Dynex Capital Inc (DX) 2004 Q4 法說會逐字稿

Welcome to the Dynex Capital incorporated 2004 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a a question-and-answer session. At that time, if you have a question, please press the one followed by the four on your telephone key pad. As a reminder this conference is being recorded, Friday, March 18, 2005. Your speakers for today are Mr. Tom Aiken Chairman of Dynex Capital Incorporated, Mr. Stephen Benedetti, Chief Financial Officer of Dynex Capital incorporated. I would now like to turn the conference call over to Mr. Stephen Benedetti. Please go ahead, sir.

Thank you, operator. I will spend a few minutes at the top end of the call here talking about results for the quarter and then I will turn the call over to Tom for a discussion of strategic issues and the outlook of the Company. I do appreciate everybody's attendance on a Friday afternoon call. We will try to make Friday afternoon calls the exception and not the rule going forward.

First, let me review the customary Safe Harbor statement and the SEC rules regarding the use of non-Generally Accepted Accounting Principles, or non-GAAP financial measures. I will review the forward-looking statement disclosure first. This conference call may contain forward-looking statements within the mean of the Private Securities Litigation 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 materially from those projected in or contemplated by the forward-looking statements as a result of unforeseen external factors. These factors may include but are not limited to changes in general economic and market conditions, disruptions in the capital markets, fluctuations in interest rates, defaults by borrowers, defaults by third party servicers, the accuracy of subjective estimates used in determining the fair value of certain financial assets of the Company, the impact of recently issued financial accounting standards, increases in overall costs, and other general competitive factors. For additional information, see the Company's quarterly report on form 10-Q currently on file, and that's for the quarter ended September 30, with the Securities and Exchange Commission, and then of course our annual report on form 10-K, when we do file it. And then in regards to non-GAAP disclosure information we will attempt to reconcile any non-GAAP numbers on this call and in our filings with the SEC to GAAP.

Let me briefly review the highlights for the quarter. Net income for the fourth quarter was 15 million. Net loss for the year actually was 3.4 million. Net income to common shareholders for the quarter was 13.7 million. And there was a net loss to common shareholders for the year of 5.2 million. The fourth quarter results include several nonrecurring items. First, as we alluded to or disclosed prior and talked about in our last conference call, we sold redemption rights on our manufactured housing securitization for 11.9 million which resulted in a gain of 17.6 million, and a derecognition of 217 million in securitized finance receivables, and 225 million of associated securitization financing bonds. We also recorded a $4.9 million adjustment to the carrying value of a delinquent property tax receivable security. In effect adjusting the carrying value to the estimated fair value of that security as a result of our ongoing efforts to sell the security and the associated servicing operations which are located in Pittsburgh, Pennsylvania.

Excluding those items, net income was 2.3 million, for the quarter, or approximately $0.19 per common share. As for a comparison, the third quarter net income excluding nonrecurring items was approximately $2.5 million. Let me briefly touch on the issue that we noted in our press release regarding provision for losses, for loan losses. This quarter, the provision for loan losses includes approximately 1.1 million where the Company does not retain the credit risk on the loans that such losses are provided for. And I'm going to do my best here to explain a fairly esoteric accounting issue.

We had previously believed that the GAAP -- that GAAP would recognize the mitigation of the credit risk on the pool of loans pledged to securitization trusts. Our securitization structure mitigates credit risk to the Company as well as interest rate and liquidity risk. However, after consultation with our independent auditors and the SEC, we now know that GAAP requires evaluating the assets pledged to a securitization trust separate and distinct from the liabilities created by the trust. This will require us to continue to provide for losses on loans even where we do not have the credit risk. Ultimately, there is going to be a a mismatch in the timing and the recognition of current estimated losses on the collateral versus the recognition of the transfer of the credit risk on -- on those assets to the holders of the securitization financing bonds. The recognition, the risk transfer for GAAP purposes actually does not occur until the loans are actually liquidated at cumulative losses in excess of our investment in the trust, which results in the legal extinguishment of the bonds by the trust. The losses on the loans that are estimated in our financial statements may or not happen -- may or may not happen, but GAAP requires us to accrue for them if they are probable and reasonably estimatable. And that is actually consistent with our -- has been consistent with our accounting to this point.

Bottom line is, is we will report provisions on losses on loans in the income statement one period, and then gain on the extinguishment of debt as realized -- as the debt is extinguished and as loan losses are realized in a subsequent period where the actual credit risk for those losses is not borne by the Company. It is important to note there will not be any impact on the cash flow off these structures as a result of this issue, or the Company's economic interest in these structures. We understand that others who are using financial accounting -- financing accounting where you present the assets and liabilities on your balance sheet, instead of gain on sale accounting or experiencing similar issues, and it's certainly our hope that perhaps the FASB or the SEC will address the disparate GAAP reporting with the economics of the transaction at some point in the future.

