Dynex Capital Inc (DX) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Quarter 2010 Dynex Capital Earnings Conference Call. My name is [Chiquana] and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference. (Operator Instructions). I would now like to turn the presentation over to your host for today, Mr. Thomas Akin, Chairman and Chief Executive Officer. Please proceed, sir.

Thank you, operator, and thanks everyone for taking the time to join our call. On the call with me today is Byron Boston, our Chief Investment Officer; Steve Benedetti, our Chief Financial and Chief Operating Officer; and Alison Griffin, who heads up our Investor Relations area.

Before we get started, I'd like to have Alison read our standard Safe Harbor disclosure.

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 that was issued yesterday, April 27th, and our annual report on Form 10-K for the period ended December 31, 2009, as filed with the Securities and Exchange Commission.

I'd like to turn the call back to Tom now.

Thanks, Alison. I'd like to briefly cover some of the information included in the press release and then add information regarding our investment portfolio. Our net interest declined slightly from quarter-over-quarter. The net interest spread was 282 for the first quarter 2009 and 311 basis points for the fourth quarter of '09. That has to do with respect to prepayment as a result of Freddie Mac's buy-out activity in March.

Our CPR for the quarter was 28.6% versus 17.8% last quarter. We expect Fannie Mae's loan buy activity to keep prepayment speeds high for the second quarter, but such activity has already been factored into the effective yields of our Agency MBS. On average, we own our Agency MBS at a premiums of 2.3 point above par as of March 31, which should help mitigate the impact of the GSE buyout loan activity on our results.

We continue our theme of portfolio diversification as we added $61 million in CMBS during the quarter. On a gross basis, our investment portfolio is now approximately 60% agency and 40% non-agency investment, which is our current target ranges.

Our leverage targets are 7x for our Agency MBS and 4x for our non-agency MBS and CMBS. Financing conditions continue to improve and we now have 15 repo counterparty relationships and we are active with 12 right now. Financing for non-agency MBS in the repurchase agreement market is becoming more competitive and we continue to see improving availability in turn.

During the quarter, we had 1.1 million shares and raised $9.7 million of common equity under our controlled equity offering program. We saw our book value improve during the quarter to $9.40 as spreads improved on CMBS that we enquired, as you recall, the previous quarter. We also earned $0.30 for the quarter versus our $0.23 dividend. We have continued to see improved prices on our CMBS so far here in the second quarter.

Since the beginning of 2008, Dynex has been adding assets opportunistically to its portfolio. We started with agency MBS in 2008 and early 2009 and then started adding non-agency MBS in late 2009 and early 2010.

This last quarter we became almost fully invested. Our cash flows and earnings for the quarter represent a portfolio position. Our hybrid strategy represents a win-win for our shareholders as evident in this last quarter as our non-agency CMBS price appreciation more than offset the buybacks, Freddie and Fannie.

For the balance of 2010, we will continue to focus on execution and building out a diversified investment portfolio. We feel very good about our diversified model that we built and look forward to a solid 2010.

And with that operator, I would like to open up for questions from the floor.

Yes sir. (Operators Instructions). Your first question comes from the line of Steve Delaney with JMP Securities. Please proceed.

Good morning, Tom.

Good morning, Steve.

So you're -- I just want to focus a little bit on the non-agency activity. I think you guys added a CMBS trader back in 2009, and I know you have been very active not only with restructuring your legacy stuff, but I think you took two bites out of the TALF apple late last year and again in the first quarter. I guess, you said up to $60 million there. So, following up on that, now the TALF is gone and I guess, you could do CMBS with repo, do you guys feel you have the staff and the interest to look at the legacy RMBS universe as well, and is that something that, you know, as you get pay downs from the GSE buyouts or you have other capital available through the continuous offering plan? Should we expect your rather modest investment, I think, $5 million in -- or so -- in non-agency RMBS, is that a bucket that is likely to increase over the coming months?

