Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC  20549
FORM 10-Q
  x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2019
or
  o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Virginia
52-1549373
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
 
 
4991 Lake Brook Drive, Suite 100, Glen Allen, Virginia
23060-9245
(Address of principal executive offices)
(Zip Code)
 
 
(804) 217-5800
(Registrant’s telephone number, including area code) 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes           x           No           o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes           x           No           o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
x
Non-accelerated filer
o 
Smaller reporting company
o
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes           o           No           x


Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, $.01 par value
DX
New York Stock Exchange
8.50% Series A Cumulative Redeemable
Preferred Stock, par value $0.01 per share
DXPRA
New York Stock Exchange
7.625% Series B Cumulative Redeemable
Preferred Stock, par value $0.01 per share
DXPRB
New York Stock Exchange
On April 30, 2019, the registrant had 73,763,826 shares outstanding of common stock, $0.01 par value, which is the registrant’s only class of common stock.


DYNEX CAPITAL, INC.
FORM 10-Q
INDEX

 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheets as of March 31, 2019 (unaudited) and December 31, 2018
 
 
 
 
 
 
Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2019 (unaudited) and March 31, 2018 (unaudited)
 
 
 
 
 
 
Consolidated Statements of Shareholders' Equity for the three months ended March 31, 2019 and March 31, 2018 (unaudited)
 
 
 
 
 
 
Consolidated Statements of Cash Flows for the three months ended March 31, 2019 (unaudited) and March 31, 2018 (unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




i

PART I.        FINANCIAL INFORMATION
ITEM 1.    FINANCIAL STATEMENTS

DYNEX CAPITAL, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands except share data)
 
March 31, 2019
 
December 31, 2018
ASSETS
(unaudited)
 

Mortgage-backed securities (including pledged of $4,547,769 and $3,511,604 respectively)
$
4,842,447

 
$
3,749,464

Mortgage loans held for investment, net
10,862

 
11,527

Cash and cash equivalents
55,902

 
34,598

Restricted cash
86,761

 
54,106

Derivative assets
6,030

 
6,563

Accrued interest receivable
26,075

 
21,019

Other assets, net
7,056

 
8,812

Total assets
$
5,035,133

 
$
3,886,089

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY


 
 

Liabilities:
 

 
 

Repurchase agreements
$
4,252,893

 
$
3,267,984

Payable for unsettled securities
151,075

 
58,915

Non-recourse collateralized financing
3,219

 
3,458

Derivative liabilities
—

 
1,218

Accrued interest payable
12,939

 
10,308

Accrued dividends payable
6,927

 
13,810

Other liabilities
3,406

 
3,243

 Total liabilities
4,430,459

 
3,358,936

 


 
 
Shareholders’ equity:
 

 
 

Preferred stock, par value $.01 per share; 50,000,000 shares authorized; 6,168,062 and 5,954,594 shares issued and outstanding, respectively ($154,202 and $148,865 aggregate liquidation preference, respectively)
$
147,898

 
$
142,883

Common stock, par value $.01 per share, 200,000,000 shares authorized;
72,248,146 and 62,817,218 shares issued and outstanding, respectively
722

 
628

Additional paid-in capital
872,010

 
818,442

Accumulated other comprehensive income (loss)
50,688

 
(35,779
)
Accumulated deficit
(466,644
)
 
(399,021
)
 Total shareholders’ equity
604,674

 
527,153

 Total liabilities and shareholders’ equity
$
5,035,133

 
$
3,886,089

See notes to the unaudited consolidated financial statements.

1

DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited)
 (amounts in thousands except per share data)
 
Three Months Ended
 
March 31,
 
2019
 
2018
Interest income
$
39,957

 
$
25,190

Interest expense
26,276

 
11,595

  Net interest income
13,681

 
13,595

 
 
 


(Loss) gain on derivative instruments, net
(61,697
)
 
38,354

Loss on sale of investments, net
—

 
(3,775
)
Fair value adjustments, net
(13
)
 
29

Other operating expense, net
(231
)
 
(253
)
General and administrative expenses:
 
 
 
Compensation and benefits
(1,898
)
 
(1,962
)
Other general and administrative
(2,056
)
 
(1,681
)
Net (loss) income
(52,214
)
 
44,307

Preferred stock dividends
(3,059
)
 
(2,940
)
Net (loss) income to common shareholders
$
(55,273
)
 
$
41,367

 
 
 
 
Other comprehensive income:
 
 
 
Unrealized gain (loss) on available-for-sale investments, net
$
86,632

 
$
(49,189
)
Reclassification adjustment for loss on sale of investments, net
—

 
3,775

Reclassification adjustment for de-designated cash flow hedges
(165
)
 
(48
)
Total other comprehensive income (loss)
86,467

 
(45,462
)
Comprehensive income (loss) to common shareholders
$
31,194

 
$
(4,095
)
 
 
 
 
Net (loss) income per common share-basic and diluted
$
(0.81
)
 
$
0.74

Weighted average common shares-basic and diluted
68,435

 
55,871

See notes to the unaudited consolidated financial statements.

2

DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(unaudited)
($ in thousands)
 
Preferred Stock
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Loss
 
Accumulated
Deficit
 
Total Shareholders’ Equity
 
Shares
Amount
Shares
Amount
Balance as of
December 31, 2017
5,888,680

$
141,294

 
55,831,549

$
558

 
$
775,873

 
$
(8,697
)
 
$
(351,970
)
 
$
557,058

Stock issuance
20,319

494

 
45,401

1

 
293

 
—

 
—

 
788

Restricted stock granted, net of amortization
—

—

 
176,233

2

 
333

 
—

 
—

 
335

Adjustments for tax withholding on share-based compensation
—

—

 
(57,135
)
(1
)
 
(363
)
 
—

 
—

 
(364
)
Stock issuance costs
—

—

 
—

—

 
(19
)
 
—

 
—

 
(19
)
Net income
—

—

 
—

—

 
—

 
—

 
44,307

 
44,307

Dividends on preferred stock
—

—

 
—

—

 
—

 
—

 
(2,940
)
 
(2,940
)
Dividends on common stock
—

—

 
—

—

 
—

 
—

 
(10,079
)
 
(10,079
)
Other comprehensive loss
—

—

 
—

—

 
—

 
(45,462
)
 
—

 
(45,462
)
Balance as of
March 31, 2018
5,908,999

$
141,788

 
55,996,048

$
560

 
$
776,117

 
$
(54,159
)
 
$
(320,682
)
 
$
543,624

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of
December 31, 2018
5,954,594

$
142,883


62,817,218

$
628

 
$
818,442

 
$
(35,779
)
 
$
(399,021
)
 
$
527,153

Stock issuance
213,468

5,015

 
9,327,139

93

 
53,779

 
—

 
—

 
58,887

Restricted stock granted, net of amortization
—

—

 
152,462

2

 
296

 
—

 
—

 
298

Adjustments for tax withholding on share-based compensation
—

—

 
(48,693
)
(1
)
 
(295
)
 
—

 
—

 
(296
)
Stock issuance costs
—

—

 
—

—

 
(212
)
 
—

 
—

 
(212
)
Net loss
—

—

 
—

—

 
—

 
—

 
(52,214
)
 
(52,214
)
Dividends on preferred stock
—

—

 
—

—

 
—

 
—

 
(3,059
)
 
(3,059
)
Dividends on common stock
—

—

 
—

—

 
—

 
—

 
(12,350
)
 
(12,350
)
Other comprehensive income
—

—

 
—

—

 
—

 
86,467

 
—

 
86,467

Balance as of
March 31, 2019
6,168,062

$
147,898

 
72,248,126

$
722

 
$
872,010

 
$
50,688

 
$
(466,644
)
 
$
604,674


See notes to the unaudited consolidated financial statements.

3

DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
($ in thousands)
 
Three Months Ended
 
March 31,
 
2019
 
2018
Operating activities:
 
 
 
Net (loss) income
$
(52,214
)
 
$
44,307

Adjustments to reconcile net (loss) income to cash provided by operating activities:
 

 
 

Increase in accrued interest receivable
(5,056
)
 
(3,094
)
Increase in accrued interest payable
2,631

 
1,389

Loss (gain) on derivative instruments, net
61,697

 
(38,354
)
Loss on sale of investments, net
—

 
3,775

Fair value adjustments, net
13

 
(29
)
Amortization of investment premiums, net
31,083

 
35,769

Other amortization and depreciation, net
222

 
312

Stock-based compensation expense
298

 
335

Change in other assets and liabilities, net
1,625

 
(2,514
)
Net cash and cash equivalents provided by operating activities
40,299

 
41,896

Investing activities:
 

 
 

Purchase of investments
(1,019,100
)
 
(321,348
)
Principal payments received on investments
73,817

 
51,972

Proceeds from sales of investments
—

 
154,613

Principal payments received on mortgage loans held for investment, net
646

 
649

Net (payments) receipts on derivatives, including terminations
(62,382
)
 
36,271

Other investing activities
(102
)
 
(67
)
Net cash and cash equivalents used in investing activities
(1,007,121
)
 
(77,910
)
Financing activities:
 

 
 

Borrowings under repurchase agreements
32,608,826

 
27,508,732

Repayments of repurchase agreement borrowings
(31,623,917
)
 
(27,460,742
)
Principal payments on non-recourse collateralized financing
(242
)
 
(234
)
Proceeds from issuance of preferred stock
5,015

 
494

Proceeds from issuance of common stock
53,872

 
294

Cash paid for stock issuance costs
(185
)
 
—

Payments related to tax withholding for stock-based compensation
(296
)
 
(364
)
Dividends paid
(22,292
)
 
(12,982
)
Net cash and cash equivalents provided by financing activities
1,020,781

 
35,198

 
 
 
 
Net increase (decrease) in cash, cash equivalents, and restricted cash
53,959

 
(816
)
Cash, cash equivalents, and restricted cash at beginning of period
88,704

 
87,200

Cash, cash equivalents, and restricted cash at end of period
$
142,663

 
$
86,384

Supplemental Disclosure of Cash Activity:
 

 
 

Cash paid for interest
$
23,807

 
$
10,251

See notes to the unaudited consolidated financial statements.

4

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

Dynex Capital, Inc. (“Company”) was incorporated in the Commonwealth of Virginia on December 18, 1987 and commenced operations in February 1988. The Company primarily earns income from investing on a leveraged basis in debt securities, the majority of which are specified pools of Agency and non-Agency mortgage-backed securities (“MBS”) consisting of residential MBS (“RMBS”), commercial MBS (“CMBS”) and CMBS interest-only (“IO”) securities that are issued or guaranteed by U.S. Government sponsored agencies (“Agency MBS”) and MBS issued by others (“non-Agency MBS”). The Company also invests in other types of mortgage-related securities, such as to-be-announced securities (“TBAs” or “TBA securities”).

Basis of Presentation

The accompanying unaudited consolidated financial statements of Dynex Capital, Inc. and its subsidiaries (together, “Dynex” or, as appropriate, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to the Quarterly Report on Form 10-Q and Article 10, Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all significant adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of the consolidated financial statements have been included. Operating results for the three months ended March 31, 2019 are not necessarily indicative of the results that may be expected for any other interim periods or for the entire year ending December 31, 2019. The unaudited consolidated financial statements included herein should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Form 10-K”) filed with the SEC.

Consolidation and Variable Interest Entities
 
The consolidated financial statements include the accounts of the Company and the accounts of its majority owned subsidiaries and variable interest entities (“VIE”) for which it is the primary beneficiary. All intercompany accounts and transactions have been eliminated in consolidation.

The Company consolidates a VIE if the Company is determined to be the VIE’s primary beneficiary, which is defined as the party that has both: (i) the power to control the activities that most significantly impact the VIE’s financial performance and (ii) the right to receive benefits or absorb losses that could potentially be significant to the VIE. The Company reconsiders its evaluation of whether to consolidate a VIE on an ongoing basis, based on changes in the facts and circumstances pertaining to the VIE.

The Company consolidates a securitization trust, which has residential mortgage loans included in “mortgage loans held for investment, net” on its consolidated balance sheet, of which a portion is pledged as collateral for one remaining bond recorded as “non-recourse collateralized financing” on its consolidated balance sheet. The Company owns the subordinate class in the trust and has been deemed the primary beneficiary.

Though the Company invests in Agency and non-Agency MBS which are generally considered to be interests in VIEs, the Company does not consolidate these entities because it does not meet the criteria necessary to be deemed a primary beneficiary. Please refer to Note 2 for financial information regarding the Company’s investments in these debt securities.

Use of Estimates
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenue and expenses during the reported period. Actual results could differ from those estimates. The most significant estimates used by management include, but are not limited to,

5

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


amortization of premiums and discounts, fair value measurements of its investments, and other-than-temporary impairments. These items are discussed further below within this note to the consolidated financial statements.

Income Taxes

The Company has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986 and the corresponding provisions of state law. To qualify as a REIT, the Company must meet certain tests including investing in primarily real estate-related assets and the required distribution of at least 90% of its annual REIT taxable income to stockholders after consideration of its net operating loss (“NOL”) carryforward and not including taxable income retained in its taxable subsidiaries. As a REIT, the Company generally will not be subject to federal income tax on the amount of its income or capital gains that is distributed as dividends to shareholders.

The Company assesses its tax positions for all open tax years and determines whether the Company has any material unrecognized liabilities in accordance with Accounting Standards Codification (“ASC”) Topic 740. The Company records these liabilities, if any, to the extent they are deemed more likely than not to have been incurred.

Net Income (Loss) Per Common Share

The Company calculates basic net income per common share by dividing net income to common shareholders for the period by weighted-average shares of common stock outstanding for that period. The Company did not have any potentially dilutive securities outstanding during the three months ended March 31, 2019 or March 31, 2018.

Holders of unvested shares of the Company’s issued and outstanding restricted common stock are eligible to receive non-forfeitable dividends. As such, these unvested shares are considered participating securities as per ASC Topic 260-10 and therefore are included in the computation of basic net income per common share using the two-class method. Upon vesting, restrictions on transfer expire on each share of restricted stock, and each such share of restricted stock represents one unrestricted share of common stock.

Because the Company’s 8.50% Series A Cumulative Redeemable Preferred Stock (the “Series A Preferred Stock”) and 7.625% Series B Cumulative Redeemable Preferred Stock (the “Series B Preferred Stock”) are redeemable at the Company’s option for cash only and may convert into shares of common stock only upon a change of control of the Company, the effect of those shares and their related dividends is excluded from the calculation of diluted net income per common share.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less.

Restricted Cash

Restricted cash consists of cash the Company has pledged to cover initial and variation margin with its financing and derivative counterparties.

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported on the Company's consolidated balance sheet as of March 31, 2019 that sum to the total of the same such amounts shown on the Company’s consolidated statement of cash flows for the three months ended March 31, 2019:
 
 
March 31, 2019
Cash and cash equivalents
 
$
55,902

Restricted cash
 
86,761

Total cash, cash equivalents, and restricted cash shown on consolidated statement of cash flows
 
$
142,663



6

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


Investments in Debt Securities
 
The Company’s investments in debt securities are designated as available-for-sale (“AFS”) and are recorded at fair value on the Company’s consolidated balance sheet. Changes in unrealized gain (loss) on the Company’s debt securities are reported in other comprehensive income (“OCI”) until the investment is sold, matures, or is determined to be other than temporarily impaired. Although the Company generally intends to hold its AFS securities until maturity, it may sell any of these securities as part of the overall management of its business. Upon the sale of an AFS security, any unrealized gain or loss is reclassified out of accumulated other comprehensive income (“AOCI”) into net income as a realized “gain (loss) on sale of investments, net” using the specific identification method.

The fair value of the Company’s debt securities pledged as collateral against repurchase agreements and derivative instruments is disclosed parenthetically on the Company’s consolidated balance sheets.

Interest Income, Premium Amortization, and Discount Accretion. Interest income on debt securities is accrued based on the outstanding principal balance (or notional balance in the case of interest-only, or “IO”, securities) and their contractual terms. Premiums or discounts associated with the purchase of Agency MBS as well as any non-Agency MBS rated ‘AA’ and higher are amortized or accreted into interest income over the expected life of such securities using the effective yield method, and adjustments to premium amortization and discount accretion are made for actual cash payments. The Company may also adjust premium amortization and discount accretion for changes in projected future cash payments. The Company’s projections of future cash payments are based on input and analysis received from external sources and internal models and include assumptions about the amount and timing of loan prepayment rates, fluctuations in interest rates, credit losses, and other factors. On at least a quarterly basis, the Company reviews and makes any necessary adjustments to its cash flow projections and updates the yield recognized on these assets. The Company does not estimate future prepayments on its fixed-rate Agency RMBS.

The Company holds certain non-Agency MBS that had credit ratings of less than ‘AA’ at the time of purchase or were not rated by any of the nationally recognized credit rating agencies. A portion of these non-Agency MBS were purchased at discounts to their par value, which management does not believe to be substantial. The discount is accreted into income over the security’s expected life based on management’s estimate of the security’s projected cash flows. Future changes in the timing of projected cash flows or differences arising between projected cash flows and actual cash flows received may result in a prospective change in the effective yield on those securities.

