Dynex Capital Inc (DX) 2009 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter 2009 Dynex Capital earnings conference call. My name is Alicia and I'm going to be your operator for today.

At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to introduce your host for today's call, Mr. Thomas Akin, Chairman and Chief Executive officer. Please proceed, sir.

Yes, good morning, everyone, and thank you, operator. Today, joining me on the call is Steve Benedetti, our Chief Operating Officer; Byron Boston, our Chief Investment Officer; and Alison Griffin, Human Resources and Investor Relations. Alison, can you start us off with the standard protocols?

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-Q for the period ended December 31, 2008 as filed with the Securities and Exchange Commission.

Thank you, Alison. Well, welcome to the Q1 conference call and really I think our press release is pretty self-explanatory on everything going on. But I would just really like to focus on two main points that may not be part of the press release.

One is that the long-term strategy of Dynex Capital hasn't changed. Our Q1 results are reflective of our overall long-term strategy of investing Dynex Capital only in situations where the risk-adjusted yields are in favor of our shareholders. As many of you know, we did not invest our capital in the frothy markets of 2005 to 2007 and chose to delever our balance sheet instead. 2008 was the first time in over a decade that we started adding assets.

Market conditions have changed now and it favors the investor. We continue to judiciously add to our investment portfolio as we did in Q1 of 2009.

Q1 showed many changes from 2008, and I just want to point out a few -- and starting to show the value of our long-term investment strategy. Net interest (inaudible) margins picked up to 282 basis points for the quarter and 335 basis points for the agency part of our portfolio. Second-quarter margins appear to be even better. Right now, 50% of our capital is now invested in the agency MBS collateral.

Our net interest income went from $2.8 million in Q4 2008 to $5 million in Q1 '09, reflecting our cash flow strategies. Overall leverage, though, still remains very low, at four times, and reflects our conservative balance sheet.

We still have a significant amount of cash available of $22 million right now, or 15% of our capital yet to employ. Although we are under-levered, our book value still increased in the quarter from $8.07 in Q4 '08 to $8.36 in Q1 '09.

The second main point that I would like to talk about really regards our nonagency assets. As many of you know, several important government programs were announced in Q1. In particular, the TALF program should help create value for our shareholders in our nonagency investments, particularly in our CMBS. These investments all continue to cash flow along our expectations, and we continue to hold them with equity, but the valuation, as you know, has been dramatically affected in the marketplace.

The new government programs should create opportunities for Dynex to monetize the value of these assets in the upcoming year, and it will be the focus of DX management to make sure that we monetize those assets for all of our shareholders in the most efficient manner possible. We look forward to the opportunity of showing you just what we can do in that regard.

Now, I would like to open it up for questions, operator.

(Operator Instructions). Steve Delaney, JMP Securities.

So, I'm looking at your income statement, and the one number that kind of jumps off -- you report on a GAAP basis, and it looks like, if we net the JV and the fair value adjustments, there was probably a negative $110 million or maybe about $0.01 a share. So maybe a core number would be something around $0.19 or $0.20. I guess when I look at that and I compare it to your -- I think this is the third straight quarter you guys paid a $0.23 dividend, so refresh me. Is the first-quarter dividend -- and should I assume you had some carryover undistributed retractable income from '08? If that was the case -- and that was sort of the basis of being able to pay a dividend that was above sort of the core EPS. How much -- if that was the case, how much do you guys still have in the cookie jar in terms of undistributed taxable income that you could pay out going forward?

Well, first of all, as you know, we had a significant tax loss carry forward. It's approximately $150 million. So our ability to -- I mean have to distribute that income really is not a gating item for us, like many other REITs.

You know, if we are successful in monetizing some of these nonagency assets in upcoming quarters, as an aside, we will probably not distribute those to shareholders. We will just add them to our capital, because it will be a nontaxable event for them and increase our book value.

We feel that the -- well, Steve, why don't you take that earnings situation? Because we feel our earnings were more like $0.23 for the quarter.

Right, yes.

Help me get there, Steve.

Sure. If you look at the equity in joint venture of $754,000 (inaudible) about $988,000 is related to impairment charges. The difference between the $988,000 and $754,000 is our proportionate share of basically the net interest earned by that entity.

Okay, I got it.

