Dynex Capital Inc (DX) 2020 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Dynex Capital Inc.'s First Quarter 2020 Earnings Results Conference Call. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Alison Griffin, Vice President, Investor Relations. Thank you. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us today. With me on the call I have Byron Boston, President and Chief Executive Officer; Smriti Popenoe, Executive Vice President and Chief Investment Officer; and Steve Benedetti, Executive Vice President, Chief Financial Officer and Chief Operating Officer.

The press release associated with today's call was issued and filed with the SEC this morning, May 6, 2020. You may view the press release on the homepage of the Dynex website at dynexcapital.com as well as on the SEC's website at sec.gov.

Before we begin, we wish to remind you that this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, forecast, anticipate, estimate, project, plan and similar expressions identify forward-looking statements that are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. The company's actual results and timing of certain events could differ considerably from those projected and/or contemplated by those forward-looking statements as a result of unforeseen external factors or risks.

For additional information on these factors or risks, please refer to the annual report on Form 10-K for the period ending December 31, 2019, as filed with the SEC. The document may be found on the Dynex website under Investor Center as well as on the SEC's website.

This call is being broadcast live over the Internet with a streaming slide presentation, which can be found through a webcast link on the homepage of our website. The slide presentation may also be referenced under quarterly reports on the investor center page.

I now have the pleasure of turning the call over to our CEO, Byron Boston.

Thank you, Alison, and thank you all for joining us this morning. At Dynex Capital, we operate with a long-term vision. In 2019, we celebrated 30 years as a listed company on the New York Stock Exchange and we formed a new 30-year vision for the future. Such a long-term view where management is tied and totally committed to the success of Dynex is very much aligned with the interest of our shareholders, creditors and other stakeholders.

To succeed in managing a mortgage REIT over such a long time horizon, it is imperative that we adjust our risk posture as necessary to fit the complexity of the overall global environment and that we allocate our capital in a very disciplined manner. Multiple years ago, we were up in credit and up in liquidity, and we maintain that posture today. Furthermore, we have reduced our leverage in the short term as we assess the currently evolving health and economic crisis. This current global situation is very different than the great financial crash of 2006 through 2008, and the next several months will be extremely important in assessing our best risk and capital allocation strategies. It is too early to discern the broad-based impact of the current exogenous shocks across the global economy.

On our call today, we will cover the first quarter, our macroeconomic view, our view on the economy, business model, and we will give you an outlook for our dividend. I will now turn it back to Alison, who will lead us through a series of Q&A.

Thank you, Byron. Turning now to Steve. Please walk us through the company's first quarter performance.

Thanks, Alison, and good morning, everyone. Our results for the quarter on both a GAAP and non-GAAP basis are highlighted on Slide 7 (sic) [6] in the presentation and in the press release we issued this morning.

For the first quarter of 2020, we reported a comprehensive loss per common share of $1.45 and core net operating income of $0.51 per common share. While we benefited from the lower interest rate environment and our repo funding costs during the quarter, our periodic swap benefit declined as rates rallied and we lifted hedges. TBA drop income also fell, and we had a modestly smaller investment portfolio and lower prepayment compensation on CMBS.

Finally, dividends on our preferred stock increased due to the timing delay between the Series C issuance and the redemption of the Series A and partial redemption in Series B. Book value per common share declined $1.94, 10.8%, principally as the result of CMBS IO and Agency CMBS spread widening during the quarter given the tremendous volatility in prices and yields in the latter stages of March.

As we noted in our call on April 15, we actively managed our duration position, which lessened the impact of the volatility during the quarter on our book value. We also sold specified pools in early March, monetizing payout gains before spreads widen later in the month.

The issuance of the Series C preferred stock in February reduced book value by $0.15 per share, which should save us approximately 75 basis points in coupon going forward on a blended basis. We estimate book value per common share as of yesterday is relatively unchanged from March 31, though we have not conducted our normal procedures in connection with this estimate.

For the first quarter, total economic return was a negative 8.3% versus a positive 2.2% last quarter due largely to the aforementioned decline in book value. For the quarter, we declared and paid a $0.45 dividend per common share.

Average interest-earning assets were modestly lower at $4.9 billion versus $5 billion last quarter. And adjusted leverage was 8.8x total shareholders' equity at March 31, lower than the 9.0x at year-end.

As we already mentioned on our update call on April 15, we have further reduced our investment portfolio and leverage post quarter end. As of April 30, our investment portfolio asset balance is approximately $2.4 billion and leverage is approximately 4x total shareholders' equity.

Looking forward, we expect our net interest spread on our existing portfolio of $2.4 billion to increase in the second quarter's repo financing rates fully reflect the benefit of the Fed reductions of March of its targeted Fed funds rate. From an earnings standpoint, much of the prepayment risk to our earnings on our Agency RMBS and CMBS portfolios has been reduced at this point as our amortized cost basis on these assets are a combined approximate $1.02 price. That said, our investment portfolio is smaller today. We have capital to invest. And ultimately our net interest spread and earnings will be a function of where and when we deploy our excess capital.

