Dynex Capital Inc (DX) 2010 Q3 法說會逐字稿

Good morning and welcome to the Dynex Capital Incorporated third quarter earnings conference call. All participants will be in listen only mode. (Operator Instructions) After today's presentation there will be an opportunity to ask questions. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Tom Akin. Please go ahead, sir.

Thank you, Operator.

Welcome to the Dynex third quarter earnings conference call. With me today is Alison Griffin, head of our Investor Relations group, Steve Benedetti, our Chief Operating Officer and CFO, and Byron Boston, our Chief Investment Officer. I'd like to start with Alison reading the customary Safe Harbor comments.

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 can not be predicted or quantified. Forward-looking statements also may include, without limitations, statements regarding future interest rates and the expected performance of certain of our investments. 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 to you our press release that was issued yesterday, November 4 and our annual report on Form 10-K for the period ending December 31, 2009, and other reports as filed with the Securities and Exchange Commission. I would like to turn the call back to Tom now.

Great. Thanks, Alison. Overall, the third quarter was a busy one for Dynex and I think a rewarding one for all of our shareholders. We were -- first off, we were able to continue to call highly seasoned, non-agency CMBS a very attractive spread. This contributed to our expanding interest spread without materially altering our conservative risk profile. Altogether this year, we have now called and financed almost $200 million of CMBS that were originated by Dynex in the late 1990s. These seasoned CMBS have attributes consistent with our portfolio strategy of adding short duration, highest-quality assets to our balance sheet. We have less than $50 million of remaining callable bonds in the portfolio.

Second, we raised capital to expand our balance sheet at an average price in the quarter of $9.57. This capital was used to purchase and finance the CMBS collateral at spreads on average of 750 basis points. Our book value held steady this quarter and a new capital rate should contribute to our bottom line far into the future. We're very deliberate in raising capital and will only raise capital if it benefits our shareholders for the long-term.

We also exchanged $42 million of series to be preferred subsequent to the end of the quarter for common shares effective October 15 that increased our equity market cap to almost $250 million. Our January 1 equity base now increased from $169 million to $225 million at the end of September 30. Number four, our anticipated recurring G&A cost, while in dollar terms one of the lowest of the mortgage REITs, has now decreased as percentage from 4.3% Jan 1 to 3.2% based on reported shareholders equity, and 2.9% using $250 million market gap. This will make Dynex much more competitive in the future. Our internal structure, we fill, serves our shareholders by aligning management and shareholder interest.

As noted in the press release, we also sold property subsequent to the year and will add $2 million to the fourth quarter, to the fourth quarter earnings. Year-to-date including yield maintenance and other CMBS activities, we provided at least $3 million in gains, excluding interest and that proves -- that continues to show that our CMBS portfolio is well-protected. Finally, our CPRs that we recently received continued to be below forecast. Finally, the mortgage market universally continues to represent challenges that need to be analyzed for appropriate risks. Being a leverage institution demands a careful analysis of what can go right and, most importantly, what can go wrong. Five years ago, almost any mortgage asset had outside risks vis-a-vis the anticipated returns and that is why we chose an extremely conservative cash investment profile.

Today with rates reaching all time lows and the government calling for QE2 to effectively lower risk returns even further, there is a temptation to add extension risk to the portfolio, increase leverage or add credit risk. We see all of these risks as opportunities to be carefully weighed given the risk inherent in the market long-term. While short-term success might be found in those types of strategies, they could create long-term problems. A mortgage REIT portfolio manager has to understand these trade offs to be successful. Dynex is fortunate through careful long term planning to have been in a position to add high-quality assets to its portfolio since the credit market crisis began unfolding in late 2007, resulting in exceptional returns for the Company thus far. At the same time, we have kept our overall leverage ratio at four times. We realized that interest rates can and will be quite volatile. Any investment portfolio must be able to perform in this type of unpredictable market. Our focus on shorter duration and higher quality assets is a testament to our concern for volatile it will, and without giving much incurrent return, we can manage that long-term volatility.

We appreciate your trust in our ability to manage your capital and understand our responsibility to diligently evaluate investment opportunities and provide with you an acceptable risk adjusted return. We currently believe opportunities exist today that are attractive given our long-term outlook and the macroenvironment. We believe our track record over the last five years is second to none and we look forward to delivering solid results for the next five years. With that, Operator, I would like to open it up for questions.

At this time, we will now begin the question-and-answer session. (Operator Instructions) At this time, we will pause momentarily to assemble our roster. Mr. Weaver, did you have a question, sir?