Determination of MBS Fair Value. The Company estimates the fair value of the majority of its MBS based upon prices obtained from third-party pricing services and broker quotes. The remainder of the Company’s MBS are valued by discounting the estimated future cash flows derived from cash flow models that utilize information such as the security’s coupon rate, estimated prepayment speeds, expected weighted average life, collateral composition, estimated future interest rates, expected losses, and credit enhancements as well as certain other relevant information. Refer to Note 5 for further discussion of MBS fair value measurements.

Other-than-Temporary Impairment. An MBS is considered impaired when its fair value is less than its amortized cost. The Company evaluates all of its impaired MBS for other-than-temporary impairments (“OTTI”) on at least a quarterly basis. An impairment is considered other-than-temporary if: (1) the Company intends to sell the MBS; (2) it is more likely than not that the Company will be required to sell the MBS before its fair value recovers; or (3) the Company does not expect to recover the full amortized cost basis of the MBS. If either of the first two conditions is met, the entire amount of the impairment is recognized in earnings. If the impairment is solely due to the inability to fully recover the amortized cost basis, the security is further analyzed to quantify any credit loss, which is the difference between the present value of cash flows expected to be collected on the MBS and its amortized cost. The credit loss, if any, is then recognized in earnings, while the balance of impairment related to other factors is recognized in other comprehensive income.

Following the recognition of an OTTI through earnings, a new cost basis is established for the security. Any subsequent recoveries in fair value may be accreted back into the amortized cost basis of the MBS on a prospective basis through interest income. Please see Note 2 for additional information related to the Company’s evaluation for OTTI.

Repurchase Agreements
 

7

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


The Company’s repurchase agreements, which are used to finance its purchases of debt securities, are accounted for as secured borrowings under which the Company pledges its securities as collateral to secure a loan, which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. The Company retains beneficial ownership of the pledged collateral. At the maturity of a repurchase agreement, the Company is required to repay the loan and concurrently receives back its pledged collateral from the lender or, with the consent of the lender, the Company may renew the agreement at the then prevailing financing rate. A repurchase agreement lender may require the Company to pledge additional collateral in the event of a decline in the fair value of the collateral pledged. Repurchase agreement financing is recourse to the Company and the assets pledged. Most of the Company’s repurchase agreements are based on the September 1996 version of the Bond Market Association Master Repurchase Agreement, which generally provides that the lender, as buyer, is responsible for obtaining collateral valuations from a generally recognized source agreed to by both the Company and the lender, or, in an instance when such source is not available, the value determination is made by the lender.

Derivative Instruments

The Company’s derivative instruments generally include interest rate swaps, futures, and forward contracts for the purchase or sale of non-specified Agency RMBS, commonly referred to as “TBA securities” or “TBA contracts”. Derivative instruments are accounted for at the fair value of their unit of account. Derivative instruments in a gain position are reported as derivative assets and derivative instruments in a loss position are reported as derivative liabilities on the Company’s consolidated balance sheet. All periodic interest benefits/costs and changes in fair value of derivative instruments, including gains and losses realized upon termination, maturity, or settlement are recorded in “gain (loss) on derivative instruments, net” on the Company’s consolidated statement of comprehensive income. Cash receipts and payments related to derivative instruments are classified in the investing activities section of the consolidated statements of cash flows in accordance with the underlying nature or purpose of the derivative transactions.

The Company’s interest rate swap agreements are privately negotiated in the over-the-counter (“OTC”) market and the majority of these agreements are centrally cleared through the Chicago Mercantile Exchange (“CME”) with the rest being subject to bilateral agreements between the Company and the swap counterparty. The Company’s CME cleared swaps require that the Company post initial margin as determined by the CME, and in addition, variation margin is exchanged, typically in cash, for changes in the fair value of the CME cleared swaps. The exchange of variation margin for CME cleared swaps is legally considered to be the settlement of the derivative itself as opposed to a pledge of collateral. Accordingly, the Company accounts for the daily exchange of variation margin associated with its CME cleared interest rate swaps as a direct increase or decrease to the carrying value of the related derivative asset or liability. The carrying value of derivative instruments on the Company’s consolidated balance sheets is the unsettled fair value of the instruments subject to bilateral agreements and not centrally cleared through the CME.

A TBA security is a forward contract (“TBA contract”) for the purchase (“long position”) or sale (“short position”) of a non-specified Agency MBS at a predetermined price with certain principal and interest terms and certain types of collateral, but the particular Agency securities to be delivered are not identified until shortly before the settlement date. The Company accounts for long and short positions in TBAs as derivative instruments because the Company cannot assert that it is probable at inception and throughout the term of an individual TBA transaction that its settlement will result in physical delivery of the underlying Agency RMBS, or the individual TBA transaction will not settle in the shortest time period possible.

Please refer to Note 4 for additional information regarding the Company’s derivative instruments as well as Note 5 for information on how the fair value of these instruments are calculated.


8

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


Share-Based Compensation

Pursuant to the Company’s 2018 Stock and Incentive Plan (“2018 Plan”), the Company may grant share-based compensation to eligible employees, non-employee directors or consultants or advisors to the Company, including restricted stock awards, stock options, stock appreciation rights, performance units, restricted stock units, and performance cash awards. The Company’s restricted stock currently issued and outstanding may be settled only in shares of its common stock, and therefore are treated as equity awards with their fair value measured at the grant date and recognized as compensation cost over the requisite service period with a corresponding credit to shareholders’ equity. The requisite service period is the period during which a participant is required to provide service in exchange for an award, which is equivalent to the vesting period specified in the terms of the time-based restricted stock award. None of the Company’s restricted stock awards have performance-based conditions. The Company does not currently have any share-based compensation issued or outstanding other than restricted stock issued to its employees, officers, and directors.

Contingencies

In the normal course of business, there may be various lawsuits, claims, and other contingencies pending against the Company. On a quarterly basis, the Company evaluates whether to establish provisions for estimated losses from those matters. The Company recognizes a liability for a contingent loss when: (a) the underlying causal event has occurred prior to the balance sheet date; (b) it is probable that a loss has been incurred; and (c) there is a reasonable basis for estimating that loss. A liability is not recognized for a contingent loss when it is only possible or remotely possible that a loss has been incurred, however, possible contingent losses shall be disclosed. If the contingent loss (or an additional loss in excess of any accrual) is at least a reasonable possibility and material, then the Company discloses a reasonable estimate of the possible loss or range of loss, if such reasonable estimate can be made. If the Company cannot make a reasonable estimate of the possible material loss, or range of loss, then that fact is disclosed.

Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, Financial Instruments - Credit Losses, which replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. For assets measured at amortized cost, the amendments in this ASU eliminate the probable initial recognition threshold in current GAAP and broaden the information that an entity must consider in developing its expected credit loss estimate to include the use of forecasted information. For assets classified as available-for-sale with changes in fair value recorded in other comprehensive income, measurement of credit losses will be similar to current GAAP. However, the amendments in this ASU require that credit losses be presented as an allowance rather than as a write-down, which is referred to in current GAAP as an other-than-temporary impairment. An entity will be able to record reversals of credit losses, if credit loss estimates decline, in net income for the current period. The amendments in this ASU will not permit an entity to use the length of time a debt security has been in an unrealized loss position to avoid recording a credit loss and removes the requirements to consider historical and implied volatility of the fair value of a security as well as recoveries or declines in fair value after the balance sheet date. The amendments in this ASU will affect an entity by varying degrees depending on a number of factors, including but not limited to, the credit quality of the assets held by the entity, their duration, and how the entity applies current GAAP. These amendments will become effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. An entity will apply the amendments in this ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. Though the Company has not fully completed evaluating the impact this ASU will have on its financial condition and results of operations, the Company does not expect it will have a material impact given that the majority of its investments are Agency MBS.

NOTE 2 – INVESTMENTS IN DEBT SECURITIES
 
The majority of the Company’s debt securities are pledged as collateral for the Company’s repurchase agreements. The following tables present the Company’s debt securities by investment type (including securities pending settlement) as of the dates indicated:

9

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


 
March 31, 2019
 
Par
 
Net Premium (Discount)
 
Amortized Cost
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Fair Value
 
WAC (1)
RMBS:
 
 
 
 


 
 
 
 
 
 
 
 
Agency
$
2,683,276

 
$
77,584

 
$
2,760,860

 
$
31,813

 
$
(11,403
)
 
$
2,781,270

 
4.04
%
Non-Agency
803

 
—

 
803

 
27

 
(21
)
 
809

 
6.75
%
 
2,684,079

 
77,584

 
2,761,663

 
31,840

 
(11,424
)
 
2,782,079

 
 
CMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency
1,507,835

 
10,775

 
1,518,610

 
30,766

 
(9,864
)
 
1,539,512

 
3.23
%
Non-Agency
2,910

 
(1,927
)
 
983

 
677

 
—

 
1,660

 
6.27
%
 
1,510,745

 
8,848

 
1,519,593

 
31,443

 
(9,864
)
 
1,541,172

 
 
CMBS IO (2):
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency
—

 
282,636

 
282,636

 
5,982

 
(154
)
 
288,464

 
0.53
%
Non-Agency
—

 
227,868

 
227,868

 
3,249

 
(385
)
 
230,732

 
0.56
%
 
—

 
510,504

 
510,504

 
9,231

 
(539
)
 
519,196

 
 
 
 
 
 
 
 
 
 
 
 
 


 


Total AFS securities:
$
4,194,824

 
$
596,936

 
$
4,791,760

 
$
72,514

 
$
(21,827
)
 
$
4,842,447

 
 
(1)
The weighted average coupon (“WAC”) is the gross interest rate of the security weighted by the outstanding principal balance (or by notional balance in the case of an IO security).
(2)
The notional balance for Agency CMBS IO and non-Agency CMBS IO was $13,146,249 and $10,158,055 respectively, as of March 31, 2019.
 
December 31, 2018
 
Par
 
Net Premium (Discount)
 
Amortized Cost
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Fair Value
 
WAC (1)
RMBS:
 
 
 
 


 
 
 


 
 
 
 
Agency
$
2,118,639

 
$
56,744

 
$
2,175,383

 
$
8,902

 
$
(26,264
)
 
$
2,158,021

 
3.95
%
Non-Agency
856

 
—

 
856

 
24

 
(22
)
 
858

 
6.75
%
 
2,119,495

 
56,744

 
2,176,239

 
8,926

 
(26,286
)
 
2,158,879

 
 
CMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency
1,071,906

 
8,518

 
1,080,424

 
6,141

 
(29,550
)
 
1,057,015

 
3.22
%
Non-Agency
3,040

 
(2,037
)
 
1,003

 
413

 
—

 
1,416

 
6.47
%
 
1,074,946

 
6,481

 
1,081,427

 
6,554

 
(29,550
)
 
1,058,431

 
 
CMBS IO (2):
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency
—

 
287,062

 
287,062

 
4,281

 
(239
)
 
291,104

 
0.55
%
Non-Agency
—

 
240,681

 
240,681

 
1,675

 
(1,306
)
 
241,050

 
0.57
%
 
—

 
527,743

 
527,743

 
5,956

 
(1,545
)
 
532,154

 
 



 
 
 


 


 
 
 


 
 
Total AFS securities:
$
3,194,441

 
$
590,968

 
$
3,785,409

 
$
21,436

 
$
(57,381
)
 
$
3,749,464

 


(1)
The WAC is the gross interest rate of the security weighted by the outstanding principal balance (or by notional balance in the case of an IO security).
(2)
The notional balance for the Agency CMBS IO and non-Agency CMBS IO was $13,048,666 and $10,275,494, respectively, as of December 31, 2018.


10

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


Actual maturities of MBS are affected by the contractual lives of the underlying mortgage collateral, periodic payments of principal, prepayments of principal, and the payment priority structure of the security; therefore, actual maturities are generally shorter than the securities' stated contractual maturities. The following table categorizes the Company’s debt securities according to their stated maturity as of the dates indicated:
 
March 31, 2019
 
December 31, 2018
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Less than 1 year
$
119,121

 
$
121,882

 
$
39,868

 
$
39,808

>1 and <5 years
151,888

 
154,615

 
151,041

 
152,917

>5 and <10 years
911,278

 
910,315

 
828,543

 
806,015

> 10 years
3,609,473

 
3,655,635

 
2,765,957

 
2,750,724

 
$
4,791,760

 
$
4,842,447

 
$
3,785,409

 
$
3,749,464


The following table presents information regarding the sales that generated the “loss on sale of investments, net” on the Company’s consolidated statements of comprehensive income (loss) for the periods indicated:
 
Three Months Ended
 
March 31,
 
2019
 
2018
 
Proceeds Received
 
Realized Gain (Loss)
 
Proceeds Received
 
Realized Gain (Loss)
Agency CMBS
—

 
—

 
$
108,758

 
$
(2,052
)
U.S. Treasuries
—

 
—

 
46,498

 
(1,723
)

$
—

 
$
—

 
$
155,256

 
$
(3,775
)

The following table presents certain information for the AFS securities in an unrealized loss position as of the dates indicated:
 
March 31, 2019
 
December 31, 2018
 
Fair Value
 
Gross Unrealized Losses
 
# of Securities
 
Fair Value
 
Gross Unrealized Losses
 
# of Securities
Continuous unrealized loss position for less than 12 months:
 
 
 
 
 
 
 
 
 
 
 
Agency MBS
$
46,127

 
$
(174
)
 
9
 
$
581,440

 
$
(1,793
)
 
28
Non-Agency MBS
25,130

 
(177
)
 
7
 
70,876

 
(581
)
 
22
 
 
 
 
 
 
 
 
 
 
 
 
Continuous unrealized loss position for 12 months or longer:
 
 
 
 
 
 
 
 
 
 
 
Agency MBS
$
1,293,417

 
$
(21,248
)
 
61
 
$
1,543,892

 
$
(54,260
)
 
88
Non-Agency MBS
21,512

 
(228
)
 
13
 
46,154

 
(747
)
 
19

Because the principal related to Agency MBS is guaranteed by the government-sponsored entities Fannie Mae and Freddie Mac which have AAA ratings due to the Treasury’s commitment of capital under the Senior Preferred Stock Purchase Agreement, the Company does not consider any of the unrealized losses on its Agency MBS to be credit related. Although the unrealized losses are not credit related, the Company assesses its ability and intent to hold any Agency MBS with an unrealized loss until the recovery in its value in accordance with GAAP. This assessment is based on the amount of the unrealized loss and significance of the related investment as well as the Company’s leverage and liquidity position. Based on this analysis, the

11

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


Company has determined that the unrealized losses on its Agency MBS as of March 31, 2019 and December 31, 2018 were temporary.

The Company reviews any non-Agency MBS in an unrealized loss position to evaluate whether any decline in fair value represents an OTTI. The evaluation includes a review of the credit ratings of the non-Agency MBS, the credit characteristics of the mortgage loans collateralizing these securities, and the estimated future cash flows including projected collateral losses. The Company also assesses its ability and intent to hold any non-Agency MBS with an unrealized loss until the recovery in its value in accordance with GAAP. The Company performed this evaluation for its non-Agency MBS in an unrealized loss position and has determined that there have not been any adverse changes in the timing or amount of estimated future cash flows that necessitate a recognition of OTTI amounts as of March 31, 2019 or December 31, 2018.

NOTE 3 – REPURCHASE AGREEMENTS
    
The Company’s repurchase agreements outstanding as of March 31, 2019 and December 31, 2018 are summarized in the following tables:
 
 
March 31, 2019
 
December 31, 2018
Collateral Type
 
Balance
 
Weighted
Average Rate
 
Fair Value of
Collateral Pledged
 
Balance
 
Weighted
Average Rate
 
Fair Value of
Collateral Pledged
Agency RMBS
 
$
2,582,697

 
2.75
%
 
$
2,719,705

 
$
1,887,878

 
2.66
%
 
$
1,998,922

Agency CMBS
 
1,220,326

 
2.68
%
 
1,304,731

 
919,833

 
2.51
%
 
986,861

Agency CMBS IO
 
253,168

 
3.05
%
 
282,927

 
253,258

 
2.96
%
 
285,247

Non-Agency CMBS IO
 
196,702

 
3.39
%
 
230,244

 
207,015

 
3.38
%
 
240,574

Total repurchase agreements
 
$
4,252,893

 
2.78
%
 
$
4,537,607

 
$
3,267,984

 
2.69
%
 
$
3,511,604


The Company also had $151,075 and $58,915 payable to counterparties as of March 31, 2019 and December 31, 2018, respectively, which consisted of securities pending settlement as of those respective dates.

The following table provides information on the remaining term to maturity and original term to maturity for the Company’s repurchase agreements as of the dates indicated:
 
 
March 31, 2019
 
December 31, 2018
Remaining Term to Maturity
 
Balance
 
WAVG Original Term to Maturity
 
Balance
 
WAVG Original Term to Maturity
Less than 30 days
 
$
3,459,566

 
52

 
$
2,319,911

 
56

30 to 90 days
 
793,327

 
82

 
948,073

 
89

Total
 
$
4,252,893

 
58

 
$
3,267,984

 
66


The following table lists the counterparties with whom the Company had approximately 10% or more of its shareholders’ equity at risk (defined as the excess of collateral pledged over the borrowings outstanding) as of the date indicated:
 
 
March 31, 2019
Counterparty Name
 
Balance
 
Weighted Average Rate
 
Equity at Risk
Wells Fargo Bank, N. A. and affiliates
 
$
357,111

 
3.56
%
 
$
43,381

    
Of the amount outstanding with Wells Fargo Bank, N.A. and affiliates, $212,631 is under a committed repurchase facility which has an aggregate maximum borrowing capacity of $400,000 and is scheduled to mature on May 12, 2019, subject

12

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


to early termination provisions contained in the master repurchase agreement. The facility is collateralized by CMBS IO, and its weighted average borrowing rate as of March 31, 2019 was 3.32%.

