Dynex’s investment portfolio is comprised of loans and securities consisting of or secured by, single-family mortgage loans, commercial mortgage loans, manufactured housing installment loans and delinquent property tax receivables. These investment portfolio assets are a mix of both fixed-rate and adjustable-rate loans and securities. The majority of the investment portfolio is financed through the issuance of adjustable and fixed rate, non-recourse, collateralized bonds, with the remaining being funded with equity. The collateralized bonds provide long-term financing for the investment portfolio while limiting credit, interest rate and liquidity risk.
In the collateralized bond security structure, the loans and securities are pledged to a trust which issues non-recourse bonds. The excess of loans and securities pledged over the bonds issued represents our net investment in the security structure, commonly referred to as “over-collateralization”. This net investment in the collateralized bond security is directly exposed to losses on the loans and securities pledged, with the net interest spread (the interest income on the loans net of interest payments and other expenses on the collateralized bonds) as our principal source of earnings and cashflow.
Because we maintain the credit risk, but the benefit of the “excess spread income”, our portfolio value is directly affected by i) credit performance of our assets, ii) changes in interest rates, and iii) prepayment speed of the underlying loans and securities. The objective of our Portfolio Management group is to maximize earnings and cash flows from the investment portfolio through:
• Minimizing losses through Master Servicing and credit administration
• Minimizing interest rate risk through management of interest rate hedges
• Maximizing investment opportunities
Master Servicing and Credit Administration
Dynex serves as Master Servicer and/or credit administrator for certain of the series of collateralized bond securities which it has issued. The Master Servicer’s function typically includes monitoring and reconciling the loan payments remitted by the servicers of the loans, determining the payments due on the securities and determining that the funds are correctly sent to a trustee or investors for each series of securities. Master servicing responsibilities also include monitoring the servicers’ compliance with its servicing guidelines. As both Master Servicer and credit administrator, the Portfolio Management group tracks the performance of assets to determine potential trends in various sectors, and provides direction to the loan servicers on mitigation or disposition of non performing loans and foreclosed properties. All of these actions allow us to maximize the value of our loan portfolio and minimize losses.
Interest Rate Risk Management
Dynex has used a mix of adjustable-rate collateralized bonds and fixed-rate collateralized bonds in financing its investment portfolio. As the recipient of the net interest off the loans in excess of the interest payments due on the bonds, Dynex can be adversely affected by a volatile interest rate environment. To manage the interest rate risk associated with this volatility, Dynex attempts to match fund fixed-rate investments with fixed-rate collateralized bonds and floating-rate assets with floating-rate liabilities. Where Dynex has not match-funded investments, it uses various derivative instruments including swaps and interest rate futures contracts to minimize its interest-rate exposure.
