Dynex Capital Inc (DX): This 11% Yielder Is Well Positioned to Maintain Its Dividend

Page 2 of 2

CYS Investments Inc (NYSE:CYS), a similar hybrid mortgage REIT, owns an investment portfolio consisting of 56% 15-year fixed rate MBS, followed by .19% hybrid ARMs and 18% 30-year fixed rate securities. The company reported a net interest spread of 0.94%, down 30 basis points from the linked quarter. Its prepayment speed at the end of the fourth quarter was up 3 basis points to 17.6%, while the book value decreased 8% compared to the linked quarter.

In contrast, American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY) invest exclusively in Agency mortgage backed securities. American Capital’s recent earnings were positively impacted by a hike in asset yields, supported by a hike in the interest yielding assets during the quarter. Asset yields increased despite the challenging micro-environment, where the Fed is committed to keep the rates low and the yield curve flat. American Capital is believed to be a highly prepayment protected portfolio. Annaly Capital’s asset yields and net interest spread were compressed again during the most recent quarter. However, the management managed expenses well during the fourth quarter, which is why they declined 36%. Annaly is involved aggressively in diversifying its portfolio by acquiring CreXus Investments.

Future Outlook

2013 will be marred by low interest rate for the US mortgage RIETs as the Fed has dispelled any concerns regarding the risk of its aggressive bond buying and the resultant halt of the strategy. Ben Bernanke has again shown his resolve to continue the bond buying program to stimulate the US economy. This means, the downward pressure on bond yields will continue to prevail, which will continue to decrease the asset yields earned by mortgage REITs. The lowered asset yields result in lower net interest rate spread and resultantly lower dividend distributions. Give the situation, I believe Hybrid REITs with well diversified MBS portfolio will be the best choice in the coming quarters, as their high yielding assets other than Agency RMBS will continue to support the bottom line and the net interest rate spreads. Since Dynex Capital is both hybrid and possesses a very well diversified MBS portfolio, it will be one of my top picks within the mortgage REITs sector for 2013.

Investment Strategy

I am bullish on Dynex Capital due to its highly diversified MBS mix, particularly given the continued Fed bond buying. The company offers a dividend yield of 11.2% and an upside potential of 5.3% on my target price of $10.95. The large presence of high yielding non-Agency MBS in the company’s highly diversified MBS mix will enable it to maintain its current dividend throughout 2013. It is also worth noting that Dynex Capital increased its quarterly dividend in 2012 when most of its peers were forced to cut their shareholder distributions.

The article This 11% Yielder Is Well Positioned to Maintain Its Dividend originally appeared on Fool.com and is written by Adnan Khan.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Page 2 of 2