As of March 31, 2019, the Company had repurchase agreement amounts outstanding with 19 of its 36 available repurchase agreement counterparties. The Company’s counterparties, as set forth in the master repurchase agreement with the counterparty, require the Company to comply with various customary operating and financial covenants, including, but not limited to, minimum net worth and earnings, maximum declines in net worth in a given period, and maximum leverage requirements as well as maintaining the Company’s REIT status. In addition, some of the agreements contain cross default features, whereby default under an agreement with one lender simultaneously causes default under agreements with other lenders. To the extent that the Company fails to comply with the covenants contained in these financing agreements or is otherwise found to be in default under the terms of such agreements, the counterparty has the right to accelerate amounts due under the master repurchase agreement. The Company was in full compliance with all covenants as of March 31, 2019.

The Company's repurchase agreements are subject to underlying agreements with master netting or similar arrangements, which provide for the right of offset in the event of default or in the event of bankruptcy of either party to the transactions. The Company reports its repurchase agreements to these arrangements on a gross basis. The following tables present information regarding the Company's repurchase agreements as if the Company had presented them on a net basis as of March 31, 2019 and December 31, 2018:
 
Gross Amount of Recognized Liabilities
 
Gross Amount Offset in the Balance Sheet
 
Net Amount of Liabilities Presented in the Balance Sheet
 
Gross Amount Not Offset in the Balance Sheet (1)
 
Net Amount
Financial Instruments Posted as Collateral
 
Cash Posted as Collateral
March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
4,252,893

 
$
—

 
$
4,252,893

 
$
(4,252,893
)
 
$
—

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
3,267,984

 
$
—

 
$
3,267,984

 
$
(3,267,984
)
 
$
—

 
$
—

(1)
Amounts disclosed for collateral received by or posted to the same counterparty include cash and the fair value of debt securities up to and not exceeding the net amount of the repurchase agreement liability presented in the balance sheet. The fair value of the total collateral received by or posted to the same counterparty may exceed the amounts presented.

Please see Note 4 for information related to the Company’s derivatives which are also subject to underlying agreements with master netting or similar arrangements.

NOTE 4 – DERIVATIVES

     The Company is a party to certain types of financial instruments that are accounted for as derivative instruments. Please refer to Note 1 for information related to the Company’s accounting policy for its derivative instruments.

Types and Uses of Derivatives Instruments
Interest Rate Derivatives. Changing interest rates impact the fair value of the Company’s investments as well as the interest rates on the Company’s repurchase agreement borrowings used to finance its investments. The Company primarily uses interest rate swaps as economic hedges to mitigate declines in book value and to protect some portion of the Company's earnings from rising interest rates. The Company may also periodically utilize other types of interest rate derivatives, such as Eurodollar and U.S. Treasury futures as economic hedges.
TBA Transactions. The Company also holds long positions in TBA securities by executing a series of transactions which effectively delay the settlement of a forward purchase of a non-specified Agency RMBS by entering into an offsetting TBA short position, net settling the paired-off positions in cash, and simultaneously entering into an identical TBA long position with a later settlement date. These long positions in TBA securities (“dollar roll positions”) are viewed by management as economically

13

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


equivalent to investing in and financing non-specified fixed-rate Agency RMBS. TBA securities purchased for a forward settlement month are generally priced at a discount relative to TBA securities sold for settlement in the current month. This discount, often referred to as “drop income” represents the economic equivalent of net interest income (interest income less implied financing cost) on the underlying Agency security from trade date to settlement date.
Periodically, the Company may also hold short positions in TBA securities for the purpose of economically hedging a portion of the impact of changing interest rates on the fair value of the Company’s fixed-rate Agency RMBS. The Company did not hold any short positions in TBA securities as of March 31, 2019.
The table below summarizes information about the fair value by type of derivative instrument on the Company’s consolidated balance sheets as of the dates indicated:  
Type of Derivative Instrument
 
Balance Sheet Location
 
Purpose
 
March 31, 2019
 
December 31, 2018
Interest rate swaps
 
Derivative assets
 
Economic hedging
 
$
112

 
$
324

TBA securities
 
Derivative assets
 
Trading
 
5,918

 
6,239

 
 
 
 
 
 
$
6,030

 
$
6,563

 
 
 
 
 
 
 
 
 
U.S. Treasury futures
 
Derivative liabilities
 
Economic hedging
 
$
—

 
$
(1,218
)

The table below provides detail of the Company’s “(loss) gain on derivative instruments, net” by type of derivative for the periods indicated:
 
 
Three Months Ended
 
 
March 31,
Type of Derivative Instrument
 
2019
 
2018
Receive-fixed interest rate swaps
 
$
—

 
$
(1,129
)
Pay-fixed interest rate swaps
 
(71,764
)
 
49,372

Eurodollar futures
 
—

 
1,905

TBA dollar roll positions
 
10,176

 
(12,087
)
TBA economic hedges
 
—

 
293

U.S. Treasury futures
 
(109
)
 
—

(Loss) gain on derivative instruments, net
 
$
(61,697
)
 
$
38,354






14

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


Interest Rate Swaps

The following tables present information about the Company’s interest rate swaps as of the dates indicated:
 
 
March 31, 2019
 
 
 
 
Weighted-Average:
 
 
Years to Maturity:
 
Notional Amount (1)
 
Pay Rate (2)
 
Life Remaining (in Years)
 
Fair Value (3)
< 3 years
 
$
1,435,000

 
2.01
%
 
1.3
 
$
112

>3 and < 6 years
 
1,930,000

 
2.27
%
 
5.7
 
—

>6 and < 10 years
 
1,530,000

 
2.85
%
 
9.0
 
—

   >10 years
 
120,000

 
2.84
%
 
28.4
 
—

Total
 
$
5,015,000

 
2.38
%
 
6.0
 
$
112

 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
Weighted-Average:
 
 
Years to Maturity:
 
Notional Amount (1)
 
Pay Rate (2)
 
Life Remaining (in Years)
 
Fair Value (3)
< 3 years
 
$
1,560,000

 
1.96
%
 
1.4
 
$
324

>3 and < 6 years
 
1,230,000

 
2.23
%
 
4.4
 
—

>6 and < 10 years
 
1,505,000

 
2.80
%
 
8.3
 
—

   >10 years
 
220,000

 
2.81
%
 
21.9
 
—

Total
 
$
4,515,000

 
2.35
%
 
5.5
 
$
324

(1)
The notional amounts include $0 and $775,000 of forward starting pay-fixed interest rate swaps as of March 31, 2019 and December 31, 2018, respectively.
(2)
Excluding forward starting pay-fixed interest rate swaps, the weighted average pay rate was 2.38% and 2.29% as of March 31, 2019 and December 31, 2018, respectively.
(3)
The majority of the Company’s interest rate swap agreements are centrally cleared through the CME. Please refer to Note 1 for information regarding the exchange of variation margin being legally considered as settlement of the derivative as opposed to a pledge of collateral.

A portion of the Company’s interest rate swaps were entered into under bilateral agreements which contain cross-default provisions with other agreements between the parties. In addition, these bilateral agreements contain financial and operational covenants similar to those contained in the repurchase agreements as described in Note 3. The Company was in compliance with all covenants with respect to bilateral agreements under which interest rate swaps were entered into as of March 31, 2019.

TBA Securities

The following table summarizes information about the Company's TBA securities as of the dates indicated:
 
March 31, 2019
 
December 31, 2018
Implied market value (1)
$
733,130

 
$
888,469

Implied cost basis (2)
727,212

 
882,230

Net carrying value (3)
$
5,918

 
$
6,239

(1)
Implied market value represents the estimated fair value of the underlying Agency MBS as if settled as of the date indicated.
(2)
Implied cost basis represents the forward price to be paid for the underlying Agency MBS as if settled as of the date indicated.

15

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


(3)
Net carrying value is the amount included on the consolidated balance sheets within “derivative assets (liabilities)” and represents the difference between the implied market value and the implied cost basis of the TBA security as of the date indicated.

