Dynex Capital Inc (DX) 2007 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Dynex Capital Inc. fourth-quarter and annual 2007 results 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 Wednesday, February 13, 2008.

I would now like to turn the conference over to Mr. Tom Akin, Chairman and Chief Executive Officer of Dynex Capital. Please go ahead, sir.

Good morning, everyone. On the call with me today is Barry Igdaloff, one of our Dynex Directors; Steve Benedetti, our Chief Operating Officer; Wayne Brockwell, Portfolio Manager; Bob Nilson, Head of Credit Risk Management; and Alison Griffin, Assistant Vice President Investor Relations. Also with me today is Byron Boston of Boston Capital Advisors who as you might have seen from the press release has been hired to assist us in investing our capital and agency RMBS activity.

Before we start the call today, I want to note for everyone on the call that next Monday, February 18 marks the 20th anniversary of Dynex being a public company. This is quite an achievement for the Company to successfully have navigated the business through several mortgage cycles. Today begins a new chapter for the Company as we embark on a building out of the agency MBS investment platform as part of our overall diversified investment strategy.

As we normally do, I will have Steve start out today briefly reviewing the second quarter -- or the fourth-quarter results -- excuse me -- and I will discuss our strategic initiatives. We will then open up the call for questions.

Before we get started, Alison will 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 Reform Act of 1995. The words believe, expect, forecast, anticipate, estimate, project, plan, hope, and should 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 yesterday and our annual report on Form 10-K for the period ended December 31, 2006 as filed with the Securities and Exchange Commission.

Thanks, Allison. This is Steve Benedetti. I will briefly review the results. I think as everyone likely saw, we reported net income of $8.9 million for 2007 versus $4.9 million for 2006, $0.40 per common share versus $0.11 per common share. For the fourth quarter, we reported net income of $1.6 million or $0.04 per common share versus $2.3 million or $0.11 per common share for the fourth quarter in 2006.

I will discuss some aspects of the earnings but excluding the fair value write-down that flowed through the equity and earnings of joint venture, as well as the gains from the sale of certain publicly traded mortgage REITs, the Company would have had net income to common shareholders of $1.5 million during the quarter or roughly $0.12 per common share.

Net income for the fourth quarter includes a loss of approximately $1.2 million, as I mentioned earlier on the equity and loss of joint venture. That primarily relates to a non-cash fair value adjustment of $1.6 million, which is the Company's proportionate share of the write-down of the fair value of a call option on a pool of loans, mortgage loans that the joint venture owns. That call option had been carried at a positive fair value and it was written down on the joint venture's books to approximately $0.5 million. The remaining fair value of -- or our proportionate share of that remaining fair value is roughly $0.2 million or $200,000. The write-down resulted from the widening of credit spreads essentially which occurred across the entire commercial mortgage-backed securities market during the quarter.

As I mentioned before, the results also included a gain on sale of certain publicly traded mortgage REITs of approximately $700,000. For the year, net interest income after provision for losses was $4.2 million. We had an additional $1.6 million of net interest income after provision, if you will, from reversal of previously provided reserves on loan losses. As we've mentioned in the past, in general we've seen improved performance on our loan portfolios over the last several quarters. And we attribute this fact to the fact that our investment portfolio is comprised predominately of highly seasoned single-family and commercial mortgage loans as we indicated in the press release, and I will touch upon a little bit later in my comments.

Net interest spread for the quarter was 180 basis points versus 139 basis points last quarter, and those exclude any non-cash effective interest type adjustments, level yield type adjustments. There's 141 basis points for the same period in 2006. This excludes our cash and cash equivalent yields, which were approximately 4.2% during the quarter.

In terms of our balance sheet, our investment assets are very seasoned, as indicated in our press release. To give you some perspective, we've had cumulative losses on our single-family securitized pool of approximately $1.2 million relative to a $600 million original balance, and cumulative losses of approximately $2.2 million relative to an original balance of approximately $415 million.

I think it is also worth noting that we are not adding loans to this particular aspect of our portfolio and as each month passes, the outstanding balance of these loans further amortizes. As an example, our commercial mortgage loans have amortized on average approximately 27% from their original unpaid balance -- principal balances.

As of today, we have no commercial mortgage loan delinquencies in our balance sheet. All told we have -- excuse me -- $2.6 million of reserves relative to our outstanding commercial loans that have no pool insurance or similar enhancement of approximately $114.9 million. And we have approximately $131,000 of reserves relative to our outstanding single-family mortgage loans, which again, have no pool insurance or other credit enhancement of approximately $66 million.

Our book value per common share is $8.22 versus $7.78 at the end of last year. Our adjusted common book value per share is $8 versus $8.13 at the end of last year and $8.22 at the end of the last quarter. Of course we refer to this calculation effectively as our net asset value. That net asset value decline this quarter can be generally attributed to credit spread widening on CMBS and nonagent CMBS during the quarter. As we intend to hold most of these investments which suffered spread widening to their maturity, we expect a difference in book value and NAV to decline over time as the investments are repaid or potential if spreads tighten the future.

