Mortgage-Backed Securities? Wait! Don’t Run!

by Jon Markman | May 10, 2012 8:30 am

It can still be taboo to mention mortgage-backed securities since they were at the center of the global financial crisis of 2008. Yet that history has opened up opportunities.

Dynex Capital (NYSE:DX[1]), a real estate investment trust (REIT), focuses on leveraging up select mortgage-backed securities. Its specialty is short-duration agency residential and commercial assets in the U.S., and it’s purchased primarily for its yield, which is now 11.9% per annum.

Click to Enlarge
Dynex, like many of its peers, is taking full advantage of super-low interest rates in a big way. The Federal Reserve’s zero-interest-rate policy extension through 2014 means it will remain very cheap to borrow money through that period, leading to attractive spreads between mortgage yields and borrowing costs. If there’s ever going to be a “free lunch” in our lifetime, this may be it.

Dynex keeps the quality of its portfolio high, with 89% of its holdings rated AAA, with a relatively short duration of less than five years on two-thirds of its portfolio. Shorter-term assets help to limit Dynex’s exposure to the potential of rising interest rates.

Dynex is one of the few internally managed mortgage REITs in the industry, which has resulted in slightly lower management fees and a more focused strategy. The firm opened in 1988, and for a brief span from 1992 to 1997, it originated its own residential and commercial mortgage loans.

The company is led by Thomas Akin, who took on the chief executive role in 2008 but has been chairman since 2005. He has 33 years of experience in the mortgage-security realm, having previously founded Talkot Capital as well as serving in various positions with Merrill Lynch and Salomon Brothers.

Click to Enlarge
The firm has been able to deliver an annualized total return of 11.5% since 2008 and increased its dividend by 11% last year alone. Nearly every important financial measure has seen double-digit growth over the last few years, including sales, quarterly earnings, dividend yield and free cash flow.

Last year also saw Dynex’s investment portfolio grow by $900 million, to $2.5 billion. About 75% of the portfolio is comprised of residential-based securities, with the other 25% split between commercial and securitized loans.

There aren’t many investments that can claim 52% annual growth over the past five years, but that’s what Dynex has accomplished. Thus it’s no surprise that nearly 7% of the company is owned by insiders and key executives. It’s a clear example of the faith those around Dynex have in the firm and its strategy.

Dynex recently reported spectacular first-quarter results, with net income rising 15% from a year ago, to $16.5 million, and a return on average equity of 14.7%. Shares are trading at just 9.2 times earnings, compared with a 17.4 industry average, so Dynex’s valuation, along with very favorable market conditions, make it an intriguing long-term investment.

  1. DX:

Source URL:
Short URL: