Dynex Capital Inc (DX) 2005 Q3 法說會逐字稿

Welcome to the DYNEX Capital 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 call is being recorded Friday, November 18th. The speakers for today are Chairman, Tom Akin and Executive Vice President, Steve Benedetti. I would now like to turn the conference over to Mr. Akin. Please go ahead, sir.

Thank you, operator. Good morning, everyone and welcome to the DYNEX conference call. This quarter, we're going to conduct the call a little bit differently than before as I will be discussing the strategic issues relating to the Company, then turn the call over to Steve Benedetti for a brief review of the quarter and the year-to-date results. Before we get started, I would like to ask Alison Griffin to review the customary Safe Harbor and forward-looking statement closures.

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, the 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 competitive factors. For additional information, see the Company's annual report on Form 10-K for the period ended December 31, 2004 and the Company's quarterly report on Form 10-Q for the period ended September 30, 2005 as filed with the Securities and Exchange Commission.

Thank you, Alison. A year ago on our third-quarter 2004 conference call, I pledged to all our shareholders that DYNEX would invest its capital in an intelligent and shareholder friendly manner and that we would not stretch for yield and take uncompensated risk with our capital. I also noted that while we were looking for adequate risk-adjusted return investment opportunities, we really needed to be disciplined and patient. I also mentioned that we would continue to work on issues with respect to the legacy portfolio of investments, principally the manufactured housing assets with the idea that we would possibly try and remove them from the portfolio.

At that time, the Fed funds rate was 2% and the yield on the ten year was approximately 4.13. Today, a year later, that same Fed funds rate has doubled to 4% with the market predicting another three-quarters of a percent increase before the Fed is done. The ten year is now up 33 basis points to a 446 at yesterday's close also during that same period of time, most of that increase in the last couple of months.

Over the past twelve months, there have been opportunities to invest our capital but we declined to invest and instead kept short duration investments out of concern for the future volatility of asset prices and interest rates.

Looking backwards today and it is always 100% hindsight, we believe that strategy was a correct one. Other mortgage investors have seen their results suffer and stock prices decrease and book values decline as asset valuations have been impacted by the rising rate scenario and the flat yield curve. Our book value per share for 2005 is up slightly from year end and is up dramatically since the third quarter of '04.

In addition, the strategy of dealing with our legacy assets has improved the overall transparency of our balance sheet and added almost 42 million in net cash to the Company over the last twelve months. Our balance sheet today is in excellent shape.

Today, we are a company with $150 million in equity capital, 64 million of that in immediately investable capital. We continue to hold a large net operating loss carryforward that will allow us to retain and compound our capital tax free for years to come. We also believe that we're much closer today to finding acceptable reinvestment opportunities given the recent backup in interest rates and asset prices.

Notwithstanding the improved prospects for reinvestment however, the Board felt compelled to redeem a portion of the Series D preferred given the level of available capital in the Company today. While the Series D was permanent capital, its cost, its high cost continued to be excessive given today's rate environment. This redemption, when complete, will also enable the Company to repurchase up to one million shares in common stock if we so elect. Those purchases will be accretive on an accretive basis to book value, an option which the Board felt was important for all our shareholders.

As we look forward to 2006, our primary goal will remain to continue to look for solid investment opportunities with positive risk return characteristics. We remain committed to investing in only compelling opportunities where we believe we are being adequately compensated for the risk involved. Despite actions by the Fed, long-term rates remain low. The yield curve is very flat and there is very little margin for profitable carry trade with out excessive leverage or excessive risk, credit risk in particular.

Our goal will remain to seek only those investments that will generate superior risk-adjusted returns with the long-term objective of capital preservation and earnings stability in a variety of interest rate and credit cycles. Our investment model may include a third-party management relationship or joint venture structure along with internal management. The objectives of the third-party management model or joint venture structure would be to maximize returns while minimizing G&A expenses.

At this point, I should probably also announce that we have given Steve Benedetti the job of Chief Operating Officer at the Company. While our progress is slow and conservative and patient is demanded, I am excited about the future of DYNEX more today than I have ever been and feel that over the year we will continue to show our ability to steadily reinvest DX Capital in an intelligent shareholder friendly manner. I appreciate our shareholders' continued support in this endeavor and now I would like to turn the call over to Steve to discuss the quarterly results.

Thanks, Tom. I'm sure everyone on the call has seen the press release. I will just briefly hit some of the highlights of our results for the quarter and year-to-date and the balance sheet and then open the call up for questions. We posted a net loss of 1.9 million for the quarter and our net income year-to-date is 8.6 million. The net loss for the quarter came as a result of really several non-recurring items, including 1.1 million in accruals for indemnifications on prior asset sales and other income-related items representing what we believe to be the current aggregate probable amount of payment by the Company. It is also possible that the fee amount of the payment could be less but that is our best estimate today.

