Dynex Capital Inc (DX) 2008 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2008 Dynex Capital earnings conference call. My name is Noelia and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's conference, Mr. Thomas Akin, Chairman and CEO. Please proceed, sir.

Thank you, Noelia, and good morning to everyone. Welcome to the Dynex fourth-quarter 2008 conference call and full-year discussion. With me today from the Company is Steve Benedetti, our COO; Byron Boston, our CIO; and Alison Griffin, Head of Investor Relations.

Alison, I would like you to read our disclosure statement please.

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 and/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, 2007 as filed with the Securities and Exchange Commission.

Thank you, Alison. As many of you know, 2008 was a year of transition for Dynex Capital. But more importantly, that transition foundation was laid in the earlier years, 2005, 2006, and 2007, when we delevered the Company and basically gave us a firm foundation as we entered into 2008 to add to our investment portfolio.

We started out modestly in 2008 by buying some agency mortgage securities in March and we added that portfolio in July, but more importantly, we carefully added a short duration agency portfolio throughout the year as we saw fit and as spreads widened. As such, we ended the year with a portfolio of $311.6 million agency bonds as of 12/31. We continued to add to that here in the first quarter of 2009 and we feel that we have got an agency portfolio that has a very short duration, and an average coupon above 5%.

On the other side of that trade, we kept our funding costs very, very short as well. We did not hedge our positions and we basically felt that a short duration portfolio would be best served in this rather complicated and volatile market if we kept it in the repo rates as low as short as possible.

At the same time in 2008, our non-agency portfolio performed admirably. We continued to get the cash flow from that portfolio and much of our cash flow in 2008 was derived from our non-agency portfolio.

Our net interest spread before the quarter was approximately 140 basis points on the agency portfolio. But as we have seen as we have gone into to first quarter 2009, our agency mortgage financing costs have dropped dramatically and that spread is now approaching 300 basis points.

As we look forward into 2009, we could expect some of the transition portfolio with adjustments we made into 2008 carry through. Let me give you just a couple.

We expect the agency portfolio to make a much bigger contribution to earnings in 2007. As we have stated before, we did not hedge the portfolio and therefore we are getting full advantage of the mortgage rates which are now averaging below 1% at mortgage repo rates.

Secondly, we expect our non-agency portfolio to continue to cash flow. Even though that non-agency portfolio is smaller than has been vis-a-vis our addition to the agency portfolio, we still see good, solid cash flow from that portfolio in 2009. We also expect that the TALF could have an impact, a positive impact on high-quality paper of which we own quite a bit, and we are looking forward to see how that whole system manifests itself as we go into the end of March here and better information is available.

Another thing that has occurred in 2009 which gives us some pause for optimism is that we have been able to repo some of our high-quality RMBS collateral. In particular, our SASCO Bond, which we have not been able to repo for approximately -- for over a year now is back on repo and I think that is a testament to the fact that the repo market is beginning to improve.

Our expectation is that we have built a very solid foundation for Dynex Capital. While we have transitioned the portfolio carefully in 2008, we do not expect that to change as we move into 2009. We are moving Dynex's business model forward carefully given the extraordinary conditions in the marketplace. Again, we are not willing to risk short-term gains for the long-term viability of the Dynex franchise. We remain ever vigilant that there is volatility out there, that there is risk out there, and we remain committed to protecting shareholder net asset value.

As you can see from our results in 2008, we were able to keep our book value right in the $8 range, and we are very proud of that. We will continue to monitor that very carefully.

Dynex continues to be in a great position to capitalize on investment opportunities as the market unfolds. We still have a significant amount of cash on our balance sheets, but we feel that we have enough invested capital right now that we can sustain our earnings power going forward and provide a very comfortable dividend for our shareholders.

Operator, I would like to open it up for questions, and Byron and Steve are on the line with me to help answer them.

(Operator Instructions) Steve DeLaney, JMP Securities.

Good morning, Tom. Listen, you talked about the spread expanding pretty dramatically here and I assume most of that is obviously the drop in the cost of funds. I was wondering whether Byron has handy like which are -- as of 12/31 on a spot basis, what was your average repo rate at 12/31 and approximately what would that be today?

I am sure he has that handy. Byron, why don't you go ahead and answer that.

Hey, Steve, the average rate today is 1% lower and that's down from -- we were rolling at the end of fourth quarter posted 3% and I would put the range at the end of fourth quarter -- because we started rolling some assets like many other players back at the end of October/beginning of November over year-end. And so we were probably at a range of 2.75% to 3.50% during that period. And it was more outliers that kind of got us up to that 3.50% level. Everyone else was in around that 2.75% to 3% range, and so --

And have you got everything -- have you got everything back down to sort of a 30-day kind of maturity now?

We've got a little bit of the ladder. We got some 30 day, some 60 day, and some 90 day.

We've seen the ability to go out a little bit longer, Steve, and we have added two counterparties to our existing 10 just this quarter, so we see expanding appetite for repo agreements.