Yes, hello, good morning. First of all, congratulations on a good quarter. Seeing that leverage fell to 3.8, after the issuance and getting all the offering proceeds invested, where do you see leverage currently and what is your current comfort zone going forward?

I think our leverage ratio is back to slightly above 4 right now and, obviously, it depends on the asset. We're obviously leveraging our agency portfolio much more than we are our non-agency portfolio. Clearly, Jason, the market for repo is very robust right now and there are a lot of opportunities to expand our leverage. We're going to look at that carefully. We have added a fair amount of securities since quarter end and let me let Steve answer exactly where we are right now. Steve, do you have that?

Yes, in terms of leverage, Tom, you're correct. We're slightly above four times, kind of in our -- what we have historically run around the 4.2 times at the moment.

Thank you, one follow-on question. I know we had previously spoke about the possibility of some time doing a resecuritization transaction where you would be able to get some permanent financing on some of the assets, has there been any thought given to that or updates on that front?

We had been working on that and Byron is very up to date on where we stand on that. I'll let him answer that question.

We continue to look at that as an opportunity and we're pretty diligent in fact. We have a pretty intense focus on that. We believe there are opportunities to potentially generate return by taking out some of the repo financing. We haven't gotten to a conclusion at this point, but we're very focused on that. And have been for some time now.

I think the good news, Jason, from our perspective is the QE2 is adding a lot of cash into the floating around the market place and a lot of that cash, as it appears, is being used to finance just the kind of paper we have and so there is some very aggressive bidding for high-quality assets like the ones we have. And that is basically like refinancing a home loan. We're going to be looking at this to -- when it's attractive for us. The good news is it's a very attractive -- the spreads we have on are attractive and this should make them better. Most importantly, it would probably free up a fair amount of cash for us to increase our leverage a little bit.

Okay. Thank you very much.

The next question is from Trevor Cranston of JMP Securities.

Hi, thanks for taking the question. I wanted to follow up on your comment that you've added a fair amount of investment since quarter end. I think in the press release you also mentioned that you're looking to maintain about a 60/40 split between agency and non-agency. I was wondering if you could just expand a little bit on which areas of each market you're looking at in today?

We have been able to add assets, really -- this is November and I would say since August, we have been very focused on distributing our capital across agencies, non-agency CMBS and agency CMBS. We have been able to successfully, again, diversify across those sectors. Are we focused on one more than another? It's a function of liquidity, it's a function of relative value. We do maintain a certain percentage of our agency portfolio, always thinking in terms of that 60/40 split. We're not afraid of having a 50/50 portfolio if the relative value worked out in that manner, but to date we have been able to really continue to invest our capitol in the agency market without taking a lot of extension risk and focusing on the high proof sectors, and likewise continuing to focus on the agency CMBS paper and some non-agency CMBS.

And to follow up on that, can you give a little bit of color for the agency CMBS in terms of the types of yields that are available in that market?

Well, we have, you have Todd Kuimjian on the phone today who is our portfolio manager in that area, and I will let Todd take that call.

Sure. We see, depending on the tenure, we will see yields any where between 3.75% and 4%.

Okay. And that is fixed rate paper generally?

That is correct.

Given that you're adding that type of stuff, should we look to see an increase in the swap book going forward? Or what is your thinking on the hedging strategy in general?

The swap book -- yes, at some point, you will see an increase in terms of swaps. However, what is really important to understand is the agency CMBS paper comes with very high premium dollar prices with very, very little duration. If you look at the actual imperical durations in terms of how these bonds actually trade, it's very, very low duration. At some point we will continue to look for the opportunity strategically put on swaps, but really important to understand, when you talk about hedging a mortgage security to understand imperical versus cash flow durations, and for very premium securities, these bonds won't move a lot in price, especially when rates drop. As rates rise, you will see another 50 to 100 basis points and bonds won't move that much in price. We don't have an enormous amount of duration on the books in actuality.

Okay. That is helpful. That is all I have for now. Thanks. Thanks a lot.

Thanks, Trevor.

(Operator Instructions) Our next question is from Henry Coffey of Sterne Agee.

Good morning, everyone, you can hear me?

Yes, Henry. Sorry, Sterne Agee.

We were talking to one of your competitors about this who said there have been some changes in how you're required to amortize new issue hybrids. I think you -- their view was it resulted in kind of a more aggressive than actual experience and, as a result, was actually creating a very cash flow dynamic. Is -- can you comment on that? Is there -- are there any favorable quirks in the hybrid market right now that you might be able to take advantage of or -- Related question, Tom. Can you give a sense of your actual amortization rate versus your CPRs? Are they lined up, are they more aggressive?