The Company also experienced an isolated loss on a securitized finance receivable of approximately $400,000, which we included in the provision for losses, which is the reason for that amount increasing from the prior quarter. And finally, there were approximately one-half million in G&A expenses related to professional fees for the termination of our prior independent auditor as well as litigation-related fees.

All told, these items amount to approximately $2 million. Excluding these items, we would've had a breakeven result for the quarter with a net loss to our common shareholders of 1.3 million, essentially equal to the quarterly preferred dividend. On a year-to-date basis, net income was 8.6, million which of course includes gains from sales of assets and net of impairment charges of 7.5 million and raised cash in amounts that Tom referred to earlier on the call.

The reason for and the purpose behind the sales was discussed in the second quarter and in our second-quarter conference call so I won't go into it here. In terms of net interest income, it was 2.6 million this quarter versus 2.7 million. Net interest spread last quarter -- net interest spread was 23 basis points versus 14 basis points last quarter.

Overall we would expect net interest income and net interest spread to decline slightly for the fourth quarter. We would also expect the provision for loan losses to decline next quarter to between 0 and $1 million depending on the expected resolution of several delinquent commercial mortgage loans. We believe that we're adequately reserved for all known problem assets today in all of our investment portfolios.

As previously mentioned, the G&A expenses included approximately one-half million of non-recurring items during the quarter and we estimate that our run rate today is approximately 1.2 million per quarter. In terms of our balance sheet, obviously our balance sheet continues to shrink on a quarter-to-quarter basis and year-over-year basis from asset sales and run off of investments. Our investment portfolio consists largely of short-term securities today, single-family and commercial mortgage assets. We like to look at our investment on a net investment basis, that is the assets minus the financing liabilities or conversely, our net invested capital. I usually run through this every quarter. Our net invested capital can be summarized today as follows.

We have approximately 45 million in short-term securities that are predominantly T-bills and commercial paper. We have approximately $23 million in triple and double-A rated, highly liquid, single-family seasoned residential mortgage-backed securities. We have approximately 13.2 million of our capital invested in subordinate and whole loans seasoned single-family residential assets. Those are generally going to be prime assets. Again, they are going to be seasoned a number of years.

We have approximately 43.8 million invested in subordinate tranches and CMBS transactions. Those are transactions that we did in 1997 and 1998. We have a remaining balance of 4.4 million in our -- approximately 4.4 million in our tax lien portfolio and we have other investments, including equity, securities and unrated commercial whole loan participations of approximately 3 million.

In addition to those investments, we obviously have 19.2 million in cash and cash equivalents. If you look at the risks in our balance sheet in our capital and investment portfolio, today credit risk remains the predominant risk for the Company and that credit risk is really principally in our commercial loan securitization transactions. As most on this call will know, our CMBS transactions are commercial and securitization transactions. GMAC is the prime rate servicer on that securitization as well as a special servicer and we work very closely with them on managing the at-risk assets.

At September 30th, of the approximate 589 million in commercial mortgage loans, approximately 40 million were delinquent as of payment of principal. We had reserves of roughly 20.4 million on those assets. Our assets are now substantially match funded and we believe that the liquidity risk in the balance sheet is very manageable. Our balance sheet obviously now is largely insulated from rising short-term interest rates given its match funded basis.

Operator, that concludes our review of the third-quarter results. We would like to open the call up for questions now.

(OPERATOR INSTRUCTIONS). John Stankowski, Clayton Capital.

It's Jason, of course, instead of John. Just had a question if you could go through -- I saw that the comprehensive income was about 1.250 million less than your net loss and wondered if you could -- do we have an unrealized gain in the quarter of that amount or maybe can you reconcile what the delta is there?

Yes, Jason, the way that works actually is that it excludes the preferred stock charge. So it is net loss of 1.9 million plus a very modest change of around 100,000 in our unrealized gain loss. Most of our investments today are not mark to market in our balance sheet. So that number is not really today with as the balance sheet is currently constructed. That mark to market change is not going to move around a whole lot.

In terms of continuing -- we keep saying that we are fully reserved for all the losses. Yet it seems like we end up having accounting charges. Can you may be explain a little bit the difference between the $1.6 million reserve versus the economic position of the assets that you have taken those reserves on? Are they tracking identically the way you guys see the economics and the accounting or are you seeing a divergence, continued divergence I guess?