Well, I am going to take a shot at this. On the line with us today is [Todd Kumgen] who we hired to be as CMBS Portfolio Manager and has been responsible for a lot of that and I will let him comment on that as well as Byron.

But we feel that we've got the talent at this point to basically take a bite out of a lot of different apples and I think that's in evidence by what we have done up until now. Byron, why don't you address?

Let me dive in. Hi Steve.

Hi Byron.

Our strategy is a multi-product strategy focused on agency securities, high-grade non-agency residential and CMBS products. We are staffed more than appropriately to invest our capital across these sectors. One of the interesting things about Dynex is we have got really long-term history in terms of dealing with these non-agency assets, and we have got talent within the talent pool here of dealing with these assets from the bottom up, meaning the actual properties and the actual making of loans, and from the top-down, which is actually dealing in the secondary market and looking at security back towards how the loans were made.

So, we would expect to find opportunities in the non-agency residential bucket. We look at the opportunity that select opportunities across these sectors that we are in a period where security selection will be important. We are not looking to do deep credit work, meaning to purchase assets with that make an originally rated BBB, A, any other of type of...

Right.

I think you need more staff to do that type of work than we want to put towards it. We are focused at the high end of cash flow quality. And so, you should expect to see that bucket grow given the opportunity. No opportunity, the bucket won't grow, you know what I mean?

Got it, got it. Going back to sort of the traditional agency book, over the last two or three days on earning calls from some of your peers, I mean, we have heard a range of preferred trades. Everybody uses the buzzword relative value and it's interesting that we are hearing 15 years -- new production 15 years look great. We are going to stick with new 5/1s and we are hearing some people say we like the -- now that the GSE buyout issue is quantifiable, we like these high coupon. We think there is value in these high-coupon legacy hybrids. So, I know something you can talk about Byron but that's all that's right into your sweet spot either. Do you have sort of a -- if you had a $1 to put into agency today, do you have a sort of a preferred trade in mind in terms of where you see value?

Sure. I definitely have an opinion on this. It depends on what concerns you the most. Extension risk is a very real issue and it has been for some time and it will eventually come to bear on the overall market sector. So, we have created our portfolio with an eye towards minimizing extension risk, which keeps us in the shorter duration asset.

Right.

Now the positive of having already built a shorter duration position is I can always marry that with something like a longer 7/1, 10/1 or 15 year, if it was an attractive enough relative value opportunity.

One of the best stories out here as far as I am concerned has been simply the fact that is the optionality in the mortgage market in general, the origination process has more friction. Therefore, now that we do know more about the buyouts, now that we do know Freddie Mac buyouts that's gone forth, we are getting a better idea of how delinquencies are rolling through various buckets.

I do think the premiums represent pretty attractive value especially once you consider extension risk and up rate market cycles. And, I really, again we built the short duration portfolio, we still lean in that direction, but it does give us a lot of flexibility that we do see the type of relative value, meaning that there is some reason why it should add a longer duration security such as a 15 year, we would have the opportunity to do it. But I prefer trying to get that extra yield in the non-agency sectors.

Okay and when you said premiums just for clarity, I think you were talking about premium hybrids rather than premium 30s is that...?

I think I am constantly looking at the relative value between short premium hybrids, a season premium [15 year] and a season premium 30 year.

Okay.

But obviously with the longer stuff start to add a little more -- even though they are premiums, they are still a longer duration.

Sure. Okay, well, listen guys, that's great. That's very helpful and congratulations. You are continuing to move the numbers forward. Good job.

Thanks Steve.

(Operator Instructions). And your next question comes from the line of Henry Coffey representing Sterne Agee. Please proceed.

Good morning everyone and thank you. I was wondering if you could help me figure out the future a little bit, at least the immediate future over the next couple of days. We are very anxious sort of collectively to get a sense of what marks look like in the non-agency business, and I know there is no such thing as a generic and a residential MBS. But, could you give us a sense of what your marks look like relative to principle at the end of December and at the end of March just as it applies specifically to your non-agency residential MBS?