So, Tom, in his comments, suggests that these non-cash charges were about $343,000, but I think you should add that number back as opposed to the number that you were adding, which was $150,000 or something like that.

Okay, and the non-cash, does that include the -- you referenced some sort of one-time G&A expense. Are you including --?

That's an additional $250,000.

Yes, but that was probably just like -- was that just like first-quarter spike in payroll taxes or something seasonal?

Yes, correct.

No, it was more along the lines of some consulting work.

Okay, so it truly was sort of one-time rather than just seasonal?

Right.

Okay. What I'm hearing, guys, is that, going back to my original question in that basically you were paying out what you see sort of your core earnings flow to be. We are not paying out really more than you saw yourself earning on a core basis. Is that a fair statement?

That's a fair statement, absolutely.

To your point, Tom, on the NOL, I was focused on the fact that it looked like maybe you were paying out more than you earned. What you're certainly point out is that you've got the flexibility to retain some and not have to pay out everything because of the benefit of your NOL. It just looked like we had the reverse situation. (multiple speakers)

No, the other thing to remember is that, with all of the programs that the government is implementing for nonagency assets, if we are to get any sort of turnaround in some of these assets -- our CMBS, some of our CMBS assets are now, on a cash flow basis, at a 40% yield. We find that to be a little -- it would be a nice cash flow that we could definitely take away into the future.

Tom, you guys say stated that -- this is a pretty interesting comment, I think -- you suggested that you are starting to see some repo available for I assume some very senior-level nonagency securities?

Yes. Byron, why don't you discuss the recent redeeming of some of our AAA collateral?

Yes, Steve, we have found some interest in financing some of our non-agency assets. Just on an historical basis last year, we did have some assets on repo. With Lehman Brothers, we pulled some assets back in time to not have any exposure to Lehman Brothers.

Then, as our conversations went out into the market about finding other financing sources, for the most part into the latter part of last year, there was no conversation to really be had. (multiple speakers) 2009, now there is conversation. Here we are sitting here in April and May and we actually have assets that were not financed at the beginning of this year that are currently financed.

Interesting. I mean, can you offer any color? I know you don't want to be specific, but could you give us any idea of sort of haircuts and pricing on the nonagency funding?

Steve, I don't know if I can give that specific detail.

Okay. All right, well, I won't press that but I think it's a great sign that you guys have found it, because I'm only aware of a few isolated cases, sort of legacy things where people have been able to do that, so that's a sign of the falling credit markets.

I think you see that -- I think you see that, I think you see that in LIBOR pricing. I think, if you really go out in the marketplace and really talk to a variety of repo debts, I think one repo trader put it best when he said "There is more trading amongst us, between banks at this point, than there was last year."

So I, mean yes, the markets have definitively gotten better. If we can stay away from any event such as last fall with Lehman Brothers -- the further away we can get away from that event and not have others occur, we would expect, given the amount of liquidity that the Fed has pumped into the marketplace, for the environment to continue to improve.

Great. Well, guys, thanks for the color. That's helpful. I appreciate it.

Jason [Stankowski], with Castle Peak.

I had a couple of questions. I guess the first one is a little easy. You know, as you talked with Steve about paying out your core earnings, what you believe is kind of your core earnings in the first quarter, as you see LIBOR or your funding rate coming down and you get more fully invested, I assume you believe that, the second quarter and going forward, the potential earnings kind of on a run-rate basis are in excess of what you saw in the first quarter.

Well, I just want to point out that we are continuing to add to our investment portfolio. We added a significant amount of bonds in the first quarter. We have continued to add in the second quarter. They are all very accretive to the cash. We still have 15% of our capital in cash, and we are reviewing all our opportunities. At the same time, we don't know what's going to happen to the pricing of our nonagency assets, but we are thinking that, instead of taking a hit like we have every quarter for over a year now, that we would be very happy if they just stabilized. It appears that they are stabilizing, although I don't want to go on record as saying that. To the extent that they stabilize, and may even -- God forbid -- improve a little bit, obviously then our results would reflect that.

You know, back in '03 and '04, we had a significant amount of the manufactured housing kind of optionality in our portfolio. Can you talk about sort of as you guys see the potential impact of book value, not only of the kind of 100% equity finance CMBS, but that as well as any optionality that you have because of your positions in the CMBS? Sort of what order of magnitude, any transactions -- how you guys think about that, relative to book value, not only in the pickup of maybe the pricing but also any optionality you have?