Often we refer to -- we run through what we have -- we sort of look at our balance sheet on a net investment basis, and our capital investment based on that net investment basis at 12-31 can be allocated in the following approximate manner. We had $38 million of our capital invested in cash and cash equivalents. We had roughly $54 million or 38% of our capital invested in nonagency RMBS. We had $9 million or approximately 6% of our capital invested it in agency MBS. We had $21 million or 16% of our capital allocated to commercial mortgage-backed securities. And we had approximately $18 million or 13% of our capital and other investments.

With respect to the nonagency RMBS, we have an investment of $44 million in a AAA rated security which is collateralizing approximately $5 million in repurchase agreement financing. Assuming we sell this bond at current market prices, we could raise a net approximate $38 million which would increase our cash and available capital to invest by a similar amount. Since the end of the year, we've also sold approximately $10.5 million of the other investment category, increasing our cash and available capital by a similar amount.

That concludes my comments, and I will now turn the call over to Tom.

Thanks, Steve. As you might have seen in the press release, 2007 was a very good year for us. Although we didn't add a lot of assets and built up cash, we'd managed to grow book value by 5% and our stock value was up 25%. And we reported our best results for our common shareholders in nearly a decade. Our stock is at an eight-year high, and we declared our first dividend since the third quarter of 1998.

Enough about the past. This call is about the future. I have asked all our shareholders to be patient while we conserved our capital and waited for better investment opportunities. Over the last year spreads on virtually all mortgage products have moved to historic wides. With the Federal Reserve having reduced the Federal Funds rate by 225 basis points since last summer and 125 basis points since year-end, we think the timing is right for investing our capital in agency MBS.

A lot of people are attempting to enter the same business with some experience and some without. Dynex has been in the mortgage business for 20 years. We believe with the addition of Byron Boston to the team and his 25 years in the business, coupled with the strong balance sheet, reputation and infrastructure of Dynex, we have a winning formula. Byron was the co-Manager of Freddie Mac's mortgage portfolio and CIO at another major REIT.

I would like to ask Byron to make a couple of comments, if he can.

Thank you, Tom, and good morning. It is a pleasure to be joining this very experienced management team. Over the past two years, I have had multiple conversations with the management of Dynex about the potential for developing new investment strategies. We now feel it is the appropriate time that we come together to take advantage of the opportunities that exist today to generate solid double-digit returns in the high-grade mortgage space.

This management team has skillfully navigated a very difficult period in the credit markets as spreads have widened across all asset classes. We are now in the process of building out the strategies that will allow Dynex to generate attractive returns in the future. Our goal will be to remain prudent and disciplined as we execute these plans. Over the next several months, we will be deploying capital, available capital in high-grade investment strategies that will boost the overall returns to the shareholders of Dynex. Tom?

Thanks, Byron. We currently have access right now to over $80 million or approximately 60% of our equity capital to deploy in the RMBS agency trade. At current market spreads and returns, we have the potential to improve our overall portfolio yield and earnings. We are also reviewing opportunities in the CMBS and nonagency mortgage-backed space as well. Today those opportunities look less compelling than the agency trade. Spreads continue to widen, and these sectors remain liquidity challenged. At some point, there will be opportunities, but not today.

Let me comment on the quality of the current investment portfolio of Dynex. I have heard from many of you expressing concern over the investments now in our portfolio including our single-family and commercial mortgage loans. While it is true our economics are tied to the credit performance of these assets vis-a-vis our relationship interest, I think it is important to note that these loans, all of these loans are a decade or old or more. They have very low or even no delinquencies and have extraordinary levels of coverage from pool insurance and other forms of credit enhancement.

While we cannot predict the future, we believe that the investment portfolio is positioned to outperform even without adding agency MBS.

In summary, we are very excited here as we restart the engines of Dynex. Investors can expect that we will continue to work as hard as we can at improving shareholder value, investing wisely and preserving your capital by diligently evaluating and managing investment opportunities. We hope that we are building a business for the next 20 years.

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

(OPERATOR INSTRUCTIONS) Steve DeLaney, JMP Securities.

Good morning, Tom. Exciting times there at Dynex.

Good morning, Steve. Thank you so much.

Sure. One little housekeeping question. It wasn't clear to me when you declared your first -- re-established a quarterly dividend of $0.10. Was it the Board's intent that that dividend would be for the completed fourth quarter, or should we view that as being the dividend kind of being paid early for the first quarter?

I think the latter is true. As you know, last year we earned about -- well we earned $0.41 and we didn't really pay a dividend last year. And we really feel that being a mortgage REIT and getting our assets back reinvested, we can start to become like a more normalized REIT. And we really look at that dividend as being our core earnings even with as much cash as we have. And we would like to see that dividend continue to increase as we deploy our capital.