Turning back to the results of operations for the fourth quarter, if you -- the impairment charge item I already mentioned was -- we reported 5.2 million, 4.9 of which related to the tax lien security in our portfolio. The impairment charge taken against that. G&A sequentially continued to decline this quarter from reductions in our tax lien servicing operation. Principally really from the sale of the Ohio portfolio which occurred in the third quarter. In terms of the remaining tax lien assets, we will continue to manage the collection process, as cost efficiently as possible. I think the fourth quarter of 2004 provides a decent trend line for the Company. However, just like every other company that's a public Company these days, we're likely to see increases in expenses as we begin to address the requirements of Section 404 of Sarbanes-Oxley.

In terms of cash flow, cash flow excluding sales proceeds for the quarter was 6.8 million. Through February, of 2005, so for the first quarter thus far, we've had 4.3 million of cash flow from the investment portfolio, absent sales proceeds, so you can see that there is some modest sequential decline as the Company is generally reinvesting cash in very short-term instruments as opposed to meaningfully redeploying cash and investment opportunities. Our cash flow continues to predominantly come from our securitized financed receivables portfolio. We may see some continued decline as rates, LIBOR rates increase from fed tightenings. But most of our assets and liabilities are match funded, we think that risk is really well in hand for the Company.

As the investment portfolio is currently structured, our cash flows will remain more sensitive to the credit performance of the underlying assets and less so to the interest rate environment. From a balance sheet point of view, our balance sheet of course continues to shrink from prepayments and asset sales, we believe the balance sheet is becoming much more transparent, and of course, we believe that the monetization of assets that occurred in 2004 has improved our financial flexibility. At the end of 2004, our securitization finance receivables securitized finance receivable portfolio which is the largest portion of our investment portfolio consisted of approximately 348 million of single family loans, 640 million of commercial mortgage loans, and 348 million of manufactured housing loans. Of course, all of these assets are pledged to securitization trusts and collateralize the securitization financing that is shown as a liability on our balance sheet.

Investments in securities increased from last year to this year, but also last quarter to this quarter, as we purchased a short duration MBS with a little bit of moderate -- with modest recourse leverage in order to enhance the earnings on some of our investable capital. The other investments line item at the end of the year is substantially our remaining investment in the Pennsylvania tax liens are, and the other loans line item on our balance sheet approximately half of those loans are single family whole loans, and the other half are commercial mortgage loans.

Shareholders equity at the end of the year was fairly flat to the beginning of the year. As was book value per common share. But as we mentioned in the press release, the quality, if you will, of the shareholder's equity improved solidly in 2004, as almost half of our equity, if you will, is -- today is cash or is invested in highly liquid -- what we believe to be highly liquid instruments and of course during the year we eliminated the preferred dividends in arrears during the year as a result of the recapitalization of the preferred. In terms of the risk to the balance sheet from an economic point of view, credit risk is the predominant risk to the remaining investment portfolio today. Principally as a result of our retention of overcollateralization residual interest in our securitized finance receivables securitization structures.

If you look at it from a GAAP point of view, our net unreserved credit risk in our securitized finance receivables structures is approximately $40 million. That predominantly relates to our commercial mortgage loan portfolio and we will continue to likely add to the reserves on a quarterly basis for the commercial mortgage loans and then obviously the issue -- the accounting issue that we addressed previously will continue to be adding for reserves on our manufactured housing loan and portfolio. That concludes my remarks, so I will turn the call over to Tom now to discuss outlook.

Great, Steve, thanks. Good afternoon, everyone. Last quarter, on our call, I gave you an overview of what we had accomplished at the Company since the end of '03. And today, I would like to highlight just a few of those things that we finished 2004 on, and also focus on what our objectives are going to be for 2005.

For 2004, big picture, we were successful in shoring up the balance sheet of the Company, and preparing our balance sheet and its investment portfolio for a rising interest rate environment. Obviously, recapitalizing our preferred stock and eliminated the dividend in arrears on that preferred was at the top of the list. But let's consider also in 19 -- in 2004 other things that were done. One, we improved our cash and cash equivalents by $45 million. Increased it to $52 million at the end of the year. And we have it invested in additional 10 million of capital in highly liquid securities.