Volume of Activity

The tables below summarize changes in the Company’s derivative instruments for the periods indicated:
Type of Derivative Instrument
 
Notional Amount as of December 31, 2018
 
Additions
 
Settlements,
Terminations,
or Pair-Offs
 
Notional Amount as of March 31, 2019
Interest rate swaps
 
$
4,515,000

 
$
1,500,000

 
$
(1,000,000
)
 
$
5,015,000

TBA dollar roll positions
 
860,000

 
2,720,000

 
(2,865,000
)
 
715,000

U.S. Treasury futures
 
50,000

 
—

 
(50,000
)
 
—


Offsetting

The Company's derivatives are subject to underlying agreements with master netting or similar arrangements, which provide for the right of offset in the event of default or in the event of bankruptcy of either party to the transactions. The Company reports its derivative assets and liabilities subject to these arrangements on a gross basis. The following tables present information regarding those derivative assets and liabilities subject to such arrangements as if the Company had presented them on a net basis as of March 31, 2019 and December 31, 2018:
 
Offsetting of Assets
 
Gross Amount of Recognized Assets
 
Gross Amount Offset in the Balance Sheet
 
Net Amount of Assets Presented in the Balance Sheet
 
Gross Amount Not Offset in the Balance Sheet (1)
 
Net Amount
Financial Instruments Received as Collateral
 
Cash Received as Collateral
March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
112

 
$
—

 
$
112

 
$
—

 
$
—

 
$
112

TBA securities
5,918

 
—

 
5,918

 
—

 
(1,699
)
 
4,219

Derivative assets
$
6,030

 
$
—

 
$
6,030

 
$
—

 
$
(1,699
)
 
$
4,331

December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
324

 
$
—

 
$
324

 
$
—

 
$
—

 
$
324

TBA securities
6,239

 
—

 
6,239

 
—

 
(1,719
)
 
4,520

Derivative assets
$
6,563

 
$
—

 
$
6,563

 
$
—

 
$
(1,719
)
 
$
4,844



16

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


 
Offsetting of Liabilities
 
Gross Amount of Recognized Liabilities
 
Gross Amount Offset in the Balance Sheet
 
Net Amount of Liabilities Presented in the Balance Sheet
 
Gross Amount Not Offset in the Balance Sheet (1)
 
Net Amount
Financial Instruments Posted as Collateral
 
Cash Posted as Collateral
March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury futures
—

 
—

 
—

 
—

 
—

 
—

Derivative liabilities
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury futures
1,218

 
—

 
1,218

 
—

 
(1,218
)
 
—

Derivative liabilities
$
1,218

 
$
—

 
$
1,218

 
$
—

 
$
(1,218
)
 
$
—

(1)
Amounts disclosed for collateral received by or posted to the same counterparty include cash and the fair value of MBS up to and not exceeding the net amount of the derivative asset or liability presented in the balance sheet. The fair value of the total collateral received by or posted to the same counterparty may exceed the amounts presented. Please refer to the consolidated balance sheets for the total cash posted as collateral, which is recorded as "restricted cash", and the total fair value of financial instruments pledged as collateral for derivatives and repurchase agreements, which is shown parenthetically.
Please see Note 3 for information related to the Company’s repurchase agreements which are also subject to underlying agreements with master netting or similar arrangements.

NOTE 5 – FAIR VALUE OF FINANCIAL INSTRUMENTS
 
ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and also requires an entity to consider all aspects of nonperformance risk, including the entity’s own credit standing, when measuring fair value of a liability. ASC Topic 820 established a valuation hierarchy of three levels as follows:
 
•
Level 1 – Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities as of the measurement date.
•
Level 2 – Inputs include quoted prices in active markets for similar assets or liabilities; quoted prices in inactive markets for identical or similar assets or liabilities; or inputs either directly observable or indirectly observable through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.  
•
Level 3 – Unobservable inputs are supported by little or no market activity. The unobservable inputs represent management’s best estimate of how market participants would price the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.  
    
The following table presents the Company’s financial instruments that are measured at fair value on a recurring basis by their valuation hierarchy levels as of the dates indicated:

17

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


 
March 31, 2019
 
December 31, 2018
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets carried at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
MBS
$
4,842,447

 
$
—

 
$
4,839,977

 
$
2,470

 
$
3,749,464

 
$
—

 
$
3,747,190

 
$
2,274

Derivative assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
112

 
—

 
112

 
—

 
324

 
—

 
324

 
—

TBA securities
5,918

 
—

 
5,918

 
—

 
6,239

 
—

 
6,239

 
—

Total assets carried at fair value
$
4,848,477

 
$
—

 
$
4,846,007

 
$
2,470

 
$
3,756,027

 
$
—

 
$
3,753,753

 
$
2,274

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities carried at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury futures
$
—

 
$
—

 
$
—

 
$
—

 
$
1,218

 
$
1,218

 
$
—

 
$
—

Total liabilities carried at fair value
$
—

 
$
—

 
$
—

 
$
—

 
$
1,218

 
$
1,218

 
$
—

 
$
—


The fair value of interest rate swaps is measured using the income approach with the primary input being the forward interest rate swap curve, which is considered an observable input, and thus their fair values are considered Level 2 measurements. U.S. Treasury futures are valued based on closing exchange prices on these contracts and are classified accordingly as Level 1 measurements. The fair value of TBA securities is estimated using methods similar those used to fair value the Company’s Level 2 MBS.
    
The fair value measurements for a majority of the Company's MBS are considered Level 2 because these securities are substantially similar to securities that either are actively traded or have been recently traded in their respective markets. The Company determines the fair value of its Level 2 securities based on prices received from the Company's primary pricing service as well as other pricing services and brokers. The Company evaluates the third-party prices it receives to assess their reasonableness. Although the Company does not adjust third-party prices, they may be excluded from use in the determination of a security's fair value if they are significantly different from other observable market data. In valuing a security, the primary pricing service uses either a market approach, which uses observable prices and other relevant information that is generated by market transactions of identical or similar securities, or an income approach, which uses valuation techniques to convert future amounts to a single, discounted present value amount. The Company also reviews the assumptions and inputs utilized in the valuation techniques of its primary pricing service. Examples of these observable inputs and assumptions include market interest rates, credit spreads, and projected prepayment speeds, among other things.

The Company owns certain non-Agency MBS for which there are not sufficiently recent trades of substantially similar securities, and their fair value measurements are thus considered Level 3. The Company determines the fair value of its Level 3 securities by discounting the estimated future cash flows derived from cash flow models using significant inputs which are determined by the Company when market observable inputs are not available. Information utilized in those pricing models include the security’s credit rating, coupon rate, estimated prepayment speeds, expected weighted average life, collateral composition, estimated future interest rates, expected credit losses, and credit enhancement as well as certain other relevant information. Significant changes in any of these inputs in isolation may result in a significantly different fair value measurement. Level 3 assets are generally most sensitive to the default rate and severity assumptions.

The activity of the Company’s non-Agency MBS measured at fair value on a recurring basis using Level 3 inputs is presented in the following table for the periods indicated:

18

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)


 
Three Months Ended
 
March 31,
 
2019
 
2018
Balance as of beginning of period
$
2,274

 
$
7,243

Unrealized gain included in OCI
268

 
(310
)
Principal payments
(183
)
 
(361
)
Accretion
111

 
311

Balance as of end of period
$
2,470

 
$
6,883


The Company reviews the classification of its financial instruments within the fair value hierarchy on a quarterly basis, and management may conclude that its financial instruments should be reclassified to a different level in the future if a change in type of inputs occurs.

The following table presents a summary of the carrying value and estimated fair values of the Company’s financial instruments as of the dates indicated:
 
March 31, 2019
 
December 31, 2018
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
Assets:
 
 
 
 
 
 
 
Mortgage-backed securities
$
4,842,447

 
$
4,842,447

 
$
3,749,464

 
$
3,749,464

Mortgage loans held for investment, net (1)
10,862

 
7,458

 
11,527

 
8,566

Derivative assets
6,030

 
6,030

 
6,563

 
6,563

Liabilities:
 

 
 

 
 

 
 

Repurchase agreements (2)
$
4,252,893

 
$
4,252,893

 
$
3,267,984

 
$
3,267,984

Non-recourse collateralized financing (1)
3,219

 
3,073

 
3,458

 
3,475

Derivative liabilities
—

 
—

 
1,218

 
1,218

(1)
The Company determines the fair value of its mortgage loans held for investment, net and its non-recourse collateralized financing using internally developed cash flow models with inputs similar to those used to estimate the fair value of the Company’s Level 3 non-Agency MBS.
(2)
The carrying value of repurchase agreements generally approximates fair value due to their short-term maturities.

NOTE 6 – SHAREHOLDERS’ EQUITY AND SHARE-BASED COMPENSATION

Preferred Stock. The Company's articles of incorporation authorize the issuance of up to 50,000,000 shares of preferred stock, par value $0.01 per share, of which the Company’s Board of Directors has designated 8,000,000 shares of 8.50% Series A Preferred Stock and 7,000,000 shares of 7.625% Series B Preferred Stock, (the Series A Preferred Stock and the Series B Preferred Stock collectively, the “Preferred Stock”). The Company had 2,300,000 shares of its Series A Preferred Stock and 3,868,062 shares of its Series B Preferred Stock issued and outstanding as of March 31, 2019 compared to 2,300,000 shares of Series A Preferred Stock and 3,654,594 shares of Series B Preferred Stock as of December 31, 2018.

