Dynex Capital Inc (DX) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dynex Capital's fourth-quarter results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Friday, February 16, 2007.

I would now like to turn the conference over to Thomas Akin, Chairman for Dynex Capital. Please go ahead, sir.

Good morning, everyone. Welcome to our fourth-quarter conference call. With me today from the Company is Steve Benedetti, Executive Vice President and Chief Operating Officer. Steve will start out the call today with the forward-looking statement disclosure and then discuss third-quarter results, and I will discuss our strategic initiatives. We will then open up the call for questions.

Let me turn the call over to Steve now for 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 projected in or contemplated by the forward-looking statements as a result of unforeseen external factors. For additional information on these factors, we refer you to our press release issued Wednesday and our quarterly report on Form 10-Q for the period ended September 30, 2006, as filed with the Securities and Exchange Commission. Let me do a brief review of the fourth-quarter results.

Fourth-quarter results really reflect the first, if you will, clean quarter for the Company, where the underperforming assets that were previously on our balance sheet are really no longer dragging our results down. As result, we reported good net interest income with net interest spread improving from 65 basis points in the third quarter to 120 basis points for the fourth quarter, excluding -- excuse me excluding a favorable-level yield adjustment from a commercial loan prepayment.

As we mentioned in the press release, our yield on our balk capital from the investment portfolio was approximately 10% that includes our investment in the joint venture for our proportionate share of the results of the investment in joint venture for expenses and preferred dividends. Given our current asset mix, capital allocations and leverage, we could expect to maintain this yield into 2007. That of course assumes no reinvestment activity and any unforeseen events, such as additional defaults or prepayments on commercial loans.

As was indicated in the press release, net income for the quarter of $2.3 million includes $724,000 of nonrecurring items and loss on sale of investments of $409,000. In aggregate, these items represent roughly $315,000 you would consider nonrecurring-type items, which is roughly $0.03 per share.

In terms of the prepayment on the commercial loan, most of our commercial loans today remain in their lockout periods. And in terms of asset sales, we do not expect any additional asset sales for the foreseeable future.

In terms of the performance of the joint venture, that contributed $809,000 for the quarter, which includes approximately $270,000 of fair value adjustments on a derivative held by that joint venture. Joint venture remains heavily invested in cash today, and we continue to look for investments and have acceptable risk-adjusted return profiles for both Deutsche, our partner, and for us at Dynex. We would expect to begin to deploy some capital this quarter out of that joint venture.

In terms of our balance sheet, book value per common share was $7.78, and adjusted common book value per share was $8.13. The adjusted common book value per share of $8.13 is not meant to portray a liquidation value of the Company and does not include value, if any, of the Company's NOL tax carryforward and also does not include any provisions for any outstanding current litigation. Thus, the common equity book value consists of common equity book value, adjusted to include certain investments (technical difficulty) associated financing at their estimated fair values based on anticipated cash flows from these investments discounted at estimated market rates.

We expect to file our Form 10-K within the next four weeks. And as has been customary in the past, we will include additional disclosure in the 10-K relative to our asset mix, capital allocation, and credit weightings of our investments. Suffice it to say there will not be a meaningful -- we do not expect to have a meaningful change from information disclosed at the end of the third quarter in regard to these items.

In terms of the credit performance of our portfolio, today, I think we'd characterize it as excellent. We have no delinquent commercial loans in our balance sheet, and we only have nominal single-family delinquent loans in our balance sheet, most of which are going to be pool insured.

The joint venture with Deutsche Bank has only one remaining commercial loan delinquency. It has an approximate unpaid principal balance of $1.4 million. The $23 million delinquent loan that was in that joint venture last quarter -- in which we had indicated was under contract to sell -- that sale did close. That closed in January of this year. And based on the results of that sale, we don't expect any meaningful or any real adjustment to our results as a result of that transaction.

In terms of how we have our capital allocated, again, we will have information in the 10-K. But just real -- at a high level, have $57 million in cash. We have roughly $21 million in AAA-rated agency and private-label RMBS securities. We have another $3 million in AA and single-A rated securities.

We have roughly $10 million in securitization overcollateralization on our balance sheet. At this point, that is one single-family deal and one commercial deal, which we have the investment in the joint venture of approximately $37 million. And we have roughly $9 million of either unrated or non-investment grade-rated assets.

In terms of the risks in the balance sheet, again, our predominant risk remains credit risk. As I mentioned before, the performance on the portfolio today is quite good. In terms of interest rate risk and prepayment risk, our balance sheet today is substantially match funded and most of our assets today are carried at discounts as opposed to premiums. So prepayment risk is not much of an issue for us as well.

That concludes my discussion of the fourth-quarter results. I'll now turn the call back over to Tom.

As you heard Steve say, our balance sheet is in excellent shape. Our leverage is low, and our portfolio of seasoned investments is performing well. Any financial storm that shapes up DX's prepared -- not only to weather but possibly prosper in.

The challenge for management and the Board today remains finding suitable reinvestment opportunities. We need to maintain discipline and contemplate making investments only where we believe there is an acceptable risk return profile. By entering into the transaction with Deutsche Bank as a means of expanding our access to investment properties and assessing resources that might not -- we might not otherwise have, we continue to feel that unique investment opportunities will be available as a result of this relationship. And we are reviewing some now.