Let me outline those securities briefly. These include a short duration high credit quality MBS investment and a stock, a mortgage REIT stock. With modest leverage, we estimate about a 10 percent return on the MBS transaction, and an annualized total rate of return so far on the REIT investment of over 20 percent. So during -- during 2004 we also sold our tax lien portfolio for 19.2 million. And rationalized the remaining tax lien servicing operations in Pittsburgh. Finally, we monetized our redemption rights on certain of our securitization financing bonds, netting cash proceeds to the Company of over $19 million. And those -- a lot of those monetization of those redemption rights were done in a very timely manner. Overall, we were very successful in not only strengthening the balance sheet but also in improving the transparency of our financial position and results for the shareholders. Although we're quite pleased with what happened in 2004, the work is not yet done on the Dynex balance sheet and we are going to be focusing on a number of items over the near term.

Let me go over those briefly. Number one, as we've mentioned before, our SASCO 2002-9 securitization will be redeemable later on this month. This securitization has performed exceedingly well for us and we will almost certainly redeem this deal and securitize the underlying loans or simply reissue the bonds at tighter spreads than the deal currently has. We have been looking to grow the deal with new loan purchases, but to date have not found a complimentary pool of loans that we are comfortable with the credit and prepayment risk in the pool versus the price.

Two, we are actively marketing our remaining investment in the Pittsburgh tax lien portfolio. Although it represents only a small portion of our investment portfolio today, it is still something that we would like to sell if appropriate. Given the age of the portfolio, it will take some effort to sell it. Three, we will look for ways to continue to simplify the balance sheet and address issues that we believe obscure the economics of the Company. Like the issue that Stephen has just mentioned previously, regarding the reserving for loan losses for GAAP, even where we do not retain the credit risk.

Four, we will be focused on becoming compliant with Section 404 of the Sarbanes-Oxley act. And finally, we do not view today's environment that we should be stretching for yield with our available capital. We believe investors and fixed income instruments are not being properly compensated for the risk inherent in those investments. And are compounding those risks by using recourse leverage. We will not subject ourselves to these risks but will instead be opportunistic. For the near term, we continued to invest current cash in lower risk, highly liquid investments.

Finally, I would like to talk a little bit about areas of strategic importance to the Board and all investors. First of all, dividend policy. Currently, Dynex does not -- cannot pay a dividend as a preferred D covenant prevents any cash payment to the common until total equity is three times the Series D preferred outstanding. This covenant coupled with the advantage the Company has from utilizing the net operating losses first means that we will likely not pay a dividend for the foreseeable future. Second, our net operating loss strategy. The Company currently has a tax net operating loss carry forward of an estimated $135 million. These NOL's have a life expectancy of 20 years. With most not expiring until 2019. Until the time that these NOL's have been used, any taxable income generated by the DX portfolio will accrue effectively tax free.

The Dynex Board feels that the NOL is a very valuable asset to Dynex shareholders. And the ability to compound our capital essentially tax free offers substantial value to our shareholders. To put this into perspective, if we were a tax-paying entity, the current 130 million in NOL's assuming a 40 percent tax rate, is worth approximately $52 million. Or for Dynex, over $4.00 per share. Again our projections indicate that Dynex will utilize this net operating loss before they expire in 2019.

The Board or committees of the Board remain actively engaged in reviewing strategic alternatives for the Company. We hope to be giving more guidance as to the longer term direction of Dynex over the next several quarters. And finally, as I mentioned on the call this last quarter, I am the largest shareholder of Dynex common and preferred. My interest is in maximizing Dynex shareholder value. The Board and management have worked tirelessly to stabilize and strengthen Dynex positioning it to move forward as a public Company and give shareholders a solid expected return. We will not take undue risk to shareholder capital, and will balance risk and return opportunities, for all shareholders. I'm excited about the future of Dynex and feel that over the next several quarters we will show our ability to reinvest Dynex Capital in an intelligent, shareholder friendly manner. I appreciate our shareholders continued support in this endeavor and now I'd like to open up the call for questions.

Thank you. Ladies and gentlemen, if you would like to register for a question, or a comment, simply press the one followed by the four on your telephone. A three-tone prompt will acknowledge your request. If your question has been answered and you would like to withdraw your registration simply press the one followed by the three. If you are using a speaker phone we ask that you please lift your handset before entering your request. Our first question comes from the line of Jeff Porter. Please proceed Mr. Porter. Your line is now open.

Hi, guys. Tom, a question. Do you have an estimate on what the book value would be if those reserves that we have needed to take on the securitizations where we don't really bear the credit risk, if those were not -- not taken or if those assets were liquidated?

I believe, correct me if I'm wrong, Steve, that the risk -- I mean the reserves that we took were just the 1.1 million in the fourth quarter. Is that correct?

Yes, that's correct, Tom.

So Jeff, the book value would only be increased -- if we were to let's say close that securitization and take it off our books, we would have to recapture $1.1 million provision, that would be it at this point, but we are going to be taking these reserves each quarter going forward, so they actually, the difference is going to get wider as we go forward, unfortunately.

