Dynex Capital Inc (DX) 2005 Q1 法說會逐字稿

Welcome to the Dynex Capital Inc. first-quarter earnings conference call. During the presentation all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Thursday May 12, 2005. I would now like to turn the conference over to Stephen Benedetti, Executive Vice President and Chief Financial Officer. Please go ahead sir.

Thank you, everybody. Welcome, everybody, to our first-quarter earnings release conference call. With me on the call today is, obviously, Tom Akin, our Chairman. As we have done in the past, I will review the results for the quarter and then I'll turn the call over to Tom to discuss our outlook and some strategic issues.

Before we start, let me review the customary Safe Harbor and forward-looking statement disclosures. This conference call may contain forward-looking statements within the meaning 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 costs, and other general and competitive factors.

For additional information see the Company's annual report on Form 10-K for the period ended December 31 as filed with the Securities and Exchange Commission, and the Company's quarterly report on Form 10-Q for this first quarter which should be filed with the Securities and Exchange Commission within the next several days.

Let me briefly touch on the first-quarter results. Of course, net income as we reported was 934,000 with a net loss to common shareholders of 403,000 after consideration of the preferred stock dividend which is $0.03 per common share. This compares to first quarter last year which was a net loss of 5.4 million and a net loss to common shareholders of 6.6 million, or $0.60 per common share.

Net income improved from year-over-year as a result of an improvement in our net interest income after provision for loan losses and a decline in impairment charges, primarily as the result of the sales of our securitized manufactured housing loan assets at the end of 2004, and again this month, May of 2005, as we were able to use the results of that sale in preparing our analysis for reserves for the first quarter of 2005.

Provision for loan losses this quarter does not include any amounts related to credit risk retained by others. You may recall from our release last quarter, the fourth-quarter earnings release and the conference call, that we had to provide additional reserves even for credit risks that we did not retain. With the sale and recognition of the remaining manufactured housing assets, this is really not an issue for this quarter and we would not expect it to be an issue for at least several more quarters.

Provision for loan losses for the first quarter of 2005 was actually almost entirely for our securitized commercial mortgage loan portfolio. We have been providing approximately $1 million per quarter over the last several quarters for those assets, and this quarter we include an additional 1 million in reserves for a large past due commercial loan. Our expectation is that we will return to a normal run rate beginning in the second quarter.

At the end of the first quarter, just to give you some sense of our reserve balances, we had a total aggregate balance sheet commercial loan reserves of 18.5 million relative to past due loans of approximately 37.6 million of principal. And our aggregate commercial loan balance at the end of the quarter as reported in our press release was $621 million. In the last four quarters, we have had 113 million in commercial mortgage loans liquidate with an aggregate loss to the Company of approximately $1 million.

Regarding our single-family loan portfolio, because of the seasoning of these assets and the excellent credit loss experience, as well as some credit enhancement within the securitization structure, we are providing only very modest amounts of loan loss reserves on a quarter-to-quarter basis.

In terms of our G&A expense, turning back to the results, the G&A was 1.5 million for this quarter versus 2.5 million in the first quarter of last year, really reflecting reduced staffing levels and reduced litigation expense. Recall that last year at the end of last year we sold our investment in our Ohio tax lien pool as well as the associated servicing operations. And also recall that during the first quarter of last year we were down in Texas with litigation related to some of our old commercial origination operations.

About 40% of our G&A today relates to our Pennsylvania tax lien servicing operation. As you know, that business -- we don't consider it a core asset for the Company at this point. And that business is being marketed for sale. We do expect G&A expenses to decline for the second quarter as a result of further reduction in headcount in our tax lien operations from last quarter to this quarter, and that would be absent any unexpected expenses related to professional fees, most notably costs related to Section 404 Sarbanes-Oxley compliance.