Steve, just to give you a little more on that, I did a little market check even this morning before the call and I continue to get much more positive vibes regarding the repo market, huge change from obviously December of last year.

Byron, is that just because of a lot of institutional cash sitting on the sidelines and looking for a home outside of treasuries?

Well, I think there are multiple things. One, there is a lot of short-term cash. That's been the government's strategy is to create a lot of liquidity obviously in the short end of the market. I think with the government purchasing a lot of agency collateral, I think there is a lot of collateral that has disappeared and it's not necessarily I think repo debts have been competing for collateral. I think that there was a belief at the end of last year and I think there is still some belief that -- will there be any type of balance sheet squeeze as the year goes on? But it's apparent -- from my understanding, dealers are financing each other at a much higher rate than they were in the fourth quarter of last year. So that gives you some insight in terms of the thought process around counterparty risk.

All right, that's helpful. Tom, just one final thing. I mean the book value coming in a little over $8 was a little better than expected. Obviously, I think you got a little lift on the MBS. But does that imply that maybe -- I know for a while there the auditors were kind of looking at your legacy particularly your commercial assets and -- which have long lives on them and it's kind of a different product than what's being originated in the market in the last few years. But they were kind of applying either CMBS or CMBX kind of risk-based pricing to it.

Does the book kind of suggest that maybe they've gotten comfortable with the level -- given the nature of those assets that they've finally gotten comfortable with where you are carrying them?

Well, I mean there is a couple things going on. One, our CMBS as a percentage of our portfolio obviously is getting smaller and smaller and it is much older paper. As you mentioned, a lot of that paper is from '93 to '97/'98, so it's sort of in its cash flow stage at this point and it's very, very seasoned. So I'm not sure our auditors are comfortable with anything in the environment we are in right now. But I think it is becoming de minimis as our overall portfolio has grown into other areas and other things.

I don't know if that answers your question, but I think that's probably what we are going to also see for 2009 as well is that we are just deemphasizing that aspect of our portfolio and it's having a smaller and smaller impact on our balance sheet.

Got it. Okay, thanks. That's all I have. If Trevor has anything, I guess he will jump on himself. Thank you very much.

(Operator Instructions) Jay Weinstein, Oak Forest Investment Management.

Hi, it's Jay Weinstein, how are you?

Hey, Jay, how are you today?

I haven't had a sex change operation. I am still Jay.

Okay, for the slow amongst us on this phone call, help me out with the accounting for the obligation to the joint venture under the payment agreement. The easier part of the question is is it relatively safe to assume that all the cash has been distributed back to you and the partners so that pretty much what's left at that joint venture is just as your -- the CMBS contribution you made in the first place?

The joint venture continues to cash flow. We did this to have a fairly significant distribution of cash in the fourth quarter. Steve, maybe you can clarify the accounting at this point for Jay.

Yes, hi Jay.

That's right, good luck to you because you have got a slow learner.

Well, there's two sides to the coin here. You are correct, we did and as Tom said, we did do a distribution, so what's left in the joint venture is really substantially just the CMBS that we contributed in. As you know, we contributed in CMBS directly, which were de-recognized from our balance sheet at the time we contributed them in. And then we contributed in essentially the economics of some assets which remain in our balance sheet. That's through the obligation under payment agreement.

Okay, so that is sort of separate. (multiple speakers)

And that obligation, we -- every time we collect cash on those CMBS that are still on our balance sheet and they are shown as securitized commercial mortgage loans, we then flip that cash over to the JV and that comes through that obligation that's on our -- on the liability side. That obligation is marked-to-market. We account for it on a fair value basis similar to the way the JV accounts for its side of that transaction.

Okay, and the reason that it actually dropped sharply is because they have jacked up the discount rates so much. Is that it?

It's two reasons. One is that the principal -- the extension of the cash flow and the reduction and the overall expectations in cash flows on that as well as discount rates.

But the majority of that, Jay, is really the distribution of the cash out of there. We just took a fairly significant amount of cash. It accrued all year.

That's right, that's on the asset that. Then on the liability side, it's the discount rates and extension of the payment of the cash flow.

Yes, the liability -- the asset side is a lot easier to understand. It is the liability one I was scratching my head over. So expectations of the fluctuations, because it just affects book value but it's still interesting to follow. I think it was like $1 million-something -- was it for the year or the fourth quarter? I can't remember now.

Yes, it was for the fourth quarter, it was $1 million.

Which is still at least something worth following. Would you expect the fluctuations to be less going forward or you don't really know?

You don't really know. It depends on market volatility and spreads, but in terms of the payment side of that, we think that will be fairly stable. I don't think spreads on that type of product have moved a whole lot thus far in the first quarter. I think we used a mid-30s discount rate, which was (multiple speakers)

He has a 36 or 37 or something.

And that was kind of the oldest CMBX vintage. That's kind of the proxy that we use for that obligation.

