Dynex Capital Inc (DX) 2008 Q2 法說會逐字稿

Greetings and welcome to the Dynex Capital Inc. second quarter 2008 results conference call. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Tom Akin. Thank you, you may begin.

Thank you, operator, and good morning to everyone, and welcome to the Dynex second quarter conference call. With me today from the company is Steve Benedetti, our COO; Byron Boston, our CIO; and Alison Griffin, Head of Investor Relations. First, I'd like Alison to read the customary disclosure statement, please.

Okay. Thanks, Tom. 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 yesterday, July 22, and our annual report on form 10-K for the period ended December 31, 2007, as filed with the Securities and Exchange Commission.

Thank you, Alison. Welcome, everyone, this morning. Thanks for getting up, for many of you early, to get this call. The first six months of 2008 have been a wild ride for many mortgage rates. We've seen historic spread volatility. Freddy and Fannie guarantees called into question, many moves by the Fed and the treasury to shore up investor confidence. Although many of these concerns appear to be subsiding here as we get congressional action on Freddy and Fannie, there is no doubt that we will continue to have volatility in the markets going forward. Our second quarter results of $0.26 for the quarter and our six months' earnings of $0.59 reflect our conservative strategy that we have in place for several years now.

Book value has improved from year end from $8.22 to $8.24 at June 30, and then with the advanced mortgage, with the announced mortgage servicing relief, our book stands at July 1 at $8.52. We are very proud of protecting our investors' capital and we will continue the do so in the future. Our existing portfolio of well seasoned single family and commercial loans are acting as expected. We have very low loan loss delinquencies and don't see any reason to see those pick up. We've added almost $110 million of agency RMBS in the quarter with very attractive spreads and continue to add to the portfolio in this volatile environment. We continue to judiciously put our capital work in this highly volatile market. The market holds significant risks both perceived and unperceived, and we remain cautious in our outlook and will add investments accordingly. That's really all our prepared statements for this morning. I've got Byron and Steve here. I'd like to, operator, open it up for questions, if we have any, from the floor.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Mr. [Bill Zohos] from Odyssey Partners. Please proceed with your question.

Good morning. Hi. Congratulations on stellar results in a very difficult market. My only question was giving the stocks trading at such a discount to book and your dividend yield is so high, would you guys consider buying back some stock here?

We do have an existing stock purchase plan, I believe, in effect. We could possibly buy back stock. We have not been active in the market. There are significant investment opportunities out there, Bill. I don't have to tell you. And while the stock goes up and down on just a few thousand shares, I doubt that we could buy enough shares to be -- to make it meaningful for our shareholders. I mean, I think if a big block came up and we were aware of it, we would definitely have to take a look at that vis-a-vis opportunities. A lot of the investments we're looking at now on very modest leverage are yielding in the high teens right now and to us that's a pretty good opportunity to invest our capital long-term as opposed to if we buy back some stock, that would be just really a short-term one quarter event.

Right. And then could you just comment on sort of the capital raising opportunity for Dynex?

Well, obviously we filed our shelf back in, I believe, February or March. We are interested in raising capital, but I don't think that it makes any sense at all to raise capital where our stock is so much below our book value. A lot of the other mortgage REITs, because of what's going on in congress now, are actually getting some price appreciation, and I suspect that if the market were to get better, we would be interested in taking on more capital, if possible.

Great. Thank you and congratulations again.

Thank you. Our next question comes from the loin of Mr. [Charles Kagnas], a private investor. Please proceed with your question.

Good morning. Charles? Looks like we lost him, operator.

Our next question comes from Mr. Jason Stankowski with Capital Peak. Please proceed with your question.

Hi, guys. I was also interested in the results, good results for the quarter. I was curious, if Byron, or you, Tom, had any comments about the spreads widening currently and why that would be happening, given the -- and maybe I guess it could contract if Congress actually votes to do what they need to do here in the next day or so. But in the perceived implicit becoming explicit, why would we see kind of a widening here over the last few days in agency spreads? Do you have any thoughts on that?