Thank you, Steve. Byron, can you describe our macroeconomic outlook?

Sure. We have had a long-term economic view that has not changed. The global economy is fragile, and global risks have intensified. The current exogenous shock has only served to increase the probability of future surprises as risk factors at play are increasing in complexity and number. The entire global economic and financial system is currently increasing leverage enormously to survive this crisis. As such, the postcrisis world will continue to see a drag imposed on growth and inflation from global debt, demographics, technology, human conflict and other risk factors.

Global economies and the global financial system cannot stand on their own without the central banks continuing to play a major role. Policy risk has increased and will be a major factor well into the future. How our world will evolve is still uncertain in the short to medium term. This fragile global economy is currently absorbing the impact of multiple shocks, and it is too early to fully discern the broad-based impact of these negative developments. We are still in the early stages of a health and economic crisis. The central banks have moved swiftly to avoid a financial crisis, and a potential policy crisis might evolve in the future as the world attempts to manage the side effects of all the new fiscal and monetary programs that have been implemented. Hence, our macroeconomic opinion continues to support our investment thesis of being up in credit and up in liquidity.

Thank you, Byron. Turning now to Smriti. Smriti, can you briefly discuss the portfolio adjustments we've made post quarter end?

Yes. Alison. I'd like you to please turn to Slide 9. We've rebalanced the portfolio to focus on Agency RMBS. The adjustments we made post quarter end leave us with lower leverage, higher liquidity and a bigger capital position. You can see on this slide our cash and unencumbered asset position was at $312 million. I'll discuss our views on redeploying the capital later on in the call.

In March, we shifted our thinking on cash flow risk, and started to evaluate our portfolio for the increased possibility of delinquencies and default. While we did not and do not assess the probability of default as high, we felt it prudent to monetize the $200 million in unrealized gains in our Agency CMBS DUS portfolio. Post quarter end, as liquidity and pricing stability returned to the market, we rapidly reduced our Agency CMBS DUS position. During the month of April, we've reduced that position from $2.1 billion to $800 million. We've realized $166 million in gains and cut over 80% of our premium exposure.

Great. How are you assessing the current investment environment we are operating in? And how do you think this plays out for Dynex's investment strategy?

As Byron mentioned, Alison, this is a health and economic crisis, but it's layered on top of the already existing fault lines that we identified before the shock. Social factors, global debt, technology, environmental, geopolitical and demographic factors, these were already in place before the pandemic and oil shock. So we think, right now, there are 2 forces to consider that are working in opposition. The first force is the potential for disruption to cash flows. The shutdown of economic activity has led to loss of employment for over 25 million American workers thus far. Borrowers are seeking forbearance, renters are seeking rent relief. We're seeing a lot of evidence that the financial position of state and local governments, nonprofits, universities are compromised. Against this, you have an opposing force of the rapid and significant fiscal and monetary responses globally.

GSEs have responded by providing forbearance for single-family and multifamily borrowers. These actions collectively will probably cushion the economy in the near term and may delay cash flow disruption in some sectors. Ultimately, the question we're asking ourselves, as we design an investment strategy, will the government actions be enough to minimize the disruption to cash flows or not? How do the structural factors evolve as we see the duration and severity of the health and economic crisis play out? How does the return on the investments we are considering stack up against these risks?

There aren't clear answers yet to these questions. It's still really too early to discern how this crisis will play out, but the next several months will be critical in determining the direction this will take.

So are there areas to invest today?

Absolutely. We think that up in credit and up in liquidity is still the place to earn returns. If you turn to Page 11, you'll see our view of where we think returns are stacking up at this point. The Agency RMBS sector is the most attractive in our view. At this point, one of the most important drivers of levered returns is financing costs. We expect that financing costs will be low and stay low for a prolonged period of time, especially for high-quality assets. So that's a major positive for Agency RMBS. We can get financing for these liquid assets at low rates.

The agency multifamily sector is also a sector that's currently supported by government policy, but the near-term extent of cash flow disruptions is less certain. So until this becomes clearer, we actually think Agency RMBS is a better relative risk-adjusted return for marginal capital use.

Great. Can you talk about where you see relative value in the markets today and portfolio construction?

Yes. We prefer lower coupons TBAs and generic pools versus higher coupons and higher pay up pools. In the near term, cash flows are going to be impacted by the forbearance policies of the GSEs. And the first thing that's going to happen is a delay in prepayments.

The key beyond the near term will be the transition from forbearance either back to performance or to delinquency and then modification and finally default. Policy risk is a major factor in how this will all eventually develop, particularly given the GSE's credit risk transfer programs or CRT programs. We'll now actually get to see how much credit risk was really transferred.