Well, obviously, you have a long memory, because we did have a lot of optionality in our manufactured housing portfolio going back into that '03-'05 period. We were able to monetize that for our shareholders. I'm not sure that the CMBS securitizations are that much different.

One of our securitizations of Feb. 15 of this year became callable, and obviously just adds to the optionality of what we have in the portfolio. But Steve has some more specifics in terms of what that might do to our book value and balance sheet. Steve?

Sure. Thanks, Tom. We have -- as Tom mentioned, we just had another deal that hit its redemption date. That redemption is actually right -- is actually owned through the joint venture. That's a couple of hundred million dollar deal with coupons ranging anywhere from sort of the high 7s to the low 8s on the bonds that are outstanding.

As Tom mentioned, we own those assets either on our balance sheet or through the JV at an effectively discounted cash flow rate of right around 40%, which is information that we obviously typically put in our Q as to what discount rate we use.

So you're looking at, just taking the joint venture for example, an entity that we value at $5.4 million and that's essentially a discounted cash flow at 40%. So the contribution from that entity, at that discount rate, you can obviously do the math there. It's over $2 million a year. That's just on the positions that entity owns.

Given that we have some redemption rights on the entire deal, assuming, as Tom had mentioned earlier at the top of the call, some assistance from the government, some of those redemption rights could have some pretty good value if they, for example -- the classes are TALF-eligible and you can secure a non-recourse financing for a AAA senior bond and a CMBS capital structure at very nice rates.

So there's a lot of upside potential there, sort of depending on where the government programs go. But by -- even without that, just sort of looking at our balance sheet and the earnings contribution from this joint venture, it's pretty good.

Yes, I think the point to make here is just, as Bryon pointed out, that we had access to a $665 million coupon on a AAA-rated CMBS that we just put out on repo.

You know, current market rates are, let's say, 4% or 4.5%. You know, having the ability to have access to significant amounts of collateral like Steve is mentioning, these are AAA-rated CMBS issues that we -- from 1998 with 40% credit support and a coupon over or at 8%. I don't know anybody that -- we have the opportunity to buy them at par. That's a great opportunity, and I think a lot of people -- if we do see things moderate, there's going to be some real value there. The good news is we had that optionality in our portfolio with no costs associated to it.

Great. Thanks a lot, guys. I will get back in the queue.

(Operator Instructions). It appears we have no additional questions in the queue at this time. Actually, Mr. Stankowski has re-queued up for a question. One moment please. Please proceed, sir.

I guess there is no queue, so I am back again.

Byron, I am just wondered if you could talk a little bit about your thoughts on the duration. Obviously the portfolio has a very nice yield and, from what I can tell, we are not taking a tremendous amount of duration risk -- and just how you think about that and how you view it for the agency side and maybe what you think kind of a blended duration is, in your mind, of the whole book.

Our strategy -- if you roll back a year ago, we started adding agency assets approximately 14 months ago. We deliberately focused on a very short-duration strategy for multiple reasons. One, it is more simplistic in a very high risk environment. So we have a fundamental core belief that we are in a high-risk environment. We felt that a very short duration portfolio that throws off a nice, solid, double-digit return was more simplistic than one where we would have to layer in an enormous amount of interest-rate swaps to hedge the position.

We have never been naïve about prepayment speeds. We've always felt as if the government would get involved with prepayment speeds. So, we had those assumptions, but the market has allowed us to build this portfolio that's very short in terms of duration.

As we've added assets and we've continued to focus on really short-duration hybrid ARM, this is somewhat of a unique period in the sense that we've got all of these Season 51, Season 71 type assets that create these really naturally short instruments that are guaranteed by both Freddie Mac and Fannie Mae. So we've taken advantage of the fact that you can buy a very short-duration instrument and earn very, very solid double-digit returns versus our current funding.

We don't have an enormous amount of duration risk. We have an extremely small amount of extension risk.

Our current month-to-roll, average month-to-roll is approximately 23 months. So we are very, very happy with our portfolio, and we are very happy with where we've focused our attention.