Well, Henry we've got a very small amount of non-agency residential MBS. So it's going to be de minimus to us. If you are looking for a more substantive marks, I would say it''s going to be in the CMBS, which we've already commented on that spreads are narrowing even further and that the recent marks we have have been higher from both December 31st and March 31st from where they are today. Byron, you want to add any more to that?

Sure. Henry, we've got our largest non-agency resi division, it's probably marked in the high 80s. We believe that if we were probably to put that bond out for a bid, I think that has a 90 handle on it because it's a 15-year old bond with really 15-year old loans, so the credit quality is excellent on it.

And how was that marked Byron back in December?

They were about the same.

So, there hasn't been a whole lot of appreciation in terms of the mark you would have put on it?

No. When I talk about what appreciation is what I just described that if I put it out for bid, I believe I would get above 90 type of price. So we are very disciplined in our marking process and so, in sticking with that and in prices that we've gotten back from our pricing services and from dealers, this bond -- our largest position is priced in the high 80s.

And then, in terms of the marks on the CMBS market, if we had -- I had all my numbers in front of me, the fair value too, principal mark in December and the fair value and principal mark in March would look sort of like what?

So you went on the par bond, you are on the CMBS now right?

Yeah, yeah.

Hey Steve, why don't you answer that question? I know you've got that at your finger tips.

Yeah, Henry, the sort of all-in position for December in the CMBS was around $104 and today that's closer to $106 -- at the end of March that's closer to $106. So, that's moved higher and those spreads for this quarter have continued to move higher.

Henry, remember those bonds that we had, we specifically held the call options on those for -- gosh, well, we originated those bonds. So, we've had them forever and we strategically kept those 8% coupons the ability to call those on our books for years and years and years, just as we have other bonds that are callable currently and other bonds that are going to be callable out in late 2011 early 2012, and other older securitizations that we've held intentionally for the environment we are at right now. So, depreciation of those bonds has a whole lot to do with the fact that we had the right to call them only when they became profitable. So they were well into the profit category when we called them, and it's not surprising that their value is so much higher today. They are 8s which are pretty substantive coupons as you know.

Well, this is helpful. Thank you very much.

Henry, I think I misspoke. Spreads are tighter today, prices are higher.

Right.

All right. We miss you in New York, Henry.

Your next question comes from the line of Jeff Porter representing Porter Capital. Please proceed.

Hi guys, great quarter. So, in reading to the release you issued $9.7 million of equity in the quarter, and getting back to somebody else's question, in terms of operating expenses, can we expect that line to stay sort of stable and start to get some leverage as we grow the equity and asset base, and is that part of the plan going forward to opportunistically sell equity under the controlled offering so that we can maybe get a little bit more operating leverage in the business?

Well, as we stated in the press release, Jeff, our operating expenses were a little higher this quarter having to do with several one-time items in the first quarter that will not occur in the second quarter, and we expect our G&A expenses to be lower in the second quarter. And we do not need to expand our overhead with the additional equity that we brought on board the books. Steve, do you have those exact numbers on our overhead?

Yeah, I think Tom we had $2.1 million in G&A in the first quarter and we indicated in the press release that there is roughly $300,000 of sort of non-recurring G&A. So that would suggest a run rate of around $7 million.

And we talked about this a lot and with the current team that we have in place, it would be fairly easy to be able to double our assets under management without noticeably changing that cost structure on our G&A. And, again, we feel opportunistically the capital that we added here in the first quarter was primarily as a result of the TALF opportunities, and as you recall, actually, I added to my position in Dynex as part of that, because these TALF opportunities were quickly dissipating.

If other opportunities arise of the nature of that where we really feel that offer we cannot refuse and we will probably go out and seek out more capital. At this point, we are very happy with the staff we have right now and our overhead seems to be fairly stable and that will be that way for the foreseeable future.

