7.5 mortgage rate that they mentioned. So, yes, our portfolio is built accordingly, right? We're built to generate solid cash flows throughout a range of environments. I do think that a lot of these, you know, that convexity profile we discussed in the stable duration profile that's so important to earning these ROEs I think that's what I think is most compelling in coupons, say, five and a half and lower at this point.

Thanks. Yeah. Good morning, Trevor. I'd say overall, the most important thing to keep in mind is what's priced into swaptions markets, into the interest rate options markets that I mentioned, and those implied volatilities being higher, as high as they are, which is, again, notably higher than realized volatility. I think that's one of the most important constructs that will drive our ability to earn these ROEs and the returns that are available. So, you know, the convexity profile in a higher rate environment for the overall mortgage market is very, very stable. Those durations just don't extend all that more. Overall, you think from a very high level macro perspective, overall housing turnover is, you know, around four and a half percent per year.

If you look at existing home sales, which are very depressed and could make a case are making a bottom formation over the last several years. So at these turnover rates that are implied in the mortgages, so you've got very low turnover in the mortgages that drives the mortgage cash flows, creating that very stable cash flow. And then you have this wide spread that's there because the implied vols are so high on the macro side. It makes it very compelling for us to earn these ROEs that we're talking about. You know, so broadly, it's not an environment where taking significant macro exposures makes a ton of sense. We're being paid for it in the spread. So by design, very strategically, that's where our focus is, on this spread and earning those ROEs without more or less agnostic to interest rate direction.

Yeah, Trevor, I would say like the way the mortgage market is priced today, the level of extension on the margin for the next 25, 50, 100 basis points is very limited because we've extended 90% already, right? So any future extension from rates rising is limited. So if you're concerned about, again, rates up those types of scenarios, what PJ is mentioning is that it's all about the price of options in the implied vol markets and those, that's the mortgage market today is already pricing significant risk premium in implied vols. So we feel like we're getting compensated for that incremental risk.

I think you've got to go back to the idea of earnings power in the portfolio, Trevor, not having delivered in the quarter. That just means that we've taken the mark in book value, but the earnings power of the portfolio is preserved. And over the past several quarters, we've been pretty confident about our ability to cover the dividend even before we got to this point. So from here on, I don't think that's really changed that much because we did not significantly adjust the portfolio. It's definitely not on the asset side, right? So that piece of it, I think, is relatively well-preserved. In terms of the marginal ROEs, you know, we use a range of numbers. TJ, you can clarify on the low 20s, et cetera, the numbers that we quoted.

Right. Yeah, there's significant variables involved there, Trevor, but the numbers I was quoting were based on a 10 leverage number. And as you point out, we were sitting at 9 at quarter end. I will note we have net purchased assets since quarter end as well.

Thanks everyone for joining us today and we look forward to updating you on our performance in January.