Yes. It's interesting, there are a couple of dynamics that have taken place. One is to understand the technicals in the mortgage market and understand what each player happens to be doing. There hasn't been -- if you look back to March, there was an enormous amount of volume. There were delevered -- there were sellers deleveraging in the space. I don't think you had that type of activity taking place this time around. But you have had, for example, mortgage servicers whose books of businesses have whittled out in terms of duration or extended in terms of duration, actually selling mortgages, and then, more importantly, it appears to be an absence of buyers. So real money really standing on the sideline. You've had some activity in terms of keeping mortgages in check with some leverage players getting involved as mortgages have widened out. But a lot of -- a lot of participants actually sitting on the sidelines, it appears, over the last let's call it week and a half or so, especially some foreign buyers actually sitting on the side lines.

So I would not expect mortgage spreads, especially in the ARM sector, to have a situation like they did back in March. 30- and 15-year spreads are out or near about where they were in the March time period, but I wouldn't expect the same thing in ARM, mainly because you really don't have as much supply. But I would probably characterize this situation more in the sense of an absence of buyers. It does appear that there have been more -- a little bit of a pickup in activity over the last day, potentially, but I -- until there's some more uncertainty out of the air, I think you could still have just spreads out at wider levels. Freddy and Fannie are not involved, from my understanding, from a purchase perspective. If you have foreign buyers also on the sidelines and you have banks on the side lines, you have somewhat of an absence of buyers. The mortgage market, the agency mortgage market, especially, is a technical market. So understanding what each of the participants are doing is a very important component of understanding where spreads will go.

Okay. And what type of -- what type of leverage are you guys comfortable talking about taking in the agency trade that we're actively investing in?

Well, we see our leverage -- obviously our leverage is still rather modest. We have stayed very short on a large of the agency resets that we've had just because of the volatility in the market place. We could see going to a number of about six times here over the near future. As spreads have been widening out, we've been buying more and more securities. We still have lots of room before we get to that six times leverage. So I would say that's sort of the goal right now. We cannot go by investment [edict] over 10. So we would be employing modest leverage. But I'd say our first goal, as spreads widen here, is to get to 6.

Which is kind of a mid to high teens ROE? Is that --?

Well, that's what we're seeing on the currently, yes, leverage trades there we're ding right now.

Okay.

And in some cases, it's -- it's high teens. It's high teens.

Okay. Great. And I would just -- to echo Bill's comment, it would be -- it would be nice to see perhaps a 10(b)5 or something in place with our million share buy-back just to have a catcher's mitt there if something did happen with one of our shareholders needing to get out at significantly less than book value. It would be great to be able to all participate in that actively. So I would encourage the Board to look at that.

Well, I will go back and check. The last time we bought stock was when the stock was down around $6.35. So I think when it gets significantly below book, let's say greater than 15%, it probably becomes an interesting opportunity for us. But, again, like I say, there just isn't a ton of stock out there to buy.

Thanks, guys.

Thank you. Our next question comes from Mr. Bose George with KBW. Please proceed with your question.

Good morning, guys.

Good morning, Bose.

I just had a question on the tone of the agency recall market just in terms of availability, hair cuts, funding costs?

I'll let Byron answer that. He's living that day to day. We've expanded our repo counterparties now. I'll let Byron talk about that a little bit.

Hey, Bose. One of the things I think we're probably most proud of is the fact that we have put together a string of repo counterparties since March despite the really tough conditions, and we still have -- the spread widening has led me to try to have more conversations with our creditors just to try and ensure that they're not concerned about other apartments, and we've likewise kept our positions relatively short to try to build some confidence amongst our creditors. We have not seen, at the moment, a reason to believe that we're at the situation like we were back in March. But I do still feel that it's a stressed environment, meaning that my creditors do want to have conversations with me in terms of what we're doing, how much leverage we're taking. And I can recall, just within the last few weeks a couple of conversations where people just wanted to know exactly what we're doing as we build out the portfolio, and each time we've been given the same message of we're really not rushing to do anything in a manner that would put the company at risk.

And are the minimum capital -- the hair cuts still in the 5% range from what you guys have seen?

Still in or about that level, still what we've been seeing.

Okay. Great. Thanks a lot. And good quarter.

The only thing I'll add to that is that we have been able to extend some of our repo from 30 days to 60 and 90, and we're very happy to see that a couple of our repo counterparties are getting comfortable in extending that extra time for us. Operator?

(OPERATOR INSTRUCTIONS) Thank you. Our next question comes from Mr. Jay Weinstein with Oak Forest. Please proceed with your question.

Hey, good morning, guys.

Good morning, Jay.

I was wondering if Byron could speak, I guess, somewhat in general terms, but your philosophy, the dynamics of what you're looking for in your individual security selection as you build out the portfolios, how you go about it and just the way your thought process works?