Okay. One other question. As it relates to -- I think you have about $24 million of non-performing or delinquent commercial loans and the release said there is $4 million of credit insurance there, and you are expecting I think just under $4 million of a payback this quarter, which I guess will leave you with about $20 million in problem loans. Could you give me some sort of sense as to what the underlying collateral values are and sort of how you might see that problem loan situation get resolved over the next 12 months?

Steve, why don't you take that?

Yes, sure. Jeff, of the $24 million, $21 million of it is commercial. Of that $21 million, $5 million was originated in 1993, $16 million was originated in 1997. If you were to look on that on the '93, we actually have one asset that we've gotten essentially a bid, we did a process that's been final. We've gotten pricing on that particular asset that will take us out whole in that situation. The collateral is so old and seasoned that and the loan had amortized down, we had plenty of protection. So, even going through the whole process of foreclosure and the like, we're going to get our whole loan there. I think you can think about the '93 stuff and that -- and '93 loans in that fashion that it's so seasoned that it's got plenty of protection for us.

In terms of the '97 product, the current loan balance on that in general relative to the original appraised value and that's 1997 appraisal, the loans are amortizing and it's around 55% or so, current UPB to original appraise. So, if you look at most of what published research is showing in terms of commercial real estate price performance, you are seeing price retrenchment to the 2002, 2003, maybe 2001 timeframe, but not all the way back to 1997. So most of this product will have one, amortized; two, it would have had equity built up into it; and three, it still would have some modest price appreciation. So, for all of those reasons, frankly we are seeing fairly low loss rates, if you will, for when these assets actually go through the foreclosure and REO process.

So we've got $4.7 million of allowance. Most of that will be related to this roughly $16 million of commercial real estate loans. We feel pretty comfortable at that level of reserves relative to that amount of loans outstanding given again the seasoning and the other factors that I mentioned earlier.

So it sounds to me like you may be over-reserved if ultimately those properties were liquidated?

Well, we like to think that we are reserved -- we have conservative reserve requirements and these all are older loans. Sometimes people describe them as collectors' items loans as opposed to seasoned loans. But we've experienced that there are some delinquencies that come up, but because the owners have fairly good LTVs and skin in the game, lots of times we will get our full interest payment before we have to go into foreclosure. So sometimes delinquencies are not a great measure of what actually would be classified as problem loans. There is no question that the commercial mortgage area is under stress right now or under duress, but we feel very comfortable that our seasoned loan portfolio is going to perform quite fine in here.

Okay. Thanks a lot.

(Operator Instructions). You have a question from the line of Jay Weinstein representing Oak Forest Investor Management. Please proceed.

Hey guys, how are you this morning?

Great.

Good morning.

Hi Jay.

Just a couple of things to clarify. I think the question have already been asked, Tom. In terms of the continuous equity offering and I obviously was noted that it was pretty significant in the first quarter. You kind of hinted that that was pretty much directly related to the TALF opportunities, and so exactly how does that mechanism work? And I guess, you were anticipating the second quarter will be a big drop-off from the first, is that in terms of equity raised, is that fair to say?

Well, I don't know what we're going to do, it really depends. We have a shelf out there and we have the ability to sell stock if there is demand for the stock and if we can take that capital and make it accretive to earnings and -- for our shareholders.

The TALF opportunity, we thought was a substantial opportunity today to lock in non-recourse, non mark-to-market financing for three years at nice mid double-digit rates of return, which we think was well in the best interest to the shareholders.

As you know Jay, the Board owns 22% of Dynex. I own almost 15% of Dynex. So, we really do look at these things from a shareholders' perspective, and it is not other people's money, it is our money too. So, when we can create a win-win for our shareholders, we will. If some unbelievable opportunity came along that we simply had to raise some capital for, we would certainly try and do that, because it would be in the best interest of our shareholders, as evidenced by what we are able to do with the first quarter, I mean, our book valve continues to increase and that is to us a major success of our asset purchase program.