Well if you go back to where we were this time last year and really in the beginning of the year when we had the manufactured housing assets there was -- we were adding -- the numbers escape me -- but probably five or six million a quarter in provision and clearly there was a divergence there of what we thought the economics of our investments were versus what the accounting results made us report. As I mentioned, there was a, what we will call an isolated charge of roughly 400,000 this quarter. It was related to a very old, securitized, single-family receivable that was an isolated occurrence and really shouldn't happen. That was unexpected. But it shouldn't happen again.

The remaining 1.2 million was roughly what we have been adding the last two or three quarters on our commercial mortgage loans. Each quarter we take a snapshot of what our investments are in that commercial mortgage loan and try to determine what is impaired and what the reserve levels are required under the Generally Accepted Accounting Principles. I would say that as we -- Generally Accepted Accounting Principles doesn't allow you to reserve for what you might estimate would be the losses over the entire life of the deal. So that is not necessarily going to reflect the economics of the investment, our balance sheet, which is why supplementally in our public filings we disclose information as to how we look at the economics of our net investment. Of course we applied a CDR on those commercial deals that in effect projects future losses based on the assumptions that we make.

So I mentioned in my remarks that for today, as we sit here today, today is November 17, or 18th, we are looking at the fourth quarter. We think we have got the commercial mortgage loans that are the problem loans. We have got our arms around those and feel pretty confident that those are identified. There are 40 million in loans and we've got 20 million in reserves. So on a quarter-to-quarter basis, there is some subjectivity to it of course because it is based on a loan by loan analysis. But on an upcoming quarter and go forward basis, we think we have got all the problems loans identified.

I just want to add, Jason, that we're trying to be as conservative as humanly possible. We'd like to -- when we dispose of these assets, obviously which we have been doing for the last couple of years now, we would like to make sure when we dispose of those assets it is a positive event for the Company and we don't want to make it a negative event. So to the extent that we can retain a very conservative evaluation on those, I think it is better for everybody.

And on the commercial deals, I think you have mentioned before that we have the 40 million that are delinquent with regard to principal. Can you just explain a little bit about the assets underlying? Are those two or three big deals and what do you -- in terms of the collateral value, are you seeing those as just a matter of time and rationalizing the underlying assets essentially?

Well it's primarily two big, large real estate holdings. One of them is a building in St. Paul and the other is a Holiday Inn in Richmond, Virginia. Both of those we are on top of. As Steve said, we have got $40 million in par value of delinquencies and we've got a $20 million reserve against it. And our feeling is that we want to work out those situations as best we can. Without going into excruciating detail in each of those, I'll just tell you that we feel pretty comfortable that we have them managed and properly reserved and we look forward to doing the right thing on those particular real estate assets, whatever that might be. Steve, do you have anything more to add?

No, I think that covers it.

Well thanks a lot for protecting the capital. There has been a lot of REITs that have really taken a dive in book value and their economics over the last nine months. Although it has been tough waiting to find something, it has been encouraging to see the capital preserved for when the time is right. So thanks a lot you guys. You've done a good job.

(OPERATOR INSTRUCTIONS). Mike Hughes, Ostris (ph) Capital.

What types of assets are you looking at once the spreads finally come your way?

Well obviously we would look at any asset type that is doable on a risk return basis. We are not particularly in love with credit risk right now. We would rather assume some sort of interest rate risk at this point, particularly with maybe the Fed being closer to done than not done. But we are really looking at pretty much everything at this point. I don't think we -- we feel that with the tax loss carryforward, our returns don't have to be extraordinary because of the fact that we are looking at really after-tax yields for everyone as opposed to pre-tax yields. So we are going to keep pretty high quality in our assets I would say.

So you're thinking more residential or some -- you looked at REITs at one point, residential REITs, something more akin to that?

Well one of the things you have to always do is make a make versus buy decision. And if we were to put together just a thought process of doing a carry trade portfolio let's say with 100% or let's say a very high percent of government guaranteed collateral, there our public companies out there trading at a discount right now. Some of them $0.80 on the dollar for doing the same business that we might want to get into. And I'm a firm believer that if I can buy something that is doing the same thing I am at a discount I like to do that. Those same companies nine months ago were trading at 120% of book value. So there has been a dramatic shift in the pricing of the whole mortgage REIT sector and we are definitely following it very carefully and closely and are in the process, in constant process, of evaluating our options.

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.

Well, great. I want to thank everyone for joining us on the call. I want to congratulate Steve on his promotion to Chief Operating Officer at the Company. He has done a fabulous job for us and deserves all the accolades for what I think has been a pretty solid return. We look forward to the opportunities that the marketplace will give us over the next six months. We have protected our capital in a very difficult environment and now let's hope that we can leverage that information to actually reinvest that capital in a very positive way. We have a lot -- we have a lot of cash available. We have a very solid balance sheet and I'm looking forward to the next year. Thank you all for your participation.

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