In the near term, we think higher coupons and low balance pools will still offer value. The key on the higher coupons is being able to monetize the premium and selling the pools before default and modification phases begin. We're also respecting the recent severe lack of liquidity in higher coupons and especially the higher pay up pools because of the lack of a natural buyer at very high dollar prices. That favors the lower coupons as well.

What are the returns looking like in the Agency RMBS sector?

We see attractive returns in this sector. We're by no means at the super cheap levels, but still attractive. In the 15-year sector, hedged net interest spreads are in the 80 to 90 basis point range. At 9x leverage, that's 8% to 9% static core ROE.

30-year generic lower coupons, the hedged net interest spreads in the $1.10 to $1.50 range, depending on whether you're buying specified pools or more generic pools. So ROEs are in the 10% to 15% range at 9x leverage. And there's a slight improvement there in TBAs for dollar rolls.

Okay. Our leverage today is around 4x, do you see attractive returns in the liquid sector? How are you thinking about leverage and balance sheet size? And what kind of earnings power do you think the company has?

Great question, Alison. I was hoping you would ask me that. We think the balance sheet can be up to $4 billion in assets and leverage can rise to 6x to 7x, up from the 4x that we sit today. This gives us the liquidity reserve and fire power to navigate any aftershocks. We can be flexible and leverage up or down in the face of new opportunities like a steeper curve or if there's a risk flare up. These are guideposts we're placing in the near term. We constantly evaluate these, and we'll be ready to take risk up or down as we see scenarios develop.

Now let me walk through our portfolio today and the potential earnings power as we grow the balance sheet. Our existing portfolio after all the adjustments we made is a subset of the position on Page 10. So let's turn to Page 10. Specifically, the agency MBS portion of the portfolio is down to $800 million with a book yield of 2.5%, reflecting the lower premiums in this sector. The approximate weighted average book yield on the assets as of April 30 is 3%.

Now turning to the financing side, if you would flip to Page 25, you can see on Page 25, our repo rates were pretty high at the end of last quarter because we had rolled positions through quarter end. We have already seen these repo rates come down substantially and expect to see these rates around 30 to 35 basis points for 1 month and 3-month repo for Agency RMBS, and the IO's are financing at around 1-month LIBOR plus 90 basis points on a weighted average basis. So that gets you to a net spread on the overall portfolio in the low 200s, assuming we don't sell or reposition the portfolio.

As I mentioned earlier, we think leverage can be taken up to 6x to 7x, $1.50 billion to $2 billion in assets at an average spread of 110 basis points if you include 15 years in the mix. This should get you to a weighted average net spread in the mid-100s on about a $4 billion balance sheet when you combine the two. So there's significant earnings power in the position today, and it's there in about 2 to 3 turns of leverage. It's really a matter of putting the risk on in a disciplined manner, which we feel we can do with the liquidity in the Agency RMBS space.

Very good. Our portfolio is predominantly Agency guaranteed, and you expect to be focused on that sector, can you discuss the investment we have in the nonagency sector, CMBS IO?

Yes. This is a sector in which we have been long-term investors. This is a great investment for REIT. IOs offer good returns for a shorter duration well-structured cash flow at the top of the capital stack. Over 90% of the bonds we own are triple AAA rated and receive the highest payment priority in the cash flow waterfall.

Our non-Agency CMBS position -- IO position is currently 7% of the total portfolio by assets and 7% of our total capital is allocated to this sector. Over the last 12 years, we've had no problems financing this position, and we had no issues financing this position in March. The majority of the position is funded in a committed facility through June 2021, and there were no changes in financing spread versus LIBOR even through the disruption in March.

We really like the seasoning in our portfolio. Seasoning in the credit portfolio is key. 80% of the bonds we own are 5 to 6 years old, with only 4 to 5 years left to maturity and a significant part of the underlying properties have price appreciation. The LTVs in the portfolio are in the low 50s percent for most of the portfolio.

The remaining average life on the portfolio is about 4 years, and the weighted average credit enhancement is in the 25% range. We're at the highest part of the capital stack where we have structural protection, and we own a seasoned portfolio. We're going to be opportunistic in managing this risk. We also factor in the fact that the portfolio pays down about $40 million in market value each year. So that's a tremendous amount of cash flow. The position at this time next year should be about 25% smaller just from the passage of time. We'll have more detail on the credit and portfolio metrics in our 10-Q.

Okay. So shifting back to our overall strategy then, can you put all of that together for us?

Absolutely. The main point to remember is that our financing costs are low and there is significant earnings power in the company via investments in Agency RMBS. We think we can take leverage up in this environment to 6x to 7x. Invested in Agency RMBS at a static ROE of 7% to 8% for 15-year and the 15% for 30-year. We are respecting that we're in the early stages of this economic and health crisis, and we're considering the possible future disruptions to cash flows. Our main objective is to take the appropriate amount of risk for the environment, focus on preserving capital and generating what we view to be an above-average return.

Great. Thank you, Smriti. Now turning to Byron. Byron, there have been a lot of questions about the mortgage REIT business model since March. What are your thoughts on this topic?