I can tell you that our -- right now our projected amortization, up our model CPRs, we are coming in much lower than that. So, we modeled some very aggressive CPRs, sort of counting on the worst and that is why this last quarter, we had to take a little bit of that back. If things continue to slow down we will have to continue to evaluate that. As I mentioned at the beginning of the call, our CPRs have decreased month over month and are well below our modeled rates. In terms of the amortization of new issues versus other ones, Byron, do you have any idea if there is a change in that speed?

Hi, Tom, this is Steve. I'll take a little bit of that from the accounting side. There are a variety of different accounting methodologies for amortizing premiums. Our's are, whether it's a hybrid or any premium or discount security, we use a standard methodology that incorporates actual and forecasted prepayments, and to the extent you have volatility in your experience versus your forecasted, you will have changes in the amount of amortization. That is the way we do it. So, in terms of our methodology and I don't think there is any particular sector or investment style or characteristic that makes our methodology more favorable versus another. I think the analysis is economic versus accounting, if that makes sense.

And I don't know if part of the question was is there something in the accounting changes that makes purchasing a hybrid arm more attractive? Is that --

Yes, or more or less depending on what your focus is on. It was still one of the things that came up in discussion and kind of took me back. I know there has been some sort of stepping back from the hybrid market, and I was just wondering what your thoughts on all this were.

Let me say that. The first thing you want to understand in a mortgage security, who is the borrower. There are some questions around who takes out a brand new 5-1 hybrid and what are the real nature of that borrower. When we look at our prepayment speeds, even though we don't have enormous prepayment speeds, you are still kind of surprised at the speeds of the new portfolio versus the season hybrids that we own. We've always preferred season hybrids with shorter months to roll. Both portfolios continue to outperform the newer paper, which you really would not expect. So, I think there are some questions as to who takes out a 5-1 hybrid in this market place. Some of the hybrids with 3% type of coupons, suprisingly, are paying a relatively fast. So, it kind of throws off your evaluation models when you're considering paper like. I think there are some questions around a newer hybrid in terms of what kind of assets. What kind of borrowers are underneath that loan.

Well, yes. So, the risk is more economic. This is helpful. Thank you.

Thanks, Henry.

The next question is from Jay Weinstein of Oak Forest Investment Management. Go ahead, sir.

Hi, good morning.

Good morning, Jay.

How are you?

Good.

Are you a Giant fan?

I have been a Giant fan my entire life.

Congratulations then. That's great. On the topic of the day, are you still -- this is -- and as you know, I go way back. This is the first time in memory that the stocks traded at a premium to book. Are you still sort of doing a drip in terms of an equity raise? Are you -- are opportunities such that you would like to keep raising significant amounts of equity, what are you seeing in that regard?

We continue to find what we describe as good size opportunities to put capital to work. We don't feel that we want to double the size of the Company in here, Jay, and to take down a massive amount of assets that would dilute the spread that we have right now. As you can see, we have a really nice spread. It's a really nice short duration portfolio with very low volatility, and to the extent we can continue to do that by calling -- as I mentioned, we only had $50 million of our really sort of, what I refer to as extraordinary spread bonds left, we will probably do something with that, but we are, as we commented on, fully invested now. To the extent we can find short-term, nice spread investments, we will continue to do that. Because we're small and nimble, we can buy those $3 million, $5 million, $7 million pools that other people don't look at I think attractive spreads, but it's really about staying -- keeping your volatility low. As you know, no REIT that I am aware of has ever gone out of business with rates going down, but if rates rapidly go up, you want to make sure that you stay on the short end of the volatility range and that is where we're going to stay. We're very fortunate to be able to have the spread bonds that we were able to pick earlier this year in our CMBS and will continue to add to as we see fit.

Remember, the market still is pretty frozen. The government is still doing almost all of the residential business. We are looking forward to the time where the market thaws out a little bit more. The CMBS area, as you know, is starting to thaw out a little bit. We're starting to see some activity there and it bodes well for what we can see down the road into 2011 and 2012. So, the short answer, I apologize for the long answer, is that we're going to add capital where it really makes sense to add assets. We don't want to burden our portfolio with a big slug of the wrong assets right now.

Remind me, I think you already answered this question, you were at a little over three at the end of the quarter, at four and right now is what your best estimate and on your way to kind of what would you consider where you fully invested now in terms of leverage ratio?