That's why I was just asking kind of the question going forward. So, at this point, after all these years, I trust your judgment more than mine.

Well, that gets you carried away.

Second, in terms of the -- I always ask the question in terms of tax loss carry forward, just the current kind of thinking about it, are you actually using little bits of it every quarter. Tax-wise if you sold some of these appreciated agency paper at a gain which you will be able to use some of the forward against that and does that make any sense?

Well, we always take a look at the ability to use our tax loss carry forward. We obviously earned $0.30 in the quarter and we only paid $0.23. So we are currently using part of that tax loss carry forward. And we have always, as you know, said that we feel paying a respectable dividend and taking the rest of the money and having it appreciate to book value tax free for our investors is I think a win-win.

We are currently paying $0.92 dividend with our stock here slightly above $9, we are paying a 10% dividend. And just using rough numbers, we take the 10%, pay it out to our shareholders, and the rest of it we are going to put it in the savings account for them at the company in terms of book value. We do have about a $150 million, right Steve?

Yes Tom, it's correct.

And it does not expire until 2019. So, our little piggy bank has got a long term to run and we are going to continue to look at all of those options. Quite frankly, the CMBS bonds that we called at par are now trading at substantial premium. We can sell those and redeploy those assets and take a gain, and then that would obviously be tax free for our shareholders. So, we look at that every day, every quarter, and we probably will make some moves along those lines when it makes sense for our shareholders.

Like I said, just not being a tax expert, you were allowed to net a capital gain from the securities against the tax loss carry forward doesn't have to be interest income or excess income or whatever like that?

If you recall Jay back in, I think it was '05, '06, we had the ability to sell off some of our manufactured helm residuals that had substantial premium and we used that capital gain there. We used it also when we -- remember we actually bought some equities in the MREIT sector and took gains that we offset.

Okay.

So, we are as creative as we think need be at using this --

Yeah, that was just for my own education tax question. Don't ask me if anything that happened in 2005 Tom, that's really -- I am too old as I can hardly remember yesterday.

Unfortunately, we've all been around here a long time and happily it's going in the right direction.

Yeah. Last thing, the actual balance of the agency portfolio was down from fourth quarter to first quarter. I'm assuming -- would you characterize that, is all the pre-paids from Fannie and Freddie or is that just run-offs that you didn't -- is there some run-off here that you just opted not to replace? And, I guess I have another question after that about the hedging -- your hedging strategy, going forward. But you can answer both of them if you want?

So, Byron why don't you take both of those?

I mean, a large chunk obviously came from the Freddie Mac prepayments that came through and then there is some run off as we were putting cash over on the CMBS side and we're really focused on trying to get through those last TALF windows. And -- but it doesn't reflect our desire to continue to plough our money across these three sectors and allocate it appropriately.

From a hedging perspective, we did take advantage. The two-year drop sometimes is very low levels. We have continued to allocate -- add more hedges on to our position. And what we are really looking at in our thought process to what our portfolio back to the extension risk issue, we have very, very little extension risk in our portfolio the way it's structured at the current time. And, over time we will continue to evaluate our hedging strategy within that context and we'll take advantage of when we can to sell the short end of the curve

Okay. Thanks again for a job well done. I always appreciate it and have fun in the meeting at San Francisco.

We hope you can make it, Jay.

You know me, I can't even get to Virginia much less San Francisco.

At this time, there are no further audio questions. I will now like to turn the call back to Mr. Thomas Akin for closing remarks.

Well, I want to thank all the shareholders for being on the call today. We continue to work in this interesting environment. There is going to be a lot of twists and turns, but we think it's going to create a lot of opportunities for Dynex. We have been building on these opportunities for the last seven years since we've been together.

The team I think is intact. They are working together very well as evidenced by what's going on across the different asset categories.

We are having our annual meeting on May the 12th in San Francisco and we look forward to as many of our shareholders attending as possible. Thank you much.

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