If you would turn to Slide 13, there are some interesting points on this topic. In general, though, the mortgage REIT business model is fine. The REIT model is a tax-efficient vehicle that depends on disciplined risk management and capital allocation. Simply put, liquid assets should always be a core part of your strategy throughout all business cycles. There are times when liquid assets and balance sheet liquidity should be increased in anticipation of potential surprise corrections in asset price levels. For example, coming out of the great financial crisis, we went down in credit and down in liquidity. That was a great opportunity between 2009 and 2015. However, we reversed that strategy and adjusted our focus to emphasize liquidity as we watched the global risk intensify.

The events of March 2020 in no way implied that there are fatal flaws in the mortgage REIT business model. Rather, it exposed the illiquidity of a leveraged credit strategy at the wrong point in the credit cycle. The fault lines were apparent well before the pandemic. We have been monitoring them and adjusting our strategy accordingly. There were environmental factors that uniquely impacted each company differently based on their risk posture, but there are not inherent flaws in the business model. In fact, we believe there is a strong case to be made for earning income from high-quality U.S.-based real estate assets, especially as global interest rates have collapsed to 0 or negative levels.

Thanks, Byron. Now that we have covered our key questions, what's the final message for all of our stakeholders?

The appropriate process for reopening the global economy is in a phased approach. This will allow the world to observe whether our situation is getting better or worse. Likewise, we are reinvesting our capital in a phased approach. We will remain up in credit and liquidity, which always gives us the option of increasing our capital deployment rapidly. Furthermore, with our financing costs anchored at really low levels, we are confident in our ability to generate solid cash flow. The key at this uncertain phase of this global crisis is to manage risk aggressively.

Keeping with this approach, we anticipate no change in the dividend for the month of May. As always, our dividend will reflect the earnings power of the company and our risk posture.

The final thought I'd like to leave you with today is that we are an internally managed REIT. We are invested in Dynex, alongside of our shareholders, and we continue to manage our company for the long term.

Operator, I'd like to on the call up for Q&A.

(Operator Instructions)

Your first question comes from Doug Harter from Crédit Suisse.

Byron and Smriti, can you just talk about how you're balancing kind of the flexibility and sort of the defensive posture in the uncertain time versus kind of possibly waiting too long and missing some of the attractive opportunities that are available today? Just how you think about that -- those tradeoffs?

Let me start with a high level point on this, which is, there's questions. And it's really starts -- again, back at the disciplined process, top down, there are macro questions that are still out here. How many bankruptcies are there going to be? How many permanent firings are there going to be? How many people will not pay the mortgage payments in May? How many renters will not pay rent in May? How many by June will get permanently fired and suddenly now they're joining their ranks of not paying. How many in July will not pay? So there's a lot of questions here, and I understand what you're asking in terms of this trade off. There's a lot of macro questions that still need to be evolved.

How will the energy sector be hit? And how much unemployment will come out of that sector? And then you take us back as we come down from the macro questions to our individual sector, we're an up in credit up in liquidity strategy. And with our financing costs anchored at the lowest levels we've seen really in the last 10 years, we know we can generate income.

Furthermore, back to the macro, with so much debt that's being created and need to be sold and financed, it's highly probable that we see a steeper curve. Every basis point steeper that we take our time and invest in our money, let's say, the yield core goes -- continues goes from 65 to 75 basis points. That adds to our potential future ROE.

Let's say, if it goes from 65 to 85 basis points, that's even better, given that our financing costs are anchored. So we do have a lot of options and we are trying to -- what you ask is how we're balancing it and we're trying to balance it between looking at the macroeconomic environment, depending on which is where you -- I think you also have the Fed has a cushion or a mattress underneath the mortgage -- the Agency mortgage-backed securities market. So we could always say, hey, well, let's just go all and just because the Fed has our back. We're being more disciplined from a macro perspective. But we also have in our back pocket the fact that we can invest money rapidly by having an up in credit up in liquidity strategy. Smriti, you want to give some more specifics?

Yes. I actually -- I don't think we're at much risk of missing opportunities. At this point, mortgage OASs are probably as wide as they were in early March. And then, obviously, they're not as wide as they were in the middle of March or late March. But we're seeing opportunities to put capital to work. And I think being nimble, putting the capital into sectors where we see real value, I think we have that environment right now.

At this point, the Fed is actually reducing how much they're purchasing on a weekly basis. There's some pent-up demand here in terms of mortgage pipelines coming -- being able to sell forward and so on. So I think we're going to see some chances here to put capital to work at a good level.

And Doug, let me add one other thing. As you scour the landscape and you look at a variety of companies, there are an enormous amount of people are in positions because they have no choice. They couldn't adjust the position. We're in our position because we want to be here. We've adjusted our position out of our RMBS into CMBS, back out of CMBS back in RMBS. We've adjusted our balance sheet up to $6 billion, back down to $2 billion. Now we're moving it back up again. That's deliberate.