Well again, each asset has a different leverage ability. CMBS is levered about a 4x, the agency stuff is levered about 7x. We could go substantially higher than that if we wanted to. And some competitors are starting to move up into the eight, nine range. We're able -- if you look at the spread versus our competition, our spread is fairly attractive right now given our short duration and our high quality portfolio. So, we're not hurting ourselves where we are right now. So, we'll probably stay in that -- we finished the quarter at 3.8, I think that was more technical than anything else. We would like to be at least four and probably move up our leverage. I think you're going to see our leverage moving up slightly as we add more assets to the quarter. As I mentioned, we have been pretty aggressive adding assets since quarter end and so our leverage ratio, as Steve pointed out, is up to 4.3 now and we see that going a little bit higher.

Let me ask you the $64 trillion question, and I want to hear Byron weigh in as well. Obviously as a nation we are under -- we are embarking on this tremendous experiment. I know it has to be keeping you up at night wondering what the heck it all means. What does it mean?

I will let Byron answer that.

We're in unchartered territory and we are going to be operating in unchartered territory for some years in the future. That is the most important thing to understand. Our posture is really understand Dynex in this sense, that our posture respects the fact that we're in a very uncertain environment, unprecedented territory and global risk remains high. This morning, when I looked at the news, I was much more interested in international news than to listen to CNBC yap about some political issues. Because the fed -- it's so complicated, once you think of it on a global basis.

Yes, I agree.

It is very complicated. With currency six to the dollar, it's almost like an electricity core, they are attached to our monitor policy and the unforeseen consequences, highly probable, will happen outside of our borders and that is where we can be surprised and it's very difficult, obviously, to keep up with every single issue that's happening globally. We operate our business with enormous respect to the uncertainty that's here. Ben Bernanke has never been in this type of environment. He studied it in terms of studying the 1930s, and there are little parts of the environment that you can study from all the little periods in history. We're in completely unchartered territory.

I started the liquidity trap in 1978 when I started studying economics in college. It was a theoretical concept to us at that point in time. It's basically where we are now. We don't know how this will end. We're in a -- and I will repeat it over, and over, and over again and I think it permeates the culture of Dynex Capital, that we're very respectful of the fact that this environment is unprecedented, global risks are high.

Let me throw in one other piece. I don't want to get on too big of a soap box, but when the environment does change, one of the reasons why you see us very concerned about extension risk in our portfolio, and by extension risk, meaning that mortgage cash flows are uncertain, you might think you have one duration today and when the interest rate environment charges, you will find out that you have a very, very different duration on your portfolio. When the environment ultimately changes, it will be unprecedented in terms of how the mortgage market will trade. We will have never seen this type of duration extension, in my opinion, that ultimately will happen. The longer we stay here in this low rate environment, the more people are financing to these low rate mortgages, it will make the back side of this entire environment very interesting. So, it's very unprecedented. I don't think there is any one line answer.

I didn't expect one. For sure.

The truth of the matter is we discontinued having military wars, but we have a full-on, unequivocal finance war going on. Everybody keeps escalating. Obviously, Japan was the latest escalated last night and when one country escalates the battle, then we have to respond, China has to respond, Europe has to respond and I don't know where this ends. All I know is that we're going to have to be very careful and very safe until we understand more about what this means, because there isn't a person out there -- you see the frustration in a guy like Bill Gross, his latest piece was just a rant.

Yes, it was.

We're very, very fortunate, Jay, that we were able to put on some really -- this latest round we did, 750 basis point spread and we got a lot of room to watch. We have a good period of time here where we can watch and see what happens and still not be hurting our earnings. So, we're going to take full advantage of that.

I have such high regard for you having managed so brilliantly through the last mess and the next mess, gosh, we don't know what the next mess is going to look like. It's going to be different than the last one, but we don't know what it's going to be. And -- We're out there feeling the same way, I think.

Yes, and remember, the government, with a stroke of the pen, can change prepays on the agency side in a heartbeat. And that is why we -- There is a lot of yield maintenance on those things. There is a lot of non-callable activities of that and we think the spread that we are getting on that is well, well worth the fact they are not agency.

I think it's interesting to note that the 30-year yield, I think, has actually gone up pretty substantially.

Yes. It did spike today.

In the last couple of months, it's up, I think, relatively sharply, which is -- for me, the question is what is the canary in the coal mine that all of a sudden you wake up and you say okay, we're getting really close to whatever the next, the next dislocation is. That's what's hard to know.

I can guarantee it's not going to be that obvious.

Yes, probably not. Thank you again for all your great work over the years.

Thanks for being a shareholder, Jay.

It's been good for me. I'm happy.

Operator, I think that is about it. We want to thank all of our shareholders for their time on the call today. We appreciate your confidence. We're obviously cognizant of the opportunities and the risks out there and we look forward to our fourth quarter conference call. Thank you much.

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.