Okay, last question on that front is those -- I tried to go through the legality of terminating the joint venture because obviously the liquidation voted out anyway. But the legalese was frankly beyond me in terms of going to the agreement. Is there a reason why you don't just kind of terminate it and go back to ground? It is not really doing anything -- is there any point to keeping it alive?

Well, 50% of the assets in that -- in the joint venture are obviously owned by Deutsche Bank and Deutsche Bank as our partner is sharing the gains and losses and the cash flow in that. And in order to terminate it, there are specific conditions that have to be met.

I'm sorry, I would assume it would be mutual. I mean, I'm not assuming you would do it all by yourself. I'm assuming that it would be mutual consent sort of thing.

Yes, and there is a natural sort of the end to that; the end of the agreement comes in, I believe it's April '09 and we have to sit down and agree to how we want to dispose of this joint venture. Although again, even though we continue to mark down the collateral in terms of the cash flows and everything else, there's still a significant amount of cash coming out every month off of that securitization. And again, it is well seasoned paper and we are very happy with it.

Right. The only issue is whether you would just need the legal structure or not. I mean, as I say, at this point -- I don't know what the costs are in terms of keeping it alive or terminating it. But on an economic basis, it's just another way to collect the money that you would be collecting anyway. Right?

Although, Jay, as Tom says, we own a half of it and Deutsche Bank owns half. So to collapse it would be either that both parties sell their halves externally or one party buys the other half.

Lord knows they probably don't have the money. You guys are more likely to buy from them than the other way around. You probably have better liquidity than they do.

We have been in discussions with them on all of the above.

Okay, I am only partially kidding of course. So that's the state of the world these days. Byron, on the asset purchase side, just in general what's your take? I know Fannies and Freddies still officially don't still have full faith in credit, although people are sort of treating them as they sort of do. I mean just what's your take on the general issue of credit with Fannie and Freddie stuff?

Yes, I think that -- I have a really strong opinion that the world is revolving around the federal government's credit, period. And it's in most investment returns at this point, okay? I mean asset classes are dependent on the credit of the United States government. And that's -- I have felt for a long time that Freddie and Fannie were far too big to fail.

I joined Freddie Mac in 1997 and I was shocked at the size of the balance sheet and the swap book at that point in time. I felt it was too big to fail and I haven't changed my opinion today. I think the mortgage universe until the government gets some stability in the housing universe and the mortgage universe that the economy won't make a major turn or even find the floor.

So I think those entities are extremely important to the federal government and I think basically we have -- the market is functioning. It has the backing of the government. It has been for some time and that's the way it does function and I am not disagreeing with it.

Yes, okay, interesting.

I think the really important part is that there is a huge pool of cash out there in the trillions of dollars obviously, $4 trillion or $5 trillion that will take agency collateral on repo, and that will continue to keep our repo costs very, very low as long as that pool of capital is out there. And we will accept Freddie and Fannie collateral. We don't see that changing any time soon because I think the government is very clear that they want to make sure that that area continues to be financable.

The fact that we've seen an increase in interest in the repo market, the increase in counterparties, a much lower cost of funds to me is indicative of the fact that it is a market that is very effectively being managed and we don't -- we don't see that changing anytime in the near future.

Tom, then I will ask you the last question which I always ask you in terms of your plans or just your thoughts vis-a-vis the tax loss carryforward and sort of along the same lines of -- you would be thrilled to get your stock to a level above book value, some percentage where you could issue more shares, but can't quite get it there. Any ideas on that front either?

Clearly the market is very concerned about the whole financial arena at this point. So I would say that we like many of the other mortgage REITs are suffering from the difficulties in perception of the marketplace. I don't know that that's going to get cleared up overnight. So we are very happy continuing to cash flow our portfolio, continuing to earn what we feel to be are acceptable rate of returns for us and our shareholders. And we are going to take as little risk as possible in achieving those returns so that we can basically protect our book value.

We have done that for the last five years. I don't see that changing. In the market, the place that we see right now, protecting book value is probably the most important thing we can do. So the market is going to do what it's going to do. I can't be responsible for that. But we are going to run this company with a thought process that we are going to look out for the downsides and let the upside take care of itself.

Well, I tell you every quarter how highly I think of the job you have done, so I will just say -- I will repeat it again just for consistency's sake. But having been around a long time, I do appreciate it. And I would comment, which is just my opinion, is that the other mortgage REITs that I sort of follow do actually trade at a very slight premium even these days to book. And my guess is that your discount is just simply a function of size and liquidity and nothing else. And that may not be anything you can handle, as you point out, but that's probably the best guess that I have to offer.

Thank you, Jay.

(Operator Instructions) I am showing there are no further questions at this moment, sir.

Well, I want to thank all our shareholders for being on the call with us and we are very happy with our results for 2008. We think it sets us up in a great position for 2009. We look forward to the future conference calls with all of you, and thank you for your support.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.