We're not here because we have so many low balanced bonds and we can't sell them. So we're very offensive in our current situation, but we do find it very intriguing that our financing costs are currently at a low level. We don't expect that to change. Every 1 basis point, 5 basis points, 10 basis points deeper in the curve will be a huge benefit in terms of forward return opportunities. And then you got an entire macro environment with a health crisis, economic crisis, financial crisis, and we're watching the world and see how we evolve.

Your next question comes from Eric Hagen from KBW.

Thanks for those really great opening remarks and congrats all things considered on a great quarter. You guys mentioned being a little bit more constructive on Agency RMBS right now. Do you guys think you're going to take that position through more of a specified pool position or TBAs right now?

Sure. Thanks, Eric. So I think we're going to favor generic specified pools, not extremely high pay up and the TBA position. That's what we feel makes more sense at this point. That's not to say we won't own any loan balance or any high pay up pools, but the liquidity and the flexibility at this point is really valuable. And so in the lower coupons -- by the way, lower coupons doesn't mean you're not taking premium risk. The lowest coupon out there that's trading is at 2% with almost 2 points of premium on it. The next highest coupon has almost 5 points of premium on it. So there's risk in all these coupons in terms of premiums. But the lower pay up, more generic strategies I think at this point offer us more flexibility and the TBA as well.

Great. And Byron, following up quickly on your thoughts on just the mortgage REITs and maybe the return that investors can expect over the course of the cycle, I mean, if you guys take leverage lower, is that your way of saying that investors at certain points should maybe expect a little bit less return, but also potentially much less risk?

That's the balancing act. That's literally -- again, the reason I started off with that long-term vision, and it was very important by started off with the long-term vision is because we want you to know that the only way that you make it over the long term is, first and foremost, you must prioritize risk. And so when we thought about the 30-year vision, what we told ourselves is, we must get through 1998, and we must get through a 2008 scenario. Now we've added March 2020 to that. So the first thing we're always thinking is, the key for our shareholders that they can stay in the game over the long term.

So as we continue to evaluate the environment as we move forward, it is going to be, again, this balancing act between ultimately the risk and return. It's a very easy lever to pull in terms of leverage. You're 4x leverage, you're 5x, you're 6x, 7x, very easy. The adjustment is easy to make. It's not a complicated process in that sense. Smriti, you want to add something to this?

Yes. I think the other thing we talk -- we think about in terms of returns, most of the globe has 0 or negative yields in the fixed income markets. And at this point, you've got to consider the risk environment and the return environment to say, don't reach for yield, don't reach out there and take the types of risk that actually really damage you in '98, '08 or March 2020 scenario. And so that does have an impact on, I think, taking returns lower.

Your next question comes from Trevor Cranston from JMP Securities.

Okay. I guess the first question, can you guys talk about the remaining Agency CMBS portfolio? How are you thinking about that? If it's something you might look to opportunistically continue selling as spreads have tightened? Or is that something you're comfortable continuing to hold on to at this point?

Trevor. Yes. So the book we have left is nicely split between what I would say are more par or slightly above par price bonds and then some more premium-priced securities. We're comfortable with that position. We think we can be more opportunistic in terms of taking spread tightening in what's remaining. So again, our big reason to take down that position in March and in April was really driven by the fact that we had a high premium, high gain position, in that portfolio, and we wanted to monetize those gains.

The risk is there, but we -- our thought process was more protect the gains as opposed to really making a big risk statement about Agency CMBS. So it was sort of unique to our portfolio. Most of the bonds we had purchased in that book were -- we had bought around par, and there were $15, $16, $17 price premiums on those positions that we thought was really a good opportunity to monetize. So at this point, we feel pretty good about the remaining position. If we get chances to rebalanceit's going to be a relative value decision between that and pass-throughs.

Okay. Got it. And then in terms of your...

Trevor?

Yes. Go ahead.

Can I take one other second on that last question, just to plug. Look, a core part of our business strategy has always been capital allocation. Disciplined capital allocation. We've done it for years. And in the last 6 months, we -- because of the changing risk environment, we've had to move our money around a little more than we normally would. Generally, you see us take a theme and we sit there for some time. But if you look at the end of last year's portfolio versus the portfolio after the first 2 weeks of March versus the portfolio at the end of March versus the portfolio as today, very disciplined in terms of how we're moving the capital around in our balance sheet and where we're allocating capital. So we're very disciplined about it. We think it's -- being nimble. Being our size at this point is an advantage because we can do that. And as we look to the future, we want to use the same process that we've used in the past.

Okay. Thanks for those comments, Byron. And then in terms of your interest rate positioning, I think you have the March 31 numbers in the slide deck. Can you say if those changed with the portfolio reductions in April? And more generally, sort of how you're thinking about the rate profile of the portfolio going forward given that interest rates are near 0 now. And how much risk you're comfortable taking there?