Okay. Thanks.

Thank you. Once again, ladies and gentlemen, as a reminder, to register for a question, or a comment, simply press the one followed by the four on your telephone key pad. Our next question comes from the line of Jay Bleen, Private Investor. Please proceed.

On the 57 million in repurchase agreements, would that be affected going forward if you are to do another deal, once you take these GAAP accounting on your losses and the collateral?

Jay, this is Steve Benedetti. The answer to that is there is -- that 57 million finance is the high credit quality short duration security that we have been referring to on the call so that would be separate and distinct from any resecuritization. The weighted average life of that security right now is probably around 10 months. So that repurchase agreement will be paid as that security is repaid, it wouldn't be part of any of our resecuritization thoughts on the SASCO transaction.

No, my question is, once you stop the GAAP accounting, on the losses in the collateral on the whole portfolio, will you still be able to account -- the counter party in a repurchase agreement?

Oh, I'm sorry, yes, I think the answer to that is yes. There is a timing difference, and over time, depending on the requirements of the reserve requirements for the various collateral types that we have, that timing difference could get much larger than 1.1 million. However, as I mentioned, it doesn't impact the overall economics or cash flow of the Company, and I don't think that that's certainly the counter party that we're dealing with and having discussions with on repos understand the nature of securitization and understand the limitation inherent in those structures on the credit risk and the pool of assets that you pledged. So I would say the answer to that is I don't see that that -- that issue causing us a problem.

Okay. In a separate matter, in your manufactured home collateral, say you have $3 million of REO, how much are you recovering of that loan principal in the REO?

I think our loss severity, Jay, in the last quarter were somewhere around $0.80 so it would be $0.20 on that.

Okay. Thank you. That's all I have.

Okay.

Thank you. Our next question comes from the line of Jay Buck from Lockwood Partners. Please proceed.

Hi, guys. I just -- it is not really a question, it's just a comment, I would say as a long-term holder that I think this strategy that you've undertaken over the last year has been very prudent, and I think it's well directed, and I think you guys have done a strong job, I think that there are a lot of risks, in the marketplace, and I think both you fellows and the Board have handled this and all the problems we've had and some of the directions that we are taking going forward in a very strong way and I just want to pass that thought along.

Great. Thank you, Jay. We are pretty happy with what happened in '04, and as you can see, we still have a lot of things to do in '05, and let's just hope that we can continue to earn your confidence.

I feel good about that, too.

Thank you.

Thank you. Our last question comes the line of Todd Amaf from Freedom Asset Management. Please proceed, Mr. Amaf.

Hi, guys. Two questions. The first one is on this -- what is it, 62 million of AAA-rated fixed rate things that we buy interest bearing one year, what exactly is that?

It is a AAA-rated security off of a SASCO transaction, it wasn't on our SASCO transaction, but it is the top class on that transaction.

Okay. And then I'm sure that will be in the 10-K, right?

Yes, --

I think Steve told you also it had a very short duration and it's AAA rated, right?

Yes, I'm sorry, it's a AAA-rated class, and it has a weighted average life of somewhere around 9 months.

Okay. Good. Good. And then another question, I don't know if you're going to get -- know the answer to, this sort of like be my accountant for a minute, and I left Steve a voice mail about this but it was too close to the conference call to get it, on the dividend which is, what, 48 percent tax free, or return on capital, I was wondering if you happen to know the last dividend, the third dividend, the one that was declared in December and paid in January, I don't know, if you can tell me on your 1099 -- on my 1099 that shows as a 2004 payment, so it's going through the government as a 2004 payment. But does not have the split. It's all ordinary income on my 1099. Do you know anything about that?

I'm glad you brought that to my attention. That dividend in December was not meant to be a 2004 elected dividend. It was -- so I will have to follow up on that. You're the first person to call me and tell me that. Most everyone else has told me the other way. So I will have to check on your dividend 1099 specifically.

All right. Great. I'll call you after the call is over. Thanks, Steve.

Todd, you might want to check the brokerage statement, because I get a few of those dividends and all mine -- my December shows up as -- it doesn't show up in the '04 statement.

Yes, that's what it's showing on my, on my brokerage statement is '04 which could be wrong by my brokerage. But I'll get with Steve after and find out about that.

Thank you. Gentlemen, there are no further questions at this time. Please continue with your presentation.

Well, finally, I would like to thank all our shareholders for your confidence in Dynex. We are very happy with the job that everyone did last year. Steve's team did a fabulous job. And we look forward to more activity in 2005 and once again, we appreciate your continued support. Thank you much.

Thank you. Ladies and gentlemen, that does conclude our conference call for today. We thank you for your participation. And ask that you please disconnect your line. And have a great weekend.