What we've been doing so far has really -- we observed in the spring that as spreads really widen out that close to March that there is an opportunity to stay really short in terms our security selection, meaning assets that are 30 roll or shorter. And in addition to something that's new here in 2008 versus 2004 is that you have a large amount of season 5-1, season 7-1, season 3-1s different than, let's say, three or four years ago than these securities were just being issued. So they made for an interesting opportunity because the assets are relatively short, in a volatile environment, and it behooves us in that sense to be relatively short. It's a more simplistic trade and so that's been the first order of business is looking at the overall months to roll, month to reset.

Then secondarily to that is trying to glean which securities may perform from a prepayment perspective. We do have an opinion that the mortgage market is structurally changing. I've gone -- I've been in the mortgage market since 1986, and I've watched these structural changes take place and when they take place, they actually -- the structural changes can last quite a bit of time. So we're rolling -- we have what we call rolling back the mortgage market or the origination process to some time period similar to in probably the early 90s to mid 90s, and so structurally speaking, we just believe that prepayment speeds will be slower. We've been more comfortable with adding securities up near the 101 type dollar price on shorter securities. We have added some approaching 102, but not that many, very, very few.

So, again, a couple of key tenets in our strategy has been shorter reset assets plus thinking about the overall prepayment environment. In our worst case scenario, we like to look at these assets and say, if we got really extreme prepayment speeds, how far -- how long will it take for these assets to really -- the yield on these assets to go through our if funding levels and we've got a lot of room. We've been really happy with the amount of stress -- speed stress these assets can take and still have a positive spread to our funding levels. The flip side of that would be that these mortgages would really slow down and our durations would extend on this but, again, back to the advantage of being in the short security, the overall duration extension is limited.

Yes. It's been my impression that this recognition that the extension risk was real and pre-pace would slow with a relatively low interest rate environment has been one of the issues kind of in the longer 15- and 30-year mortgage spreads just in my readings and my discussions with people, and that's not really relevant if you're in the shorter curve.

That's exactly correct. That's one of the advantages of staying short. Earlier, just to clarify, what I meant by mortgagor service or selling is basically -- there's probably -- in addition to Freddy and Fannie, those are probably the most volatile mortgages in the marketplace. What these guys have experienced is that their durations have extended, and so they've had a need to sell mortgages to hedge out their portfolio. So as their durations extended; and, again, in the absence of buyers, a minor amount of selling can push spreads higher. So one of the advantages again of trying to stay short is to minimize that overall duration extension which leads -- which ultimately could put you in a position where you're a little bit under hedged.

I'm away from my computer. Where is your ratio leverage now, Tom? I'm sorry I'm not at my desk.

Well, we have a lot of seasoned assets as well. If you take a look at the available capital that we have for the agency market right now, we still have room to probably, on a 6-to-1 leverage basis double the size of our portfolio. So we're well inside of where we'd like to be. So I would say that roughly speaking the number is probably around 3.

Okay. I'll make a comment on the previous callers about buying and shares, which generally I'm always in support of. I found that the mortgagor REIT industry works a little deferent than most other industries, which is often times if you're able to raise capital in some sort of premium to book, it actually helps your stock price become more liquid and, again, the opportunities you're seeing are so accretive that it becomes an upward spiral, the more shares you can actually issue at decent levels, the more the stock actually does well. Most companies when they issue stock it tends to depress the price. I find the opposite to be true in your industry. So the challenge is to get the shares at least a respectable premium above book before you can do the capital rates, as the liquidity for the shares improve, I think everybody would be well served. I agree obviously that if you could buy stock at a decent discount, you should do it. But I've -- it's the opposite of just most of my comments, which is usually I always want to buy stock cheaply, and here I'd be happy if you could get the chance to issue it. So I'm sure you understand that. But that's just my comment on that.

Well, anybody who's listen to me has heard me refer to the term virtuous cycle, and I think what you're talking about the is virtuous cycle that mortgage REIT can get in to. We are laying the groundwork for doing exactly that. I think we have a great strategy. We have a great team to put it together. And then I also think that we've got a significant opportunity in so much as the market is giving us some very high yield opportunities. The fact that the market is slow to perceive what we're doing or as unsure of whether we're doing, that's fine. We're very patient about this. We understand it is a marathon, not a sprint. We're planning accordingly. I appreciate the comment, Jay.