The Preferred Stock has no maturity and will remain outstanding indefinitely unless redeemed or otherwise repurchased or converted into common stock pursuant to the terms of the Preferred Stock. The Company's Preferred Stock may be redeemed in whole, or in part, at any time and from time to time at the Company's option at a cash redemption price of $25.00 per share plus any accumulated and unpaid dividends. Because the Preferred Stock is redeemable only at the option of the issuer, it is classified as equity on the Company’s consolidated balance sheet. The Series A Preferred Stock pays a cumulative cash dividend equivalent to 8.50% of the $25.00 liquidation preference per share each year and the Series B Preferred Stock pays a cumulative cash dividend equivalent to 7.625% of the $25.00 liquidation preference per share each year. The Company paid its regular quarterly dividends of $0.053125 and $0.4765625 on its Series A and Series B Preferred Stock, respectively, for the first quarter on April 15, 2019 to shareholders of record as of April 1, 2019.

19

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
(amounts in thousands except share data)



Common Stock. The following table summarizes information regarding monthly dividend declarations on the Company’s common stock for the first quarter of 2019:
 
 
Three Months Ended
 
 
March 31, 2018
Declaration Date
 
Amount Declared
 
Record Date
 
Payment Date
January 7, 2019
 
$
0.06

 
January 18, 2019
 
January 31, 2019
January 28, 2019
 
0.06

 
February 14, 2019
 
February 28, 2019
March 12, 2019
 
0.06

 
March 22, 2019
 
April 1, 2019
    
Stock and Incentive Plans. The Company’s 2018 Stock and Incentive Plan, which replaced the Company’s 2009 Stock and Incentive Plan (the “2009 Plan”), reserves for issuance up to 3,000,000 shares of common stock for eligible employees, non-employee directors, consultants, and advisors to the Company to be granted in the form of stock options, restricted stock awards, restricted stock units, stock appreciation rights, performance units, and performance cash awards. Total stock-based compensation expense recognized by the Company for the three months ended March 31, 2019 was $298 compared to $335 for the three months ended March 31, 2018, respectively. The following table presents a rollforward of the restricted stock activity for the periods indicated:
 
Three Months Ended
 
March 31,
 
2019
 
2018
 
Shares
 
Weighted Average Grant Date Fair Value Per Share
 
Shares
 
Weighted Average Grant Date Fair Value Per Share
Restricted stock outstanding as of beginning of period (1)
341,713

 
$
6.37

 
353,103

 
$
7.01

Restricted stock granted
152,462

 
6.10

 
176,233

 
6.28

Restricted stock vested (1)
(151,139
)
 
6.37

 
(194,827
)
 
7.37

Restricted stock outstanding as of end of period (1)
343,036

 
$
6.25

 
334,509

 
$
6.42

(1)
Amounts include awards previously granted under the 2009 Plan which will remain outstanding in accordance with their terms. The Company is no longer granting new equity awards under the 2009 Plan.

As of March 31, 2019, the grant date fair value of the Company’s remaining nonvested restricted stock is $1,865 which will be amortized into compensation expense over a weighted average period of 2.3 years.

NOTE 7 – SUBSEQUENT EVENTS

Management has evaluated events and circumstances occurring as of and through the date this Quarterly Report on Form 10-Q was filed with the SEC and has determined that there have been no significant events or circumstances that qualify as a "recognized" or "nonrecognized" subsequent event as defined by ASC Topic 855.

20

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our unaudited financial statements and the accompanying notes included in Part 1, Item 1. “Financial Statements” in this Quarterly Report on Form 10-Q and our audited financial statements and the accompanying notes included in Part II, Item 8 in our Annual Report on Form 10-K for the year ended December 31, 2018. References herein to “Dynex,” the “Company,” “we,” “us,” and “our” include Dynex Capital, Inc. and its consolidated subsidiaries, unless the context otherwise requires. In addition to current and historical information, the following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our future business, financial condition or results of operations. For a description of certain factors that may have a significant impact on our future business, financial condition or results of operations, see “Forward-Looking Statements” at the end of this discussion and analysis.

For more information about our business including our operating policies, investment philosophy and strategy, financing and hedging strategies, and other important information, please refer to Part I, Item 1 of our Annual Report on Form 10-K for the year ended December 31, 2018.


EXECUTIVE OVERVIEW

Company Overview

We are an internally managed mortgage real estate investment trust, or mortgage REIT, which primarily invests in residential and commercial mortgage-backed securities (“MBS”) on a leveraged basis. We finance our investments principally with borrowings under repurchase agreements. Our objective is to provide attractive risk-adjusted returns to our shareholders over the long term that are reflective of a leveraged, high quality fixed income portfolio with a focus on capital preservation. We seek to provide returns to our shareholders primarily through the payment of regular dividends and also potentially through capital appreciation of our investments.

Our common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “DX”. We have two series of preferred stock outstanding, our 8.50% Series A Cumulative Redeemable Preferred Stock (the "Series A Preferred Stock") which is traded on the NYSE under the symbol "DXPRA", and our 7.625% Series B Cumulative Redeemable Preferred Stock (the "Series B Preferred Stock") which is traded on the NYSE under the symbol "DXPRB".
    
Our investments consist principally of Agency and non-Agency MBS including residential MBS (“RMBS”), commercial MBS (“CMBS”) and CMBS interest-only (“IO”) securities. Agency MBS have a guaranty of principal payment by an agency of the U.S. government or a U.S. government-sponsored entity (“GSE”) such as Fannie Mae and Freddie Mac. Non-Agency MBS are issued by non-governmental enterprises and do not have a guaranty of principal payment. CMBS IO securities in which we invest may be issued by a GSE or a non-governmental enterprise.

RMBS. Substantially all of our investments in RMBS as of March 31, 2019 were Agency issued securities collateralized primarily by fixed-rate single-family mortgage loans. The remainder of our RMBS portfolio is collateralized by adjustable-rate mortgage loans (“ARMs”), which have interest rates that generally adjust at least annually to an increment over a specified interest rate index, and hybrid ARMs, which are loans that have a fixed rate of interest for a specified period (typically three to ten years) and then adjust their interest rate at least annually to an increment over a specified interest rate index (primarily one-year LIBOR).

We also purchase to-be-announced securities (“TBAs” or “TBA securities”) as a means of investing in non-specified fixed-rate Agency RMBS. A TBA security is a forward contract (“TBA contract”) for the purchase (“long position”) or sale (“short position”) of a fixed-rate Agency MBS at a predetermined price with certain principal and interest terms and certain types of collateral, but the particular Agency securities to be delivered are not identified until shortly before the settlement date. Our TBA purchases are financed by executing a series of transactions which effectively delay the settlement of a forward purchase of a non-specified Agency RMBS by entering into an offsetting TBA short position, net settling the paired-off positions

21

in cash, and simultaneously entering into an identical TBA long position with a later settlement date. These net long TBA positions are referred to as “dollar roll positions”, and we view them as economically equivalent to investing in and financing Agency RMBS using short-term repurchase agreements. TBAs purchased for a forward settlement month are generally priced at a discount relative to TBAs sold for settlement in the current month. This discount, often referred to as “drop income”, represents the economic equivalent of net interest income (interest income less implied financing cost) on the underlying Agency security from trade date to settlement date. We account for TBAs as derivative instruments because we cannot assert that it is probable at inception and throughout the term of an individual TBA transaction that its settlement will result in physical delivery of the underlying Agency RMBS, or the individual TBA transaction will not settle in the shortest period possible.

CMBS. Substantially all of our CMBS investments as of March 31, 2019 were fixed-rate Agency-issued securities backed by multifamily housing loans. Loans underlying CMBS are generally fixed-rate, mature in eight to eighteen years, have amortization terms of up to 30 years, and are geographically dispersed. These loans typically have some form of prepayment protection provisions (such as prepayment lock-out) or prepayment compensation provisions (such as yield maintenance or prepayment penalty). Yield maintenance and prepayment penalty requirements are intended to create an economic disincentive for the loans to prepay. From time to time we have invested in non-Agency CMBS backed by loans on multifamily housing, office buildings, retail, hospitality, and health care properties.

