Dynex Capital, Inc. (DX) Q3 2026 Earnings Call Transcript

Operator: Good day, and welcome to the Dynex Capital, Inc. Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Kaitlyn Mauritz, Head of Capital Markets and Investor Relations. Please go--

Kaitlyn J. Mauritz: Thank you, operator, and thank you to everyone joining us today for Dynex third quarter 2026 earnings conference call. Joining me on today's conference call are Smriti Popenoe, Co-Chief Executive Officer and President Byron Boston, Chairman and Co-Chief Executive Officer Michael Sartori, chief financial officer and T.J. Connelly, chief investment officer. Before we begin, I would like to remind you that today's discussion may include forward looking statements. These statements are based on current expectations, forecasts and assumptions, 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 Investors 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 Investors 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 will turn the call over to Smriti for opening remarks.

Smriti Laxman Popenoe: Thank you, Kait. 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, 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 6 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 MBS markets. These moves were driven by fundamental shifts in the macroeconomic system. US 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 rerating. 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, geopolitical uncertainty and rising government borrowing needs, both in the US 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 incentive 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 have 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 would now like to turn the call over to Mike and T.J. to discuss our financial results and portfolio positioning in greater detail.

Michael Sartori: Thank you, Smriti. I will now review our financial results for the third quarter. We reported book value per common share of $10.91 at September 30. Compared with $12.90 at June 30. Including the $0.51 common dividend, total economic return was -11.5%. Comprehensive loss was $1.49 per common share, compared with comprehensive income of 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. 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 continue 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 4.9% to 5%. Outpacing the modest increase in our effective financing cost 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 $3.1 billion equity capital an increase of 24% year-to-date. 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.

Terrence J. Connelly Jr.: 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 2 weeks of September. At quarter end, current coupon spreads to 7-year swap. Were 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. This 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 am 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 1 of the most compelling risk profiles we have seen in this market. Realized rate volatility increased and implied volatilities in interest rate options markets jumped even more. Causing cheapening of mortgages as expected. Loaders with interest rate caps were particularly exposed. Hedge funds were then forced to quickly exit or hedge their floater by selling agency MBS. We also saw convexity selling from servicers and other mortgage hedges 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 facility. All of which should contribute to the depth and resilience of funding markets over time. Smriti described the improved mortgage 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 mortgages have 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 is 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 30 is modeled to reduce common equity by only about 0.5%. Compared with 3.5% at June 30. 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% common equity per 10 basis points of spread at June 30, 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 9.0x 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. 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 ROE 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 repricing. Kept our financing, and put new capital to work at wider spreads. Today, we are earning attractive spreads on mortgages with more stable duration 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 spreads, static ROE on new investments hedge with interest rate swaps are around 20% in lower coupons and 25% in current coupons. And as you see in the interest rate sensitivity, a 10 bp spread tightening adds almost 6% of incremental return. I will now turn the call back over to Smriti for some closing remarks.

Smriti Laxman Popenoe: Thank you, TJ. Generic 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%+ ROE 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 to 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 term opportunity for our shareholders. With that, I would like to open up the call to questions.

Operator: Thank you. If you would like to ask a question. If you are using a speakerphone, please make sure your mute function is turned off. To allow your signal to reach our equipment. Once again, that is star 1 to signal for a question. And we will take our first question from Doug Harter with U. S. Bancorp. Please go ahead.

Doug Harter: Thanks. TJ, I appreciate what you just said about kind of the risk of the market today. Over kind of the longer term. Can you just talk about the risk positioning and the comfort with ability to just let leverage drift higher if markets continue to be weak and spreads wider in the short term?

Terrence J. Connelly Jr.: Yeah. Good morning, Doug. 1 of the most important factors in the market that I discussed a little bit, maybe need to even further emphasize is the favorable financing Over the last 2 to 3 years, we have 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 is really notable that while realized volatility jumped in the third quarter, the big jump was in implied volatility. there is a lot of macro risk priced into these mortgages. We are able to continue to hold the financing through these periods of volatility. So at the end of the day, it is it is all about the financing market for us. And that has been an extremely healthy part of the market. And gives us a lot of confidence in carrying the leverage that we are currently carrying.