In terms of our cash flow, cash flow excluding sales proceeds was 6.6 million and 10.8 million including sales proceeds from investments. As our portfolio declines from runoff in asset sales, cash flow will sequentially decline, of course, until we meaningfully reinvest our capital. We did utilize a meaningful amount of our capital -- available capital in April, which I will discuss a little bit later, to redeem our single-family mortgage loan securitization transaction.

Today we have approximately 45 million in cash and cash equivalents and approximately 32 million of capital invested in highly liquid single-family MBS assets that are financed with repurchase agreement financing. 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. This of course could change depending on our reinvestment strategy.

Turning to our balance sheet, obviously, our balance sheet for the first quarter shrank compared to where it was at the end of last year. Our investment portfolio consisted at the end of this quarter of approximately 325 million in single-family assets, 621 million in commercial mortgage loans and 338 million in manufactured housing loans. Today, after the sale of the manufactured housing assets, our investment portfolio consists of 273 million in single-family mortgage loans and 616 million in commercial mortgage loans.

Our balance sheet continues to shrink on an overall basis but our capital remains stable or grows as we monetize assets in excess of our reported book value. As indicated, we redeemed our single-family securitization, which we refer to as our SASCO transaction, during April of this year. In connection with that redemption, we invested 25 million of our capital and used 170 million of repurchase agreement financing to fund the redemption. The redemption will result in an effective 25 basis point reduction in our financing costs. And when you look at it from the perspective of the $25 million in capital that we invested to redeem that asset for that securitization, we expect to earn approximately 6.5% on that invested capital while the transaction is on repo. At this point, it seems unlikely that we are going to resecuritize these assets as we have been unable to find assets which we believe are complementary and which generate acceptable risk-adjusted returns for our capital that would be invested.

On our financing side, at March 31 we had 1.13 billion of non-recourse securitization financing. With the sale of the MH (ph) assets and the redemption of our SASCO transaction, that number should decline to approximately $565 million, actually at the end of -- that would be pro forma at the end of March.

The commercial -- of that 565, that is all the commercial mortgage loan securitization transactions. And of course, those are match funded structures, fixed rate assets and fixed rate liabilities. And our single-family assets now are funded with repurchase agreement debt, which, again, on a pro forma basis would increase at March 31 by 170 million to approximately $230 million.

In regards to other investments in our portfolio that we have not yet discussed, our tax lien investment at March 31 is approximately 6.7 million and we have 5.5 million in other commercial, mezzanine and single-family whole loans, of which the Company expects to sell 2 million of such loans at a gain this quarter, this upcoming second quarter of 2005. And as a result of our sale of the manufactured housing loans, we will retain a modest servicing strip from the sale of those assets.

At the end of March, our shareholders equity had declined from 145 million to 149 -- from 149 million from an adjustment to other comprehensive loss of 3.9 million on a security backed by the manufactured housing assets we discussed above before. At the end of May, the Company expects GAAP shareholders equity to exceed $150 million. At March 31, our reported book value is $7.28. But adjusted for the completed transaction to sell the MH assets as we indicated in our press release, our pro forma book value is $7.94, which is actually a $0.34 per share increase over December 31, 2004.

On a very summarized basis, today our approximate 150 million in shareholder equity capital is invested in the following manner. We have 45 million of cash and cash equivalents. We have 32 million of our capital in AAA and AA-rated liquid single-family residential mortgage-backed securities. And those assets are financed -- that capital is basically invested to finance those assets with repurchase agreement financing. We have 14 million of unleveraged subordinated whole loan seasoned single-family residential assets. We own 46 million in subordinate tranches and CMBS transactions, with the balance of 12 million being our tax lien investment, equity securities, and the unrated commercial whole loans.

In terms of the risk of the balance sheet -- and to our capital, credit risk is the predominant risk remaining in the investment portfolio today as it is currently constructed, and as we discussed above that's principally in our commercial loan securitization transactions. As we have discussed on prior calls, GMAC commercial is the primary servicer and special servicer on these assets. And we work very closely with them on managing the risks in these assets. We still have modest amounts of interest rate risk in our balance sheet, but our assets are substantially match funded and we believe that liquidity risk that we have retained in the balance sheet is very manageable.

That concludes my comments. I'd like to turn the call over to Tom to discuss outlook and strategic issues.

Thank you, Stephen, and good afternoon, everyone. Last quarter on our call, I gave an overview of what we hope to accomplish in calendar year 2005. If you recall, those objectives included -- redeeming the SASCO 2002-9 asset securitization; number two, selling our remaining tax lien assets; three, simplifying our balance sheet that has obscured our economic results versus reported results; and finally, number four, becoming 404 compliant.

Year-to-date, I am pleased to say with this release that we have made good progress toward those goals. As Steve mentioned, we redeemed the SASCO securitization and put to work over 25 million in capital at a yield of around 6.5%. The transaction that Steve described completed May 9th should remove almost 400 million in non-core assets from our balance sheet that threw off very little in cash flow, and realizing a book gain of almost $8 million on those assets and cash to our balance sheet of 9 million. Furthermore, most of those assets sold were manufactured housing assets and securitizations -- again, of little value to Dynex shareholders. I think that goes a great way to reducing or eliminating all our manufactured housing assets.

We continue to search for the right transaction for the tax lien portfolio. While we have nothing to report this quarter, we remain optimistic that we can complete a transaction in the future, although our capital commitment now to tax liens is to around 6.7 million, plus our quarterly collection expenses. Finally, on the 404 area, given the likelihood that we will be an accelerated filer as of June 30, 2005, we will have to be Section 404 compliant by the end of 2005.

Looking forward strategically, the Fed has continued to raise interest rates this year. Many other mortgage rates have suffered decreases in book value and decreases in dividends as the yield curve has become flat and spreads have narrowed. We continue to believe that the environment for the leveraged carry trade is risky and the yield compensation insufficient for that risk.

Many of the mortgage REITs are trading below book value now, currently indicating concern for that business model. We will continue to be opportunistic near-term and invest our current cash in lower-risk highly-liquid investments, as Steve just mentioned.

We will continue to sell non-strategic assets as we have been doing for the last year and lower return assets. I want to congratulate Steve and his team for an excellent job in affecting several strategic sales for all Dynex shareholders. We still have a substantial amount of work to do to complete this year's goals, and I appreciate their focus on this important effort.

Finally, I would like to discuss a little bit of our dividend and NOL policy. I would like to reiterate that our posture on dividends and net operating losses are going to remain basically the same. Dynex is paying no current dividend. A covenant in the Series D preferred prevents any common dividend until total equity is three times the Series D outstanding. There is currently 55.6 million in D outstanding; multiply that by three and you get total equity required of approximately 166.8. As Steve stated, our current equity is slightly in access of 150 million. In addition, the advantage shareholders gain from utilizing NOLs should be utilized before dividends are resumed. Therefore, dividends are unlikely near-term.

Our current NOLs stand at almost 150 million. These NOLs will effectively shelter any taxable income for the foreseeable future. The Dynex board feels that NOLs are a valuable asset to DX shareholders and the ability to compound our capital essentially tax-free offers substantial advantages in our investing posture and value to our shareholders. To put this into perspective, if we were to be a tax-paying entity, the current NOLs assuming a 40% tax rate is worth about $4 per share.

Finally, I am very pleased with our progress year-to-date. As Steve mentioned, with the sale of many of our manufactured housing assets May 9th, we have simplified our balance sheet and increased our book value to almost $8 per share pro forma. We have reinvested over 25 million of that cash through the SASCO redemption at a very attractive risk-adjusted yield. We will not take undue risk to our capital to show short-term results, but will balance risk and return for long-term shareholder appreciation. While our progress is conservative and patience is demanded, I am excited about the future of Dynex and feel that over the next several quarters we will show our ability to steadily reinvest Dynex capital in an intelligent shareholder-friendly manner. I appreciate our shareholders' continued support in this endeavor. And now, I would like to open up the call for questions.

(OPERATOR INSTRUCTIONS). David Soshnik, Stifel.

Congratulations again on a good quarter, gentlemen. I just am back from Europe, so I am a little hazy. So, it was hard for me to concentrate but I tried very hard. Tom, I have a question relating to the NOLs and your discussion of them. Given the current environment, and I think you came to the conclusion based on a 40% tax rate the NOLs are worth $4 a share. Let's just assume for argument's sake that the current environment continues. What is the probability you're going to be able to generate income to use the NOLs over time?

As you can well imagine, we do a lot of modeling going forward. And we feel that we will be able to use those NOLs, David. Most of them don't expire until 2019. Now obviously, that is a long ways out there. And we certainly hope that we're going to be able to utilize them before then. But, they are going to be utilized. It's just a question of how quickly can we find investments of a suitable return that will accelerate their use.

Aren't the NOLs something like $120 million or something like that, if my memory serves?

I think they are closer to 150.

Okay, 150. What's your estimate of how much you'll use this year?

I'm going to defer that to Steve.

Tom, the sum total is 150. You're asking me to confirm that; so, that is right. And David, last year we had a modest net loss. Of course, we have access inclusion income. The transactions that we just completed with the sale of our manufactured housing assets and the redemption of SASCO will sort of change the tax dynamic at this company going forward, but I would expect that we would end up in a similar situation in 2005 as we were in 2004.

So that the NOLs will actually be larger at the end of this year than they were at the end of last year?

They will either creep up or maybe be flat, maybe flat taxable income this year.

And a lot of that, David, obviously, has to do with reserves that we continue to take on the remaining of the portfolio and just the nature of our transition from assets to cash.

I have one more question. Again, I have been sleep deprived. So, if my mind is a little slow, you will forgive me. But the question is this. Any thought to reducing the amount of preferred outstanding modestly in order to put yourself in a position where you could pay common dividends?

Absolutely. That will be something that will continue to come up at every board meeting. And I think that we have discussed that. And currently, we feel that there -- we have 150 million of equity, roughly. And we feel that there's a critical amount of equity that we have to keep at hand to be a substantive public company. If we were to retire let's say -- obviously, with the cash on hand we could retire all our preferred.

That wouldn't be what would be necessary to make the math work for the three times multiple though.

I understand that, but I'm using an extreme case for instance. But then that would drop our capital below 100 million. And I think as a New York Stock Exchange Company with Sarbanes-Oxley, all this and that, it just takes us out of the game, so to speak. So, we're trying to balance basically the requirement -- the required capital to remain a public company versus the cost of that capital. One of the good news is, in all honesty, is that the calling of the SASCO and putting a substantial amount of money to work at something higher than the Fed funds rate or the commercial paper rate has narrowed that negative arbitrage between our preferred and our return substantively. And you know, we still feel, David, that as we go through this year we're going to find some very interesting opportunities that we are going to be able to put money to work. Particularly as the Fed continues to raise interest rates, the environment is only getting better and better. We are just trying to be patient and use that capital when we can take the least amount of risk for the largest amount of gain.

But, you still a negative arbitrage. Isn't it 9.5 versus 6.5?

Yes. That's correct. We do. But, it's a lot better than 9.5 versus (multiple speakers) 3.

Jeff Porter, Porter Capital.

My question pertains to the reserve on the commercial loans, which I think you mentioned was about $18.5 million, and then there's 37 million of past due. What happens to those past due loans? Do they go to a workout group? How do they get either written down or written off or made whole?

This is Steve. Those transactions are, obviously, they're securitization transactions. So, there's an indenture with the attendant servicing and special servicing and master servicing agreement. But, basically GMAC (indiscernible) the primary servicer when those assets become delinquent, they are passed over to their special servicing group, which is tantamount to an asset management type function -- that GMAC is -- basically has responsibility, direct responsibility under the documentation to work that loan out, or make the decision to foreclose and repossess and sell the asset. They consult with us on those decisions because we have got that first lost risk on those assets. And in the case -- in the case of the 37 million, approximately 5 million of it today is basically a repossessed asset that is for sale. The rest are being worked through. And that may include forbearance agreements or some other modification, if you will, to the loan to keep that borrower in the game on that asset. So, there are a number of different avenues that these assets can go. And at this point, only 5 million of it is going to be a loan that will liquidate.

And what is the approximate loan to value on those 37 million, the past dues?

I would say -- I would answer it that, you know, if you're looking at the severities, the 5 million in loan that I'm talking about is a hospitality asset. The other assets are substantially -- that are past due are substantially office assets. And when you sort of look at what the rating agencies publish in terms of loss severities, you're seeing on that product probably in the range of 30 to 35% loss severities on the loans. So, I'd sort of answer it that way, Jeff.

Which means that ballpark, if they were all to be liquidated we would have like a $10 million loss?

Yes. It would be a little greater than 10, but that's right.

And we have got an 18.5 million reserve. But again, some of that reserve is against the whole rest of the portfolio which is all current?

That's correct.

I think you should also explain that there is some pool insurance on a fair amount of these assets, too, from SunAmerica, which can mitigate a lot of those losses in these pools as well.

And can you just briefly tell me how that works? Do we get first loss up to a certain percent and then the insurance kicks in, or is it some percentage basis?

The way that works, Jeff, is there is a pool of loans that in effect SunAmerica takes the first 10% of loss on, loss risk on. So, if the pool is call it 150 million today, then they'd take the first 15 million of loss on that pool and then we'd take everything above that, roughly.

I think the pool insurance covers how much principal of that 600, Steve?

I think I'm a little rusty on that, Tom, because there's been a couple of -- they've bought a couple of loans out. I think it's around 200 million, so roughly a third of that 600 million, I believe -- there's still some loans in that pool.

(OPERATOR INSTRUCTIONS). Mr. Benedetti, I'm currently showing no questions at this time. I will turn the call back to you. Oh, we do have a question -- sorry -- from the line of Jason Stankowski (ph) from Clayton Capital.

Congratulations, guys. You really did a good job generating cash in the quarter. I was curious what the term and the credit risk is for the 6.5% that we reinvested that $25 million in?

Steve, why don't you explain? Well, it's our own collateral, as you know, Jason. So we're -- this is the collateral that has been in our hands for a number of years. We are extremely familiar with the collateral. And it's all single-family collateral. But, Steve, why don't you go into detail on it?

As Tom alluded to, it's basically the assets we've already had on our balance sheet. We already, vis-a-vis the securitization structure, own the over-collateralization tranche. We redeemed the outstanding securitization financing and put that on repo. It was substantially all AAA-rated classes. There was a small AA and a small A. But, when you look at the subordination that is in the deal -- and this deal was issued three years ago, so it's paid down and delevered some -- when you look at the subordination, I think you effectively really have all AAA-rated bonds. They just don't reflect the rating because the rating agencies haven't looked at it and re-rated it in a while. I think our modeling on that, Jason, says those classes will have a weighted average life of around 2.5 years.

So, when we look at the risk reward, we really have a AAA-rated credit that we're earning 6.5% effectively after-tax because of our NOLs that has kind of a year-and-a-half duration. That seems like a pretty good risk reward.

We would be ecstatic to do about 10 deals just like that, Jason. Unfortunately, the only reason we were able to get this collateral at such a reasonable price is that we already owned it and we called it at our -- called our own collateral. Just to add on, if we were to sell that in the open market, Steve, I'm sure we'd get a premium for it, wouldn't we?

We would call those assets (indiscernible) and we would get a premium for them.

Mr. Benedetti, there are no further questions at this time. I will turn the call back to you.

Let me just finish up, Steve. I wanted to thank all our shareholders for joining us on the call. We look forward to continuing on our progress here in 2005 and we appreciate all of your support as shareholders. Thank you very much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.