Again, we started from a perspective that we are operating in a very high-risk environment on a macro level. As a result, we wanted to keep our portfolio from a more simplistic perspective, especially when we could earn these types of returns.

Okay. With the nonagency piece layered in, when I look at the yield you are able to get on that portfolio if you just took the Company and kind of ran it off, do you have a sense of kind of what you would view the overall duration of the book as? A two-year, three-year?

Boy, that's really hard to say because it really depends on prepayments. The agency book obviously doesn't have much duration to speak of at all, and I don't know how you -- you would have to make a lot of estimates on the CMBS, but they have been around for a while. I mean, you know, we have some 15-year, 16-year, 10-year. So I still don't think the overall duration is the key there. It's the callability of these things and features like that.

You know, the government is putting together a significant number of programs which could create a wave of refinancing in the CMBS market. If that happens, you know, we've got assets to ride in the eye of the hurricane there. So I don't know how you come up with a duration number for that, to be honest with you, Jason.

Okay. Lastly, we are not wholly dependent on -- as you have seen, as you mentioned on this call, you've been able to find some repo for some AAA assets out there. I guess we are not wholly dependent on the government, assuming we could get a thaw in the overall banking sector coming to -- kind of moving towards the normal environment would obviously help as well.

That's correct. So we are anticipating that government programs will either directly or indirectly impact Dynex -- not only the valuation of the balance sheet of also the ability to obtain leverage at very attractive levels.

Yes, and just to finally put a cap on that is that we think the assumptions are -- right now, they are pretty worst-case I would say, and any improvement we think could have a pretty positive impact, just like they've had a negative impact over the last five quarters. So we are standing aside. We are not assuming anything. We are not taking anything for granted, but we do think that things could get better. If they do, then we are going to be able to -- we're going to be working hard to make sure we take advantage of that.

Great. Thanks for the good quarter, guys.

Bob Berlacher, Northwood Capital.

Sorry. I missed part of the Q&A because I had to drop off for a second, so if this was asked I apologize in advance. I can do this with you off-line. But I am just trying to put a few back of the envelope numbers together. The earnings were at $0.18. You paid out $0.23. Your book value went up by $0.25. So I am trying to -- and I obviously admit I don't understand the accounting as well as I probably should -- but just try to understand how you increased book by $0.25. I know that you earned -- if I back in some of the charges that you took, it looks like $0.23 to $0.25 maybe is what the real earnings were. Is that accurate?

We think it's $0.23. Right, Steve?

Yes.

Okay, all right, so I was close. But even if you are in $0.23 or $0.25, the stated book is after you pay the dividend, correct? So at 836 book and it went up $0.25, and even if you earned $0.23 to $0.25, I am just trying to put the numbers together and see how you book -- I am not complaining. I'm trying to understand better how the book still went up $0.25 after you paid out $0.23, even if you earned only $0.23 in the quarter.

Yes, it was predominantly, Bob, the increase in the fair value of the agency MBS that we own.

Okay, even after your charges then?

Right, correct. So it is really, if you look at the equity statement and see how accumulated other comprehensive loss at 12-31 turned to accumulated other comprehensive income at 3-31, it is really the change in the valuations of the agency MBS.

It is just a mark-to-market on the agency MBS?

Right.

We have a pretty good profit in our overall agency portfolio now.

Bob, we did point out that we do think that the margins are will probably improve in the second quarter as well, the way it's looking right now.

Great news. Keep it up. It's almost like watching paint dry, Tom, but it's okay. [laughter]

Well, we are trying to point out that we've got a long-term strategy, we are sticking to it and it's working.

Yes, it's working. It is working. I just wish somebody other than the few people on this call realized that. [laughter].

Patience.

All right, I do. All right, Tom, thanks very much. I appreciate it.

Those are all of the questions we have for today.

Okay, great. Well, listen, I want to thank all of our shareholders for being on this call. Again, we continue to execute on our long-term strategy. We still have a lot of cash available. We continue to add selectively to our overall balance sheet, and we think that the best days for Dynex are still ahead of us. We continue to judiciously allocate our shareholders' capital in a safe, risk-adjusted manner. We look forward to talking with you in the future. Thank you much.

Ladies and gentlemen, that includes your presentation. You may now disconnect. Good day.