CMBS IO. CMBS IO are interest-only securities issued as part of a CMBS securitization and represent the right to receive a portion of the monthly interest payments (but not principal cash flows) on the unpaid principal balance of the underlying pool of commercial mortgage loans. We invest in both Agency-issued and non-Agency issued CMBS IO. The loans collateralizing CMBS IO pools are very similar in composition to the pools of loans that collateralize CMBS as discussed above. Since CMBS IO securities have no principal associated with them, the interest payments received are based on the unpaid principal balance of the underlying pool of mortgage loans, which is often referred to as the notional amount. Most loans in these securities have some form of prepayment protection from early repayment including absolute loan prepayment lock-outs, loan prepayment penalties, or yield maintenance requirements similar to those typical for CMBS described above. There are no prepayment protections, however, if the loan defaults and is partially or wholly repaid earlier because of loss mitigation actions taken by the underlying loan servicer, and therefore yields on CMBS IO investments are dependent upon the underlying loan performance. Because Agency-issued MBS generally contain higher credit quality loans, Agency CMBS IO are expected to have a lower risk of default than non-Agency CMBS IO. Our CMBS IO investments are investment grade-rated with the majority rated ‘AAA’ by at least one of the nationally recognized statistical rating organizations.

Financing. We use leverage to enhance the returns on our invested capital by pledging our investments as collateral for borrowings primarily through the use of uncommitted repurchase agreements with major financial institutions and broker-dealers. Repurchase agreements generally have original terms to maturity of overnight to six months, though in some instances we may enter into longer-dated maturities depending on market conditions. We pay interest on our repurchase agreement borrowings at a rate usually based on a spread to a short-term interest rate such as LIBOR and fixed for the term of the borrowing. Borrowings under these repurchase agreements are renewable at the discretion of our lenders and do not contain guaranteed roll-over terms.
    
Hedging. We use derivative instruments, primarily interest rate swaps, to economically hedge our exposure to adverse changes in interest rates resulting from our ownership of primarily fixed-rate investments financed with short-term repurchase agreements. Changes in interest rates can impact net interest income, the market value of our investments, and book value per common share. We frequently adjust our hedging portfolio based on our expectation of future interest rates, including the absolute level of rates and the slope of the yield curve versus market expectations.

Factors that Affect Our Results of Operations and Financial Condition

Our financial performance is largely driven by the performance of our investment portfolio and related financing and hedging activity. In assessing our financial performance, management primarily focuses on net interest income, net interest spread, net income, comprehensive income, book value per common share, and core net operating income to common shareholders (a non-GAAP measure) and total economic return (measured as dividends declared plus changes in book value). Our financial performance is also impacted by a number of factors including, but not limited to, the absolute level of interest rates, the relative slope of interest rate curves, changes in interest rates and market expectations of future interest rates, actual and estimated future prepayment rates on our investments, supply of and competition for investments, the influence of economic conditions on the

22

credit performance of our investments, and market required yields as reflected by market spreads. These factors are influenced by market forces beyond our control such as macroeconomic and geopolitical conditions, market volatility, U.S. Federal Reserve policy, U.S. fiscal and regulatory policy, and foreign central bank and government policy.

Our business model may also be impacted by the availability and cost of financing and the state of the overall credit markets. Reductions or limitations in the availability of financing for our investments could significantly impact our business or force us to sell assets, potentially at losses. Repurchase agreement lending markets have been stable for the last several years, but lending by larger U.S. domiciled banks has declined in recent years due to increased regulation and changes to regulatory capital requirements. Their repurchase market participation has been replaced by smaller independent broker dealers that are generally less regulated and by U.S. domiciled broker dealer subsidiaries of foreign financial institutions. It is uncertain how these relatively new participants will react during periods of market stress. Other factors that could also impact our business include changes in regulatory requirements, including requirements to qualify for registration under the 1940 Act, and REIT requirements.

We believe that regulatory impacts on financial institutions, many of which are our trading and financing counterparties, pose a potential threat to the overall liquidity in the capital markets. In 2017, the Federal Reserve began curtailing its reinvestment of principal payments received on its Agency RMBS portfolio. Prices in Agency RMBS generally have not been significantly impacted by the reduction, however prices may be more significantly impacted as the amount of curtailment increases each successive quarter. Market liquidity of our investments and the financing markets could be negatively impacted if the Federal Reserve's Federal Open Market Committee (or "FOMC") suddenly changes market expectations of the target Federal Funds Rate or takes other actions which have the effect of tightening monetary policy that are not anticipated by the market. And finally, there remains uncertainty as to the ultimate impact or outcome of certain regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), and restrictions on market-making activities of large U.S. financial institutions could result in reduced liquidity in times of market stress.

Fannie Mae and Freddie Mac have announced that the Single Security Initiative will become effective for all newly issued securities June 3, 2019. All securities issued by the GSE’s after that date will be pursuant to the Uniform Mortgage-Backed Securities (“UMBS”) platform established by the GSE’s. Fannie Mae securities previously issued will automatically be considered UMBS. Beginning in May 2019, Freddie Mac securities can be exchanged for new UMBS securities with the same material characteristics of the RMBS exchanged except with a different payment delay. The Company is evaluating the strategy of exchanging all or a portion of our existing Freddie Mac RMBS for UMBS securities, including the impact on our borrowing capabilities, operations, and liquidity. Thus far, the Company has not received any indication from its repurchase agreement counterparties that our borrowing capability or liquidity on existing Freddie RMBS will be impaired. The payment delay feature for UMBS securities follows that of existing Fannie Mae securities which is slightly longer than Freddie Mac.

From time to time, we also consider expanding our capital base as well as merger, acquisition or divestiture opportunities. We analyze and evaluate potential business opportunities that we identify or are presented to us, including possible merger, acquisition, or divestiture transactions, that might be a strategic fit for our investment strategy or asset allocation or otherwise maximize value for our shareholders. Pursuing such an opportunity or transaction could require us to issue additional equity or debt securities.
    
Investing in mortgage-related securities (including on a leveraged basis) subjects us to many risks including interest rate risk, prepayment and reinvestment risk, credit risk, spread risk, and liquidity risk. Please refer to Part I, Item 1A, "Risk Factors" of our 2018 Form 10-K as well as Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 3, "Quantitative and Qualitative Disclosures about Market Risk" of this Quarterly Report on Form 10-Q for a detailed discussion of these factors and others that have the potential to impact our results of operations and financial condition.

Market Conditions and Recent Activity

During the first quarter of 2019, we recovered approximately 30% of the book value per common share that we lost in the fourth quarter of 2018 as interest rates generally rallied across the curve and Agency MBS mortgage credit spreads tightened, partially reversing their widening in the fourth quarter of 2018. Markets appeared to price in slower economic activity and lower inflation domestically and globally. The FOMC elected to not increase the U.S. Federal Funds Target Rate (“Federal Funds

23

rate”) at its first quarter 2019 meetings, holding the targeted Federal Funds rate range at 2.25%-2.50%. Though the Federal Funds rate has been increased eight times since late 2016, in March 2019 the FOMC guided the markets to a lower terminal target rate. Globally, interest rates generally declined during the first quarter of 2019, particularly in safe haven markets such as the Eurozone and Japan. We believe that markets are reflecting uncertainty regarding inflation and the overall economic environment and, in our opinion, such uncertainty is likely to continue for the remainder of 2019. As such, we expect yields to remain relatively range-bound for the remainder of the year.
The charts below show the highest and lowest U.S. Treasury and swap rates during the three months ended March 31, 2019 as well as the rates as of March 31, 2019 and December 31, 2018:    
chart-e2a866787afd533e80e.jpgchart-015b2d03817056c5a96.jpg
    

Highlights of First Quarter 2019 Results

24


Comprehensive income to common shareholders for the first quarter of 2019 was $31.2 million versus a comprehensive loss to common shareholders for the fourth quarter of 2018 of $(31.4) million. Lower interest rates experienced during the first quarter of 2019 and the recovery of credit spread widening from the fourth quarter of 2018 principally drove this increase in our comprehensive income as our MBS increased in fair value by $86.6 million.

Net loss to common shareholders for the first quarter of 2019 of $(55.3) million primarily consisted of a net loss on derivative instruments of $(61.7) million compared to a net loss to common shareholders of $(81.5) million in the fourth quarter of 2018. Like the prior quarter, net loss on derivative instruments for the first quarter of 2019 was primarily the result of a net loss in fair value of our interest rate swaps due to the interest rates on the 2-10 year portion of the swap curve declining for the second consecutive quarter. Also included in net loss to common shareholders was net interest income which increased $0.7 million compared to the prior quarter due to a larger and higher yielding portfolio of interest earning assets, which offset our increased interest expense resulting from a higher average balance of repurchase agreement borrowings and higher borrowing costs due to the markets pricing in the 0.25% increase in the targeted Federal Funds rate announced in December 2018.

Though net interest income increased modestly for the first quarter of 2019 compared to the fourth quarter of 2018, net interest spread declined 9 basis points as the increase in our interest income as a percentage of average interest earning assets was not enough to offset the increase in our interest expense as a percentage of our repurchase agreement borrowings. As shown in the table below, the downward trend in net interest spread for the majority of our investments continues as a result of higher funding costs and a flattening yield curve: