Dynex Capital Inc (DX) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dynex Capital second quarter earnings conference call. During the presentation, all participants will be in the listen only mode. Afterwards we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS)

As a reminder, this conference is being recorded Tuesday, August 16, 2005. I would now like to turn the conference over to Stephen Benedetti, Executive Vice President and Chief Financial Officer of Dynex Capital. Please go ahead, Sir.

Thank you, operator. Of course also on the line with me is Tom Akin. He's our Chairman. As we typically do, I will briefly discuss the results for the quarter, the balance sheet, cash flows and then turn the call over to Tom for the discussion of strategic items as well as the question and answer session.

First, as we typically do, let me start with the forward-looking statement disclosure. 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 materially from those protected 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 instruments and assets of the Company, the impact of recently issued financial accounting standards, increases in costs and other general competitive factors.

For additional information, participants are encouraged to see the Company's annual report on Form 10-K for the period ended December 31, 2004, as filed with the Securities and Exchange Commission and our second quarter 10-Q which will be filed shortly with the Securities and Exchange Commission.

Turning to the results obviously hopefully you've seen the press release. Net income for the second quarter was 9.6 million. That compares to a loss of 13 million for the same period last year and net income for the first quarter of 934,000. Net income was bolstered by the sale of almost 370 million in noncore assets including our remaining interest in manufacturing housing loans in four defaulted mezzanine loans.

As a result of the sale we recognized gains of 9.6 million in Other Income of $1 million and generated 12.4 million in cash proceeds.

After the sale of these assets and coupled with the sale of the manufactured housing loans in the fourth quarter of last year, we no longer have any balance sheet investment in MH or manufactured housing assets other than a modest net servicing asset of $1.1 million. In terms of other specific items in the income statement, net interest income was 2.7 million versus 5.5 million for the same period last year and 4.5 million for the first quarter. Net interest income declined as a result of the sale of investments as we just discussed and also as a result of an increase in amortization expense of approximately $435,000 from accelerated prepayment expectations on commercial mortgage loans.

Our net interest spread was 14 basis points during the quarter which was reduced approximately 16 basis points by that aforementioned amortization expense. We'd expect net interest spread to increase in the third quarter but still remain fairly low as all cash proceeds from these sales are now being invested in very short maturity assets or essentially cash equivalents; and we are not adding any net leverage to the balance sheet at this point.

We would also expect net interest income for the third quarter to reasonably approximate the second quarter amount. In terms of provision for loan losses, this was the lowest amount for at least several years. It really reflects the benefit from the sale of the manufactured housing loans on a go-forward basis. Excuse me, during the quarter. On a go-forward basis for our existing assets, we will only be meaningfully providing reserves as necessary, predominantly for our commercial mortgage loans.

Today, we believe that we are adequately reserved for all of the known problem assets in that portfolio.

Also during the quarter, we impaired our tax lien receivable security and an additional $1.8 million in anticipation of holding this security for the duration of those assets -- though we continue our efforts otherwise to sell or unwind our ownership interest in that security.

As a result of the impairment, our asset is now carried at 5 -- this asset is now carried at $5 million in our balance sheet and it's on non-accrual. That means that cash received -- we received during the quarter as we collect on this asset or applied directly against the principal of that asset -- carrying value of that asset and last quarter we collected slightly in excess of 700,000 during the quarter.

G&A expenses were 1.4 million versus this quarter versus 2 million for the second quarter of last year and 1.5 million for the first quarter this year, really reflecting the reduced staffing levels we have predominantly again in our tax lien servicing business.

We do expect sequential declines in G&A for the third and fourth quarter as we continue to rationalize our headcount and our tax lien servicing operation.

Turning to the balance sheet, obviously the story here is shrinkage in the balance sheet from the sales of the manufactured housing assets. I would say, today, our balance sheet is as transparent and as simple as it has been in quite some time; and obviously our deployable capital resources continue to improve as does our book value which was approximately -- on a common per-share basis -- was 794 at the end of the quarter.

As we indicated in the press release, most of our portfolio now is invested in commercial mortgage assets and single-family assets. Our portfolio is still largely financed with nonrecourse securitization financing debt, a portion of which we redeemed during the quarter. That is our SASCO (ph) 2002 transaction. We put that on repo.

We did two things with that. We kept the bonds from stepping up in coupon and we also lowered the overall cost to the Company on those bonds by approximately 22 basis points. Because that debt is recourse to the Company, this quarter we will reissue the securitization financing that was redeemed in effect, using the proceeds from that reissuance to pay off that recourse repo financing that was used to redeem the bonds.

What that means is the $165 million that you see on our balance sheet of securitization financing, recourse debt will be replaced effectively with nonrecourse debt and the $18 million that we put into that redemption will come back to the Company at the time we reissue that securitization financing.

Our shareholders' equity was 153 million at the end of the second quarter, sort of on a summary basis that 153 million is the capital invested in the following manner. Cash and very short-term liquid instruments of $59 million, AAA- and AA-rated liquid single-family residential mortgage backs, $28 million -- and embedded in that 28 million is the 18 million that comes back when we reissue the securitization financing. Subordinate tranches in -- excuse me subordinate tranches in whole loan sees (ph) in single-family residential assets is approximately 14 million. Again the credit experience on those assets has been very good for the Company.

Subordinate tranches in CMBS (ph) transactions is approximately 45 million. Of course I mentioned already the tax liens at $5 million; and then some miscellaneous other investments, including equity securities and unrated (ph) commercial whole loan participations of approximately $2 million.

In terms of the risk to the balance sheet and our capital, today, the credit risk is our predominant risk. Our assets are substantially match-funded now and our balance sheet is largely insulated from rising short-term rates.

On the credit risk side, again, our experience in the single-family assets has been like other participants in the industry -- very good. Ours are predominantly seasoned assets, very well collateralized in terms of real LTVs; and so our loss experience in that has been very good, losses have been very low.

On our CMBS transactions as I mentioned before on prior calls GMAC, excuse me -- GMAC Commercial Mortgage services all of the assets that we have, all 617 million in principal. They are also special servicers as a residual holder in the three securitizations. We work very closely with them on managing these assets and, in particular, assets that are at risk.

Turning quickly to cash flow, we have highlighted this in the past. Today it is kind of a less meaningful number. It's a balance sheet has shrunk. Most of our free cash as I mentioned is either in cash, cash equivalents or very short-term assets and that capital turning extremely quickly. Our commercial mortgage investments receives modest spread income or coupon on the assets that we own of the bonds that we own from the securitization transactions and the major capital of that, for these transactions, will be in the at or near their redemption date. At least that is the current expectations -- at or near the redemption date -- and really substantially in 2009 and 2010.

As we mentioned in the press release, we have approximately 63 million in cash in very short-term instruments and, again, we would expect that to increase by the $18 million that is released during the quarter from the reissuance of the SASCO securitization financing.

As the investment portfolio is currently structured, our cash flows will remain more sensitive to the credit performance of the underlying assets and, again, less to changes in the interest rate environment. This of course will change, depending on our -- or may change depending on our reinvestment strategy.

That concludes my review of the second quarter results and I'd like to turn the call now over to Tom.

Thanks. Good morning to everyone on the call. As Steve has just walked us through, over the course of the last year or so, the Board management has been focused on shedding our legacy assets that we don't believe will be part of any long-term strategy for the Company and improving our financial strength and flexibility.

I think we have largely accomplished this goal now. We sit, today, in a position that this Company has not seen for at least the last five years.

Our immediate challenge now becomes reinvesting opportunities for our available capital. While loan rates have backed up some, the yield curve remains flat and spreads our mortgage assets across a spectrum, we're still very very tight. Compelling investment opportunities are hard to come by.

We, again, reiterate that we are not going to accessibly leverage the balance sheet in this sort of environment in order to generate returns that, in our estimate, are not risk-adjusted in a positive manner in for shareholders.

It's interesting that many mortgage REITs have suffered pretty significant decreases in book value and dividends recently, as this yield curve has become flatter and spreads have narrowed. We continue to believe that the risk return trade-off for the leverage carried trade is unfavorable and the yield compensation insufficient for that risk.

Consequently, you have seen in the marketplace many mortgage REITs trading well below book value, indicating concern for that business model. Obviously, it is cheaper today to purchase a mortgage REIT business model in the open market than to produce it ourselves.

For all these reasons, we are looking at opportunities outside of the typical mortgage REIT space, but still within our level of expertise. These opportunities may include distressed real estate loans, commercial operating business loan. We are also considering alternative uses of our capital, including the purchase of stock, of quality mortgage REITs that may be trading at a significant discount to book value, redemption of a portion of our Series D Preferred as well.

The cost of our D capital even though it is permanent capital may be considered excessive, given the current investment environment. Still, we believe that we will be able to find investments within a reasonable period of time that will justify retaining all of our capital.