Yes. I think one of the nice things about having the Agency CMBS position is just how simple it is to hedge. So our book actually, from a net duration position, is not that different in the -- since we sold the bonds. So we've actually stayed fairly duration neutral. The positioning at this point, I would say, again, is really going to reflect our broader macro view. And the broader macro view is that at this point things could go in a number of different directions, right? A lot of people think the curve is going to steepen. And so if that occurs, then you push your hedges in the back end of the yield curve. We have some of that thought process going on. You also have the idea that the front end of the curve is fairly anchored. So there's really no point in having hedges in the front end. We agree with that. So as we're adding assets and growing the balance sheet, we're going to have a bias for adding hedges at the longer end of the curve and probably having that front-end position fairly open.

Okay. Got you. And then last question, can you just provide a brief update on whether or not you guys have actually had any portfolio growth or started adding agencies so far in May?

We have. We've been able to find -- we have actually found that mortgage spreads are wider in mid-May here as we've come into the month. So we've been adding assets, and expect to continue to do so.

Trevor, you other interesting thing, and I should -- how clear at this point it's come across so far, the Fed is adjusting the amount that they're purchasing. And we're still watching to see how solid really is the mortgage market. We don't believe the Agency sector will fall out a bit. But we definitively believe spreads could widen into certain circumstances, especially as the Fed brings down their purchases and it's not a bad winding. That's good winding. It means that prices are just moving to a private capital like Dynex Capital and our shareholders are willing to assume the risk of instruments such as this. So there's optionality in the future, and I'm just taking a second just to pile on top of Smriti here and make that point.

Your next question comes from Christopher Nolan from Ladenburg Tallman.

Can you give an update to book value since March 31?

Chris, yes, as we commented, it's not materially different from the end of the quarter.

Great. Thank you, Steve. And then a follow-up question would be, given your guidance in terms of leverage and spreads and so forth, I'm sort of ball parking that, it looks like you're targeting a return in the high single digits for the company or return on equity. Is that fair?

No. What I would say, Chris, it's going to depend on the risk environment. And -- so if you look back at the end of -- what we are saying though is, if you look at where we were at the end of last year, and you think about my commentary over the last, call it, a year or 2 where I made really strong cases for taking higher leverage in liquid assets. And one of the main reasons was because you have the ability to adjust your portfolio. What we are telling you here, think about us short, medium and long term. The short term in the next 4 to 8 weeks. The medium term is through the end of the year, and the long term is after the end of the year. And literally, we're thinking, short, any question you got short, medium and long-term approach.

In the short term, the world is evolving. And so we're not going to lead to where we were at the end of December and say everything is okay because everything is not okay. The world is evolving, and we're taking a phased approach toward reinvesting our capital. So I couldn't give you the -- this is something exact target. What I can tell you is this approach. Short, medium, long term. And we're evolving our way back to a -- still the philosophy that we have, which is that up in credit and up in liquidity is a good strategy. And I'd still rather be up -- I'd rather have more levers on highly liquid assets than lower leverage on less liquid assets. And that's just an argument we've been making for years.

Your next question comes from Paul Stewart from Jones Trading.

It's Jason. Paul took the day off today. I wanted to follow up on the question about Agency CMBS and taking leverage up there. It sounds like two of the markers perhaps could be yield curve steepening and Fed involvement. How willing are you to dial up and down, and if correct me if I'm wrong, if there are not markers, what are the markers? And how willing are you to dial up and down based on factors like that?

Yes. I think -- Jason, it's really an interesting trading environment. The -- if you look at how mortgages are trading every day, before the Fed comes in, you don't really -- they sometimes cheapen, they're sometimes tighter. But really, the Fed has an impact on the prices of MBS during the trading day. And then immediately after the Fed comes in and does their operation, the market has been sort of subject to the whims of originators and other investors and so on. So as we see the trading develop on a daily basis, we're finding pockets of opportunity where there's nobody else providing liquidity for the sector, and you can actually go in there and buy bonds at really good levels. So it's kind of a micro trading day strategy type of environment at this point. So we are finding good windows to add assets, even though broadly, you might say, yes, the Fed is in, mortgages are tightening, blah, blah, blah, there are still these windows that are being created because of the microstructure of the market.

So we are absolutely willing to take the leverage up, and we follow this stuff on a minute-to-minute basis. And if it meets levels, dollar price levels, OAS spread levels that we like, we jump in and put the capital to work. We're talking about the steepness in the yield curve only more as a more broader long-term thought process again here, right? So if the curve steepens, we do expect to see extension in mortgages. We do expect that at that point there'll be an opportunity to take more duration risk because you can really say, okay, look, I'm taking that long end risk. I know the front end is anchored, but then again I think we're going to be fighting with like 99% of other investors in the globe at that point. So whenever -- so we're cautious not to just sit around and wait for something like that to happen. If we see good opportunities to put the money to work, we're going to do it.