One last question. There's -- the 10 million in that adjusted book value calculation, there's just -- I mean, that's sort of a function of CMBS pricing kind of, or -- remind me of why that calculation exists. You don't actually expect to realize any of those. That's a mark to market adjustment.

Yes, Jay. That's right. It's mostly the commercial assets.

Okay. And those, as you say, are seasoned and old and have no delinquencies, if I recall.

That's correct.

Okay. I think that's all I have for right now. I'll let somebody else step in. Thanks, guys and, as always, good job.

Thank you. Our next question comes from Mr. [Ed Morow], a private investor. Please proceed with your question.

Speak to us about a possible give depend sometime later this year for common stock holders.

Well, as you know we paid $0.10 in the first quarter. We paid $0.15 in the second. We plan on paying a dividend in the third quarter and we'll be announcing that shortly. We have to work through a couple of things here, but you should hear about it soon. As I mentioned earlier, our plan is to continue to pay an attractive dividend, one that is a recurring dividend, and with the earnings we heave had this quarter, I don't see there's any problem with us paying a dividend in this quarter.

Again, thanks, and congratulations on a good quarter.

Thank you, Ed.

(OPERATOR INSTRUCTIONS) Thank you. Our next question comes from Mr. [Charles Kagnas], a private investor. Please proceed with your question.

Hello.

Hey, Charlie, you're back.

You can hear me this time. Could you talk about the difference between volatility and real risk? I know that some of your securities are you have mark to market pricing and so your economic book value has been -- or your adjusted book value has been bouncing around a little bit compared to GAAP and -- but could you just maybe talk a little bit about what you see as being the real risk in this environment? It seems like your funding sources are getting happier with you. Your spreads are looking attractive. The likelihood that interest rates are going to be bouncing up in the general economy are not that -- not that likely for the next year or so, and so what do you see the real, like, permanent risk to capital being in the business that makes you so concerned?

Well, --

Is it funding? Is it -- what is it?

I think anytime you run a levered portfolio, Charles, you'd be rather foolish not to be concerned about your funding risk.

Okay.

We continue -- you know, the issue in this marketplace, in this business has been and will be the fact that funding sources dry up at exactly the wrong time.

Okay.

As we saw last year, a number of mortgage REITs that got over-levered had to sell off assets, some of them were able to delever. They ended up usually taking a pretty significant capital hit when that happened, and some of them couldn't delever fast enough and disappeared. So I'd say, any time that you're running a levered portfolio, even lightly leverage, and you owe more securities than you have equity, you have the risk of being -- of illiquidity. We are very cognizant of that. That level of volatility in the bonds is exactly what can create problems in the repo market and one you have to constantly be cognizant of. So we are very comfortable with everything we're doing, but we realize that we've seen this movie several times, Byron much more than me necessarily, but we are very, very careful to make sure that we do not overextend, get over-levered and get in a position where we can hurt our capital. Our book values continue to increase, and we would like to see that go on in the near future and for a long time.

Good, good. Thank you. That's a good explanation. And maybe just for the sake of the people on the call. When you and I talked about your NOLs and the notion of your being able to grow your book a few dollars over the next few years by using those up, could you just give that explanation once again?

Well, the goal is for the company to pay an attractive dividend. We want the pay an attractive dividend. Obviously the opportunities in the marketplace afford us the ability to do that. At the same time, we still have had an operating loss of slightly in excess of $150 million. So we have the ability to take some of that excess return and plow it back into the company, plow it back into our book value, and basically create a capital base that we can use to reinvest and get higher returns for our shareholders. So that is the DPL. But, again, we are in great environment right now, with yields in the high teens. We can pay a very attractive dividend and consequently also increase our book value. So it's a win-win.

What do you think the book value could be trance late into in terms of -- you've got $150 million of NOLs and 12 million shares or so. What would that look like as you whittled that down? How much would that 150 turn into increased book value per share?

I think you're asking questions that legally I don't want to answer but it is a significant number.

That's very good. Okay. Thanks.

There are no further questions in the queue at this time.

Well, great, operator. I want to thank all of the callers for joining us this morning. We are very happy with our first six months. We look forward to the next six months. Dynex is well positioned to take advantage of the opportunities in the marketplace. We are getting a fair number of them. So we're -- we are looking forward to talking to you on our next conference call. Thank you very much for your support.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.