Our current objective is to continue to seek only those investments that will generate superior risk-adjusted returns with the long-term objective of capital preservation and earnings stability. Our discussions are involving such that we anticipate employing a portfolio management model, with capital allocated to assets managed by Company personnel but also, occasionally, in the third party management relationship or a joint venture structure.

The objective is to maximize returns while minimizing G&A expenses and not putting the balance sheet at risk again from material losses.

Our equity capital, as Steve pointed out, is approximately $153 million; and our global market capitalization including our preferred stock is approximately 151. That doesn't sound right. Our book value for common share now is about $8.00. Our common stock price closed yesterday at $7.40 per share. Our goal over the next 12 months is to get that stock price to $10.00 a share, which would put us in a position to convert the Series D Preferred Stock into common.

While our progress to date is conservative and patient is demanded, I'm excited about the future of Dynex and feel that over the next several quarters we will show our ability to steadily reinvest DX capital in an intelligent shareholder-friendly manner.

Finally we have determined that we are not an accelerated filer and therefore we will not have to be compliant with Section 404 of the Sarbanes-Oxley Act until no earlier than 2006. This is helpful to us as it delays a substantial cost and frees management time to evaluate other investment opportunities. Additionally, it allows for continued evolvement of the actual requirements for companies like us.

I'm sure everyone is aware that there's a lot of anticipated changes for Sarbanes-Oxley in the future.

I appreciate all our shareholders' continued support in this endeavor and now I'd like to open up the call for questions.

(OPERATOR INSTRUCTIONS) Jason Stankowski.

Good job in increasing the book value in such a tough environment and preserving capital. I had a question, Steve, on the accrual for prepayment speeds accelerating. Aren't most of your mortgages fairly seasoned? And I just wondered if you are seeing the prepayment speeds actually accelerate or is that just a result of what everybody else is seeing in the marketplace?

On the single-family side, our prepayment speeds have really not accelerated. They have been pretty much -- and these are as you pointed out -- very seasoned assets. They have been within 2 or 3% at 30 CPR forever, quite frankly.

The acceleration that we have seen, actually, is on the commercial mortgage side and what we have seen are -- if you are familiar with our structures, there is a guarantee structure within -- or credit enhancer feature within our deals where there is a guarantee from a third party that has the option of purchasing defaulted mortgage loans out of the structure at par, without paying any yield maintenance or prepayment penalties.

The trick -- it has to be a defaulted mortgage loan and they have availed themselves of that of late.

We own, in general, we own the assets that they are purchasing at a slight premium. We think that the assets that they have purchased -- while they're beneficial to us from a credit point of view because we don't have any losses on these -- it does cause some spiking in the amortization expense.

In addition, we do have 2 large loans that are delinquent that look like they are -- in fact one already is -- essentially a real estate own, the other looks like it is going that route. So we have changed our prepayment expectations for that which also required an adjustment to the amortization expense for the quarter (indiscernible) yield asset.

So the good news -- or the bad news is that the loans are in default and problematic. The good news is the risk since we have this guarantee is really only that we are getting principal back quicker than we thought we would?

That's right on most of it. The 2 large loans are not credit-enhanced by this third party guarantee. But we do have reserves and we think we have the risks on those 2 loans well boxed in.

Good job. Look forward to hearing what events you come up with and the Board come up with over the next 6 months.

Mr. Akin, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

I would like to thank all our shareholders for being on the call today and I appreciate your patience as we work through this rather difficult environment. As everyone knows, last week, the Federal Reserve raised interest rates to 3.5% on the Fed funds rate and expectations are for them to go substantially further. I don't think the environment for us to be leveraging up our balance sheet and putting a lot of money to work right now is a very positive one. And we continue to sort of hold back and wait until that climate becomes very advantageous for all of us.

I know it's going to take a lot of patience but we are looking at a number of things at all times to maximize shareholder value. What we have done over the balance sheet here, over the last year, I think has been quite remarkable in really simplifying the Company for shareholders to understand. And we continue to search to do more interesting things to create gains anywhere we can possible.

There are some interesting opportunities we are looking at. We hope to be able to talk about them as we get closer to a real strategy; but we don't want to talk about them until the time is appropriate.

So we appreciate all your time and energy and patience and we look forward to unveiling that strategy as we go forward. Thank you much for your time.

Ladies and gentlemen, that does conclude the conference call for today.