Okay. That's fair. And between now and the achievement of some medium-term ROE target, how willing are you to let core NOI sort of snake around the dividend? And how does that relate to setting the dividend?

I'll take the -- my level question, then I'll turn it over to Byron. But again, I think at this point, right, we're going to be putting the capital to work in a disciplined manner. And so core income could be below the dividend for some time and then maybe work its way up. I think at this point we're just trying to be focused on capital preservation, making sure we're not running out over our skis. And then finding those good opportunities to buy the assets. We think we have -- we're going to have the chance to do that in here.

The other point here is, if you haven't recognized, the two were separate. And there's no steel rod attached between the core and the dividend, and it's a smart decision. For risk management, managing for the long term, it's a smart decision. Our job is to generate core income, cash income, for our shareholders. There are options for -- or earning cash income are dwindling globally. So we're well aware of that. And when you read into -- what should you read to do the holding the dividend in May, shouldn't read anything really into it except respectful of our stakeholders. And remember, again, back to what I just said, short, medium and long term. In this short term, next 4 to 8 weeks, we're going to digest an enormous amount of information, so will you and so every other market participant globally. As the virus evolves, as the economy evolves, more bankruptcies are filed, et cetera, et cetera, we can come up with a gazillion questions. But we've been very disciplined in our risk management process. That includes what level do you have your dividend versus what level do you have your core income. Positive for us is that financing costs are anchored at the lowest levels. We know we can make money. Now we need to be very disciplined risk managers so our shareholders can stay in the game over the long term.

Your next question comes from Matthew Howlett from Nomura.

Byron, first of all, let me congratulate for the job in the quarter, it really where it stands now, you're probably going to have the best performance of any mortgage REIT. So I want to lead off by asking you about capital management here, obviously, the dry powder. I want to talk about buybacks. Stock, obviously, whether you're like it you or not you're grouped in this, you're in this mortgage REIT space, right? The space is dislocated, everyone's got a big discounted book, you guys included even with the performance, the out performance, how do we think about buybacks? And then you're going to have -- based on the dividend policy, you're going to have this yield so much higher than everybody else. I mean based on what we can tell, what's the -- how long are you willing to do that if you're not going to be rewarded by the capital markets for it with -- I'm assuming you'd like to grow over time. So just talk a little bit about capital management and being grouped in this space here that's really dislocated?

Yes. First off, the hold in dividend in May, again, is not that much money. The great thing about having a monthly dividend is you're getting up-to-date information. We can be more precise about our adjustments and shareholders can get a monthly payment, but it's just not that much big of a deal from a capital management perspective. We're not necessarily holding it here to get some type of reward for it. What we are, though, is, as we said earlier, a phased approach in analyzing the current risk environment. So that's literally what it reflects. We're in this phased approach in terms of analyzing the overall risk environment. So buybacks, we have the ability to manage, as we said, some time ago, we look at both sides of the balance sheet. We'd like to aggressively manage both sides of the balance sheet. If we make a decision to invest $1 into an agency mortgage backed security, we will also be evaluating why shouldn't we take that dollar and buy back stock or buy back preferred. So we're pretty disciplined in our process in terms of how we think about that. And really think about -- if you think about Dynex Capital, think about the fact we have a long-term vision, which absolutely is essential that we're very, very disciplined risk managers. And so we're in a period for the short term everyone happens to pay. We're in a period where we are assessing the overall global environment and what's the overall best risk reward and positioning of our portfolio that we should take.

Smriti, Steve, do you want to add any more specifics around this?

I think the only other thing to say here, Matt, is just the performance is the foundation on which we build our future ability to grow. And then the second thing is just that the business model itself, as Byron mentioned, they're just long-term positive factors here that you can put together a nice stream of income, one that we think is an above-average return, and over time that is something that's still in demand in the globe. So lots of fundamental long-term positives, I think that will be good for the business model. In the near term, it isn't going to be clear to everybody. But over time, I think that starts to differentiate and probably will drive...

My point was just on the capital markets, the cost of capital, you're internally run, you're already focused clearly, clearly -- I would assume you like to grow long term the size of the company. I was just curious.

Yes. Yes. We would like to grow over the long term.

And just for your structure, you should be able to. I remember following the financial crisis, there a lot of mortgage REITs that raised a lot of money and grew significantly. And I just think that Dynex is well positioned to that, but you're, again, the equity markets aren't cooperating, [firm] markets aren't cooperating. And it seems like buybacks really stand out here today. And on that note, I mean with the CMBS gains, is there going to be this taxable income requirement or some of the gains? Or is that kind of offset -- going to be offset by some of the marks in 1Q of the derivative losses in 1Q. Just curious on taxable REIT, taxable income, which everyone obviously has to abide by?