Doug Harter: Great. And then you talked about, you know, the ability to generate, 20% to 20%+ Can you just kind of walk through the math as to how you are getting to that level of return?

Terrence J. Connelly Jr.: Yeah. We are. that is a levered ROE that is, you know, based on our models and where we think where spreads are today and at the end of the third quarter in particular, So we are getting on fives through sixes around 20% static ROE and some of the higher coupons and, you know, 6 and a halves, for instance, are actually around 25% ROE. Based on the model. Leverage works out to be around, 10 on that static ROE model.

Doug Harter: Okay. Appreciate that. Thank you, TJ.

Terrence J. Connelly Jr.: Mhmm. Pleasure.

Operator: Once again, if you find your question has been answered, you may We will move next to Bose George with KBW. Please go ahead.

Bose George: Hey, everyone. Good morning. Can we get an update on book value course-to-date?

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

Bose George: Great. Thanks. And then you know, on expenses, you know, you noted the 2% I mean, just when I do the math, it looks like it was, you know, down a decent amount. Like, closer to maybe 1.5 or is there anything unusual or seasonal in that? And then just, like, thinking about it going forward, it is I guess 2% should be kind of the number we use?

Smriti Laxman Popenoe: Yeah. Bose, that is right. 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 is about performance and returns and what creates shareholder value. And what that decrease really comes from compensation expense. it is aligned with the company's performance. So and shareholder value.

Bose George: Okay. Okay. Great. Thanks.

Smriti Laxman Popenoe: Bose, 1 of my colleagues mentioned I may have cut out just slightly As I said, the book value is $10.95. Okay.

Bose George: Thanks.

Terrence J. Connelly Jr.: Yep.

Operator: We go next to Melissa Lobo with UBS. Please go ahead.

Melissa Lobo: Thank you, and good morning. You characterized the current environment as a compelling forward opportunity. Could you speak to the demand side of that view, just where you see bank demand, GSE buying, foreign demand, and who do you see as the marginal buyer of agency MBS at these spread levels?

Terrence J. Connelly Jr.: Yeah. Good morning. Importantly, as I mentioned, GSEs were very likely in the market in September. They have been a back stop bid to mortgages, and I think that is something we have 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 is really notable here is given the supply dynamics at these rate levels, you actually need all that much of a marginal demand. We have seen foreign buyers in Europe. For instance, there was the news of the Norges Bank and the possibility that they would be selling global sovereigns to buy agency mortgages, and they specifically mentioned US agency mortgages. that is notable. I think that is a long-term flow that will, underpin and really shows the quality of these assets. Right? it is a yield that you can at these real yield levels are very compelling to the global investors. So I do expect foreign investors to be active on the demand side of the equation. Of course, the mortgage REIT community remains increasingly important to this. Yeah.

Smriti Laxman Popenoe: Hi, Melissa. I would also jump in and just talk about you know, the view on forward returns being really solid here in the low to mid-20s. 1 of the other pieces to keep in mind is how we have been able to preserve our earnings power even when book value has declined. So 1 of the key decisions that we made over the quarter was the decision to not delever And by doing so, we have kept so much of the earnings power, in fact, all of it, And that is another big reason for having the level of confidence about compelling opportunity and the forward returns.

Melissa Lobo: that is helpful. Thank you. And then just shifting to the capital structure, you talked about the benefits of diversifying with the preferred. How should we think about the preferred mix from here? Is there a level of preferred within the capital structure that you are thinking is appropriate?

Smriti Laxman Popenoe: Yeah. The. I mean, we are really happy with the issuance and the timing of that particular deal. It was really massively accretive to the common shareholder. 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 is it is it is opportunistic. it is, you know, thinking through the things like how accretive 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 are really happy with, 1, re-entering 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.

Melissa Lobo: Got it. Thank you.

Operator: We will go next to Jason Stewart with Compass Point. Please go ahead.

Jason Stewart: Thank you. If we look at slide 24, and look at the changes to your hedge positions, it would be helpful if you described when you changed the positioning and what you were thinking at the time and are you satisfied with where you were positioned at the end of the period?

Terrence J. Connelly Jr.: Good morning, Jason. Yes, thanks for the question. The hedges were put. We added to the hedge book pretty much in lock step 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 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 the hedges. So you will see a modest increase in some of the longer hedges, in particular, that on page 24, as you mentioned in the. On the swap side of the book as well as on the treasury future side. Yeah. Right.