Sandler O'Neill continues to work on our behalf to find investments, and they have helped to identify several interesting possibilities, unfortunately none of which we are prepared to talk about on this call. We continue to seek joint venture opportunities as well.

Certainly, there's much more certainty in the mortgage space today, particularly recently than just a few short months ago. With the credit curve dramatically steepening over the last few weeks in the sub-prime mortgage sector as I am sure all of you have read, our view is the credit curve will steepen even further and some of that may spill over into other parts of the non-prime mortgage market, creating possible buying opportunities there as well. But for now, our focus is on the higher-quality, short-duration assets. The Fed appears to be on hold for the time being; although, that could change momentarily.

We believe the combination of substantial free capital of almost $70 million and the net operating loss carryforward and the experience of the management team and Board of this Company is valuable to our shareholders. We look forward to the future.

Operator, that concludes our review of the second-quarter (sic) results. Judith, why don't we open up the call for questions?

(OPERATOR INSTRUCTIONS). Steve DeLaney, Flagstone Securities.

Just a couple of housekeeping things first, I guess probably directed towards Steve. Did the total common shares stay constant to 930 at 12.16 million?

They are actually a little bit lower, Steve. I don't have that number in front of me. There was a little bit of buying activity.

I don't think it's anything really meaningful though. It may have been a few shares.

Okay, very good. Then, just looking at the income statement beyond the prepayment penalty, which was obviously a nice pickup. I was struck by the -- how far the cost of funds dropped, about 130 basis points to 6.28 or kind of over 7.5 in the third quarter. My question I guess is, is this simply due to the derecognition of those commercial assets and related financing?

Yes, I think part of it is that. Part of it as well is that the -- that prepayment -- the yield adjustment on the prepayment actually drove down the liability side not the asset side.

That I did not understand. So your asset yield was -- when you took the credit, you took it against your cost of funds not your -- it didn't boost your asset yield.

That's right.

I see. Well, that explains that. So basically, we should look at -- the run rate would be obviously probably closer to the 3Q level in terms of relationship to LIBOR.

Right.

That's very helpful. Thanks for clarifying that.

Tom, I guess one thing I noticed was it looks like the cash in the joint venture was pretty much flat to the initial contribution by Deutsche Bank. Do you have some sense as to how fast that money can be put to work? Is it a matter of a couple of quarters to get it to work or do you think it's a longer timeframe?

The cash is not that large amount. I mean, I think -- was is it, Steve, $37 million or something?

Yes, 38, I think.

Yes, 38. You can put $38 million to work in the mortgage market pretty quickly if you find the right opportunity. Certainly, we feel that when the right opportunities come, we're going to try and stage it in there and do several assets that make sense. We're actually looking at a very interesting situation right now.

It would not mean all that cash goes to work overnight. But I would say that depending on the opportunities, Steve, that capital could go to work very quickly. It's not a huge amount as you can well imagine.

Given that amount and your comments would lead me to believe -- so you're not -- when you look at that $38 million, you're not looking to use any leverage in that as well. That would just be directly invested?

No, we might use some leverage. If we can -- obviously right now, we're picking up cash-type returns, which are not much better than 5%. We would definitely want to get at least a double-digit return on that before I think we start doing things, but there are some opportunities out there.

The cracks are starting to form. And in those cracks, they are creating little opportunities. And we are looking at a couple of them right now, which quite frankly obviously they have got to be above our cost of capital. And we really see in that joint venture the double digits are being at a bare minimum what we're looking to return and probably more into the low teens in all honesty.

And then I guess the last thing -- when we last spoke, I got the impression that the surplus capital that you very much desire to see that invested as opposed to be used to further manage your capital structure through either Series D redemptions or buybacks. Is that sort of the Board's current view that the $68 million that your plan is primarily to put that into new earning assets at this point?

I think the situation is -- what we've always stated is we want to do what is right for the shareholders. And we have been very cognizant of the fact that 9.5% preferred that we have outstanding is a pretty large coupon to be lugging around. It's not an extraordinary large coupon. I mean you've got some other mortgage REITs out there with 8.5%, 9.5%, so it's not outrageous. But certainly, we are cognizant that with all of that money sitting there at 5%, 5.5%, paying a 9.5% preferred is not particularly intelligent for a long period of time.

On the other hand, the marketplace six months ago wasn't as interesting as it is right now. Heck, the bond market two weeks ago was not as interesting as it is right now. And we're seeing a lot more things that we're looking at that we can return a lot less riskier things than just a couple of weeks ago that we can return in excess of 9.5%.

But we are always looking at that capital structure. We're always trying to do what we think is the right thing for our shareholders on a risk-adjusted basis. So I don't want to preclude anything. But I do want to just say that the investing environment is getting better.

Right, okay, that helps. Listen guys, congratulations on a nice quarter.

(OPERATOR INSTRUCTIONS). We do have no further questions at this moment.

I want to thank everyone for being on the call. As Steve pointed out, this quarter was really kind of our first clean quarter. We are very happy that our underperforming assets are basically for all intents and purposes behind us here, given any unforeseen situations. And we feel we have got a solid base to grow from, and we look forward to discussions either the next quarter or intermittently as those opportunities arrive. We want to thank all of our shareholders for their support.

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. Have a great day.