Yes. So Matt, let me take that one. Last year, we did have some return on capital. This year, the first quarter dividend character would be all capital gain. The way the tax rules work on derivative transactions, your hedges that you lift, they're amortized over the original period of the hedge. So there were some carryforward amortizations from prior years that will offset some of these gains that we may be taking. So I would think about it as the character for the first quarter is capital. The character for the balance of the year will depend on sort of further transactions from this point forward, depending on sort of the size of what we might sell going forward.

Your last question comes from Jay Weinstein from Wealthspire.

So this company in its current form was really, as you mentioned earlier, Bill, in a rapid kind of buildup of the portfolio in 2009 and 2010. Having gone into that 2008 period, if I remember correctly, about 0.6:1 leverage or something like that. And then you really became a much more normal REIT in a pretty quick fashion, if I remember correctly. It's hard -- and now you're at a low leverage position, not under 1:1, but quite low compared to the industry. But it's hard for me to foresee both your comments and with the world, like any kind of catalyst or trigger that would say, okay -- the trigger buyer inspired you to say, okay, we're actually going to take up asset size, take up -- go down in liquidity down in credit, like you mentioned. Can you see anything like that in that environment happening? Is there any way that comes to fore?

No. Let me start. I'm going to let Smriti chime in. So let's compare, let me make a comparison to what happened in '08. So let me tell you exactly what we did in '08. So we started rebuilding this portfolio in January of 2008, and we were in the middle of a crisis. We deployed an agency mortgage-backed security strategy for the first year to 1.5 years. Now -- and while we did that, we always made it clear that we were not an agency-only REIT. We felt, given that risk environment, not only did we deploy an agency-only strategy, we deployed a short duration agency-only strategy leaning on [arms]. Now what was the big difference between then and now? Huge difference. The curve was steeper. The Fed took rates to 0%, but there was an enormous amount of steepness in the curve. In fact, you should run on Bloomberg, just go back around 2008 versus today, run the yield curve, it's amazing when you see that huge differential.

Now there's still plenty of money that can be made today, but that is a big, big, big difference. Here's the other issue with the 2008 situation, and I think if you go back to that first annual meeting that I remember I spoke at, at that point, the crisis had blown up. We knew what the situation was. We knew there were bad loans being made. We knew they were in the subprime arena. And it had blown up and because it was an endogenous shock, I mean, it came from inside of the system, we could actually make predictions from that. So the other big difference, endogenous versus exogenous shock, we have a shock that is happening outside of the system it's a health crisis, of which none of us happens to be a doctor or scientist or research professional. So it is a huge difference in terms of how you perceive the risk today versus at that point in time. But again, let me go back and recount history. We went into an Agency strategy for about 1.5 years, and then we moved into a CMBS strategy using really only AAA securities.

Then a few year -- a couple of years later, maybe a year or 2, we will start to go down in credit. We went down into the BBB sector. We went down into some non-A rate -- unrated securities, and there were phenomenal opportunities. In fact, we were the only ones purchasing at points in times in terms of IO, multifamily securities. We didn't have any competition. It was unbelievable.

This time around, the Fed stepped in immediately. They stepped in with a ginormous bazooka. A lot of those opportunities have literally been nullified because they've put enormous matches underneath the corporate market, they put it underneath the loan market, they put it underneath the -- there's still some lingering areas in some non-agency unrated CMBS or RMBS. But it's still not enough yield. Well, the overall macro risk that you're still taking is with this exogenous shock that's still creating this uncertain global economic event.

So I'm hoping that I'm giving some real play-by-play of what the difference is now versus the strategy that we deployed in 2008. That strategy was absolutely designed for 2008. This strategy is designed for today. And one of the big issues today is, for the next 4 to 8 weeks, we're going to find out about this virus. We're going to find out about the economy. All we know now is that we try to stop the economy, but do we really know how many people are going to be permanently fired? How many are not going to pay rent? How many are not going to pay their mortgage? So if we take our leverage up to 9x leverage, you know what we would be telling you right now, we do that tomorrow, we know exactly what's going to take place. And we just don't think we should do that for you, Jay. You're a long-term shareholder in Dynex. You've been around a long time. We believe the key to this business model is longevity. So I'm glad you asked the question. There's a direct comparison between 2008 and today. I could keep going. I could tell you every single investment and every thought process we had back in 2008 versus what we're thinking today.

I keep telling people, I say, they're totally different. I said that was a financial crisis that at the end of the day had a much less of an effect on the real economy for a shorter period of time while they bailed out the financial system. This time, the financial system has worked incredibly well, given the stress on it. But as you say, this is an exogenous force that we don't really have any ability to forecast much of anything with. I think I agree with everything you just said.

We have no further questions. I turn the call back over to the presenters for closing remarks.

Thank you all so much for joining us on our call today. You can -- there's a lot to talk about. It's simply a fascinating moment in history. Again, at Dynex Capital, we're playing for the long game. We believe the best success will be if we can stay in the game, our shareholders can stay in the game, our creditors can stay in the game and all of our stakeholders can stay in the game. Thank you, again, and we look forward to you joining us at our next conference call.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.