So we should, as we are modeling, we should look at your projected second quarter earnings as the basis for the next dividend? Is that -- am I interpreting you --

Correct.

Very good. Now the liquidity from both on the balance sheet at year-end plus the sale of the public mortgage REIT equities etc., and this $80 million, realistically I assume you will keep some cash just in the business for liquidity, and you do have your CMBS activities. I want to make sure I am clear as to how much of that you really see absent any other capital raising activity of that $80 million, how much would be allocated to Byron on the agency strategy?

Well, we see the bulk of that obviously going to Byron, well basically all of it, in all honesty. We are going to keep cash around for emergencies. But I would say that you could expect most all of that, if not all of it to be going to Byron. We will keep some cash but a modest amount of cash because we don't really have a lot of cash needs at the Company.

So if it was 70 and at 10 times leverage, you could conceivably have the portfolio to about $800 million?

I think that is a very safe assumption, yes.

Okay, and then just one final thing on the L2 Capital, now that you've set that relationship up for commercial assets, you had I think a year or so ago, maybe longer you did this Deutsche Bank joint venture. Should we assume the future investment in commercial will be through L2 and that that former joint venture will just kind of wind down?

We are still (multiple speakers).

Or are you going to keep them both?

We are still working on exactly how we are going to set that up. Obviously our Copperhead Ventures, that is all in CMBS, we would put any CMBS in the Copperhead Venture. I don't have to tell you, Steve, that CMBS spreads are exploding right now, and it is really hard to be able to predict a bottom to where those spreads are going, and we don't want to. We are very fortunate that all our CMBS is, as you know, ten-year seasoned. And a lot of it is callable over the next couple of years. So we are going to continue to cash flow that thing.

But adding new CMBS right now, which we would do through the Copperhead Venture, would be difficult because our joint venture partner, Deutsche Bank, is not very interested in being a CMBS investor.

Got you. Okay, so L2 is primarily it sounds like providing advisory services to you kind of globally as far as the commercial side, just like Byron is going to do on the agency side. Is that the right way to view it?

And also they are working carefully on our existing portfolio, as well. So, yes, that is correct.

All right. Well best of luck. We will keep a close eye on how this progresses over the next quarter or two. Thank you, Tom.

Thanks for your interest, Steve.

(OPERATOR INSTRUCTIONS) Jeff Porter, Porter Capital.

Congratulations, guys. Great job bringing us to this point. With regard to the new activity that Byron is going to be running, could you comment on exactly how that is going to be financed? And if you could, tell us what banks you are working with on that? And will the leverage actually be as high as 10 to 1, or will it be generally be more like 6 or 8 to 1?

Jeff, this is Byron Boston. Our expectations would be to manage leverage to the lower end, hopefully between an 8 to 10 to 1 type portfolio depending on what -- we don't want to force more out of this market than what's available in a very, very prudent manner.

Your other question, in terms of which banks, we are not at liberty to really say the specific banks at this point except to say that we have really solid relationships across the street. And one of the strongest strengths of Dynex at this moment versus some other companies is really a solid public company, 20 years of history with a very, very clean balance sheet.

Liquidity will be of the utmost concern as we go forth in putting the position together and will have some impact on the overall leverage of the portfolio. Did you have another question out of that?

Just following up that in an environment now where the credit markets are so stressed that even some of the big firms are having trouble rolling over auction rate paper and stuff like that, when you establish these lines, I'm assuming that your borrowing costs are some spread over LIBOR. What contingencies do you put in place so that these lines can't be called from you at an inopportune time?

What you want to try to do is have a portfolio of a variety of maturities of borrowings. And if you were to go to -- attempt to put on repo some nonagency type product, as Tom mentioned earlier, they are a bit liquidity challenged. On the agency side of the coin is an opposite result. There is far more liquidity per agency for financing agency paper than financing nonagency paper. That is really the basic result.

And you want to have a portfolio even today as you would four years ago, you want to run a position where you have a variety of maturities in your portfolio to try to manage the overall liquidity environment.

Let me just comment, Jeff, I think the stress that we saw last summer in the agency paper has sort of come and gone. Now that the Fed Funds rate is down here at a level where the financing of agency paper is extremely attractive, we find that all of the financing banks and counterparties are beyond the stress in the agency sector. And the Fed itself has got that special window where they are allowing agency and some nonagency paper to be put in there.

So we are really -- we've been waiting for this moment when the gloves sort of come off here on the ability to have a levered portfolio without taking that sort of dramatic, like you say, call risk. But I think that is behind us now.

All right. That's all I got. Thanks a lot.

(OPERATOR INSTRUCTIONS) There are no question at this time, Mr. Akin.

Thank you much, Vanessa. I want to thank all of our shareholders for being supportive of us over the last 20 years, and in particular, the last couple of years as you've stood by. We hope that your confidence is well founded. We are very confident that it is, and we are really look forward to discussing our results for the next quarters going forward. Thank you so much.

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