Jason Stewart: Okay. And then, Fannie and Freddie Mac says in mortgage rates, it is gonna be 7.5% through 2027. So, wondering where in that market do you receive more value? Clearly, none. It seems not in TBAs, but do you prefer discounted lower coupon pools over, you know, the current coupon.

Terrence J. Connelly Jr.: 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 are 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 and. Our portfolio is built accordingly. Right? We are built to generate solid cash flows throughout a range of environments. I do think that a lot of these, that convexity profile we discussed in the stable duration profile that is so important to earning these ROEs is most compelling in coupons, say, 5.5 and lower at this point. Interesting. Yep.

Jason Stewart: Thank you.

Operator: We go next to Trevor Cranston with Citizens JMP. Please go ahead.

Trevor Cranston: Great. Thanks. Good morning. It looks like your overall rate exposure came down this quarter. I am curious if you guys could share your macro thoughts on how you think about the risk of rates moving significantly higher or lower from where they are today? And generally, you think MBS would perform if there were to be a significant move in rates either way from here? Thanks.

Terrence J. Connelly Jr.: Yep. Good morning, Trevor. I would say overall, the most important thing to keep in mind is what is 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 is 1 of the most important constructs that will drive our ability to earn these ROE and the returns that are available. So, you know, I do think the convexity profile in a higher rate environment for the overall mortgage market is very stable. Those durations just do not extend all that more. Overall, you can think from a very high level macro perspective, overall housing turnover is, you know, around 4.5% per year. If you look at, existing home sales, which are very depressed and you could make a case are making a bottom formation over the last several years. So these turnover rates that are implied in the in the mortgages, so you have got very low turnover in the in the mortgages that drives the mortgage cash flows, creating that very stable cash flow. And then you have this widespread that is there because the implied vols are so high on the macro side. It makes it very compelling for us to earn these ROE that we are talking about. So broadly, it is not an environment where taking significant macro exposures makes a ton of sense. We are being paid for it in the spread. So by design, very strategically, that is where our focus is, on this spread and earning those ROE. Without more or less agnostic to interest rate direction.

Smriti Laxman Popenoe: 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 have extended 90% already. Right? So any future extension from rates rising is limited. So if you. If you are concerned about, again, rates up, those types of scenarios, What TJ is mentioning is that we will. it is all about the price of options in the implied vol markets, and those that is the mortgage market today is already pricing significant risk premium in implied vols. So we feel like we are getting compensated for that incremental risk.

Terrence J. Connelly Jr.: Yeah. Okay.

Trevor Cranston: That makes sense. And when you guys were mentioning the incremental ROE kind of in the 20 plus percent range. I think you said you had calculated that based off a 10x leverage number, which is a little bit higher than where you sit today. So I was just wondering if you could clarify you know, if you think the existing portfolio as it sits today provides good dividend coverage and just kinda curious how you are thinking about the dividend policy in light of all the changes in the third quarter? Thanks.

Smriti Laxman Popenoe: I think you got to go back to the idea of earnings power in the portfolio, Trevor, not having delevered in the quarter. That just means that we have taken the mark in book value but the earnings power of the portfolio is preserved. And over the past several quarters, we have been pretty confident about our ability to cover the dividend. Even before we got to this point. So from here on, I do not think that is really changed that much because we did not significantly adjust the portfolio. Definitely not on the asset side. Right? So that piece of it, I think, is relatively well preserved. In terms of the marginal ROE, we use a range of numbers TJ, you can clarify on the low 20s, etcetera, the numbers that we quoted.

Terrence J. Connelly Jr.: Right. Yeah. there is significant variables involved there, Trevor, but the numbers I was quoting were based on a 10 leverage number. And, yeah, 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.

Trevor Cranston: Got it. Okay. that is helpful. Thank you.

Operator: We have no further questions. I would like to turn the floor back to Smriti Popenoe for any additional or closing remarks.

Smriti Laxman Popenoe: Thanks, everyone, for joining us today, and we look forward to updating you on our performance in January.

Operator: This concludes today's conference. We thank you for your participation. You may disconnect at this time.