Dynex Capital Inc (DX) 2010 Q4 法說會逐字稿

Good morning, and welcome to the Dynex Capital, Inc. fourth-quarter 2010 earnings conference call and webcast. 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 Thomas Akin, Chairman and CEO. Mr. Akin, please go ahead.

Thank you, Sue, and welcome all our shareholders and the analysts to the Dynex conference call. With me today is Steve Benedetti, Dynex's Chief Operating Officer and Chief Financial Officer; Byron Boston, Dynex's Chief Investment Officer; and Alison Griffin, the head of our Investor Relations. Alison will read the customary forward-looking statement 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, projects, plan, and similar expressions identify forward-looking statements that are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified.

Forward-looking statements also may include, without limitation, 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 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 that was issued yesterday, February 10, in our Annual Report on Form 10-K for the period ended December 31, 2009, and other reports as filed with the Securities and Exchange Commission.

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

Thanks, Alison. Obviously, there's a lot going on in the mortgage market this morning, so my comments will be brief.

2010 was a breakout year for Dynex. Our strategy to deploy our capital in the highest quality and lowest duration asset has created a portfolio with substantially yield and low volatility. We continued to employ that same strategy with the capital that we raised in December, but let's take a minute and review the changes that happened in Dynex during 2010.

First of all, our book value increased from $9.08 to $9.71. Our earnings went from $1.02 to $1.41, and our assets increased from $958 million to, currently, approximately $1.7 billion. We had two increases in our dividend and ended up the year with a [27%] dividend rate. Our common equity increased from $125 million to over $300 million, including the conversion of $41 million in our preferred [T]. Total return to shareholders for the year was approximately 35%.

Our net interest spread has remained about 3% in a year where spreads continued to narrow and actually expanded from the third quarter to the fourth quarter of 2010. Our portfolio now contains over $450 million in high-grade CMBS that have filled out our hybrid REIT strategy.

We retained $7 million in earnings during the year, utilizing our tax loss carryforward, which is an estimated remaining balance of approximately $4.50 per share. While we are very pleased with the activities of 2010, we are well aware of the volatility of running a levered portfolio and remain focused on our market position into 2011 and forward.

For 2011, we expect to continue the current strategy of a high-grade, short-duration asset portfolio. We expect to modestly add to our leverage for the year, ending at 4.6, and we're currently approximately 5.2 times leverage. We want to continue to create long-term value for our shareholders by managing our dividend policy and using our tax loss carryforwards.

This morning, the Department of Treasury and the US Department of Housing and Urban Development released a White Paper outlining the future direction of GSEs and housing finance reform. While I have not read the entire report, the transformation of the role of the government in the housing market from a dominant player, to give a private market a role in the future of mortgage finance, can only be viewed as positive. This transformation will be implemented at a stable and measured pace to not disrupt the stability of the housing market. We view this as only increasing our opportunity set for potential investments beyond what we have today.

Currently, the private market for most mortgages is all but nonexistent. Opening up the private market and decreasing government intervention will present mortgage REITs, like Dynex, a broader variety of investments and more realistic pricing. We realize that these changes will take years to implement, and applaud the measured pace that will give all participants ample opportunity to make necessary economic adjustments. We at Dynex look forward to participating in this more robust and open market for mortgage products.

Finally, I would like to thank all our shareholders for their support throughout the years. We feel that Dynex has proven an ability to navigate the treacherous mortgage market and fashioned a business model that will withstand the test of time. Many market participants are trumpeting that size alone will dictate success.

We respectfully believe that being able to take advantage of a smaller asset base, in areas that larger institutions cannot meaningfully participate, is an advantage. We have used that advantage in the past and we will continue into the future. We look forward to the opportunities that will be created as the market continues to move from a GSE-dominated market to a more private free-market system.

And with that, Operator, I would like to open up the call for questions.

(Operator Instructions). Steve DeLaney, [JPM - sic] Securities.

Thank you. Good morning, everyone.

Hey, Steve, you made it to JPMorgan.

Oh, okay, well, I got promoted then. How about that? (laughter)

So as far as on the agency side of things, I guess the real hot button now is pre-pays. And it was good to see the speed drop from like [26] in the third quarter to [23]. I was just wondering if Byron could comment on what you're seeing early this year? I guess the January figures were up last week as far as actual prepays. And more importantly, the outlook that you guys see over the next six to 12 months, as far as speeds on the agency book.

Steve, prepayment risk is one of the core strategies -- taking prepayment risk is one of the core strategies we have deployed at Dynex. So we have not been afraid -- in fact, we think we, over the last three years, have felt that it is one of the safer strategies to deploy.

Our prepayment, if you recall, we didn't have as fast as the rest of the Street during the Fannie/Freddie buyouts. Our speeds have continued to decline. And the way the market is structured now where you have increasing friction in the mortgage origination process, you've got higher rates. And now you've got a GSE White Paper out that is basically saying increased GPs, increased risk-based pricing. It's a good risk to take.

So we're still anticipating slower speeds, but if our speeds even settled in at the levels where we've been recently experiencing -- and we do believe they'll be lower than this -- we're in great shape. The final point on this, really, is that, as we look out into the future -- again, as -- the real simple fundamental -- rates go up, we're anticipating our speeds to slow down.

The risk that we can consider on the other side of this uncharted territory is that when you really get into a full bear cycle in bonds -- meaning the Fed will be tightening at some point in the future; who knows exactly when that date happens to be -- I think there is some uncertainty as to how ARM borrowers will react. And I think it's uncharted territory in that sense. But otherwise, I think prepayment risk is a great risk to be taking right now.

Alright. Well, appreciate that. That's helpful, Byron.

The leverage, Tom, you mentioned in your press release, it might go up. And you gave us a little -- an indication that the [4.6] at year-end is now [5.2]. Is there a maximum range that you've set? I mean, is it sort of this 5% level? Are you there? Or is there still some flexibility?

You know, I don't think we have a maximum range right now, Steve, but 5 is clearly not the top. We've got over 300 basis points of spread right now, so we're pretty lucky to be able to utilize less leverage and still put out, I think, a very attractive total rate of return. But we do feel that the marketplace is very receptive to expanding slightly our leverage ratio. So I would not be -- I wouldn't be shocked to see that go above 6.

Okay.

And Steve, and if you look at our asset base, you look at these really short hybrid ARMs, and then you ask the question -- how much capital should I be holding against these really short hybrid ARMs? And they're really -- I think that sector especially warrants re-examination in terms of how much capital should you really hold against these really short duration assets.

Right.

I mean, Steve, we just (multiple speakers) --

And obviously, if you guys -- as you shift to more agency, as you did in the fourth quarter with that deploy, your leverage is -- overall leverage is -- it's just necessarily going to go up because you're going to lever agency more than non-agency.

Exactly. That's exactly correct.

That's correct, yes.

Okay. I guess one final thing for me -- could you guys just remind us -- I recall, you've got some investment-grade bonds remaining out of your legacy CMBS that I believe you have the ability to call or to redeem those. Could you just remind us what that position is? And I guess, do you have any thoughts or view those bonds as providing additional liquidity -- a source of additional liquidity that could help you continue to grow your overall portfolio?

Well, I mean, that number is approximately $50 million of bonds that we can call. And it's at that 8% sort of coupon rate. So we do view that as something that we would obviously like to take advantage of.

We have not done anything year-to-date on that. We are working on some things that are in process right now that will give us the ability to do that. So until we actually achieve that, those calls, Steve, I'll just table that for future opportunities.

Okay. Alright. Well, congrats on a very solid fourth quarter and especially for putting that money to work so quickly. So, things are shaping up well here for the first quarter. Thanks for the time on the call.

Jeff Porter, Porter Capital.

Congrats on a great quarter. I was hoping you might be able to clarify something for me in terms of the way you account for things. I recall in the past when you did call some bonds against some publicly-traded CMBS, we got a pretty nice bump to book value because you were able to mark those assets up to market value, which was quite a bit above where they had been on the books.

And recently, when you called some other bonds, I think it was again securitized loans, how do you treat those loans? Do we get a book value bump? Do you get to mark those up? And if not, maybe you could give us a sense of what kind of spreads we're earning there and how long we may be able to earn those excessive spreads?

I know that's a pretty complicated gap question and Steve Benedetti is probably best to be able to answer that.

Hey, Jeff, how are you? On the accounting side, you're right. We have, I guess, two deals that we've called bonds off of. One deal was not consolidated in our balance sheet; so as we called those bonds, they came on as new securities. They were carried as available for sale securities and so we marked those to market just like we do any security.

The second series, which we called in the summer, is -- the trust is consolidated, so the impact on the balance sheet really is only to show the financing that we called essentially to be -- to go away. And that was ostensibly replaced by the repurchase agreements that we used to finance the redemption of those bonds.

So, in that instance, the loans stay on the balance sheet -- loans are carried at amortized cost -- so we would not really see any market value pickup, in terms of the balance sheet and book value, from the redemption of those bonds in the summer.

In terms of the spread, obviously, that spread comes through as current income. I believe at the time we indicated that that spread would be around 500% -- or 5 points -- 5%, excuse me. And so that spread should come in over the remaining weighted average life of those bonds. I think the notional balance of those bonds today is probably around 55-or-so million. So we're earning that spread. And those bonds probably have a current weighted average life of somewhere around two to three years.

Yes, I think it was a contributing factor in the fact that our spread income widened from the third quarter to the fourth quarter, because those bonds are going to be earning spread as opposed to book value increase. And it's all part of GAAP rules. So, thanks for the question, Jeff.

Okay.

Jason Stankowski, Clayton Partners.

Great job on the quarter and look forward to seeing what the results can do with the money we deployed. Can you talk a little bit about the shift in agency to bonds that don't take prepayment risk? And what the opportunity is there? And also what your thoughts are on hedging the duration risk in those bonds, and how we should think about your tolerance for book value movement in a rising rate environment.

Well, I'm going to let Byron answer that question. And I also think that Todd Kuimjian, who's in the room as well, who's in charge of our CMBS portfolio.

But I will just say that we don't have a lot of tolerance for risk in that portfolio. We're much willing to take more spread, more guaranteed spread income, than really risk our book value. And I think that's why we added to our swap position, as you notice, in the fourth quarter. And a lot of that was basically versus the CMBS bonds that Byron is going to talk about right now.

Hey, Jason, the agency portfolio has a combination of Agency RMBS paper and agency CMBS paper. Both have premium exposure. The agency CMBS paper actually diversifies that overall premium risk because we're exposed to involuntary prepayment speeds and not voluntary prepayment speeds. And the -- so, and the agency CMBS paper has longer duration, and in lies where we focus first and foremost in terms of our overall hedging strategy.

The market is such where we're thinking more conservatively in terms of hedging. Also -- and by thinking that way, it also leads us to a conclusion of purchasing more premium short-duration hybrids. One, there is -- they're very short duration. Two, we get really solid spread out of those bonds. And three, we're not overly concerned with being caught offguard with those really short-duration bonds -- versus the CMBS paper, where we have actually increased materially the amount of swaps we have against that book.

We've increased it even more after the first of the year, and we'll continue to think in a more conservative sense toward hedging out through the duration of the portfolio. And that's a function of where we are in the cycle at this point versus where we were two years ago.

I'm hoping -- did I get to everything that you were asking there, Jason?

Yes, I think that's what I was looking to just understand. So you really think of those -- you think of the kind of the bucket separately; you're taking care of the duration risk due to the type of bonds you're buying on the side of the housing side. And then on the CMBS side, on the agency stuff, you're increasing your swaps to take care of that duration risk proactively.

Yes, we're in a more volatile period at this point.

Great. Thanks a lot. Good job, guys. Appreciate it.

Jason, let me add one thing. We don't exactly add a swap for every single bond we put on, because, as you know, those bonds have a tendency to be smaller pools. But we look at it from a total sort of [debt] portfolio.

Right, in aggregate. Yes.

Correct.

Great.

(Operator Instructions). Steve Covington, Stieven Capital.

Congratulations on a great year. (multiple speakers) Just a quick question. -- this might be for Steve. Can you help me try to model expenses going forward? How much operating leverage do you have? Should I just use $3 million a quarter in modeling? Or how should I look at that?

Well, Steve, we -- I'm not sure we've really given any color on that. But I would say that the fourth quarter included some expenses, some bonus expenses, that were related to all of 2010 activities of the Company, and the accomplishments there. It was kind of dropped into the fourth quarter because that's the way the program worked. That program is still in place and for, I think, for purposes of this year, are going to be how we're going to operate.

So I think while the fourth quarter might have been a little lumpy from that perspective, I think you could look at that, that that would be spread sort of on an annualized basis in a normal course. So, if you were to model off of the fourth quarter, I'm not sure you're going to be materially off where G&A may be on a run rate basis.

Understood. And then, Byron, I apologize if I missed this, but could you help me -- as you're putting money to work right now, what kind of spreads are available with the short-duration ARM strategy?

You know, I think you're still looking at a good -- I would call it -- the assets that we're looking at between 180 to 250 basis points in spread.

Okay. And then, lastly, could you maybe touch on the loan loss provisioning and how we should look at that going forward in the coming year?

Sure. The way we loan loss provision, Steve, is we do both a specific loan analysis primarily for our commercial pools, and then a homogenous -- sort of a overall pool analysis for our single-family pool, because it's a more homogenous pool of loans.

The driver, frankly, in the last number of quarters here has really been the commercial portfolio. We're providing reserves for any loan where there is a valuation effort undertaken by the Company -- where, first off, I guess, the property is performing below a [1.0] debt service coverage. Since these are stand-alone entities that we've lend to, basically, we look specifically to the collateral for repayment of the loan. And to the extent the collateral doesn't generate enough proceeds to service the loan, even if the loan is not delinquent, we're provisioning for it.

So, at this point, we've got reserves that we believe are adequate for every loan in our portfolio that is currently not cash flowing enough to service the debt, basically, from the underlying property. Next quarter, next year, next month -- obviously, properties can change; the performance can deteriorate. By the same token, performance can improve by properties; it might be below a [1.0].

So, I guess at this point, we've got -- we believe we've got adequately reserved all of our credit exposure for those loans where the risk is foreseeable, from the standpoint of the way the collateral is performing.

Okay.

I would want to add there, Steve, that last year, we did -- we had gains in our CMBS portfolio in total. So, we feel pretty good about our lost provisioning right now.

Okay. Thank you.

This concludes our question-and-answer session. I would now like to turn the conference back over to Thomas Akin for any closing remarks.

Thank you, Operator. Obviously, the environment for mortgage REITs is going to be very interesting over the upcoming year. We are pleased to have had succeeded so well in 2010. We look forward to the opportunities in 2011. I just want to reemphasize, we see our opportunity set as expanding. I think being a hybrid REIT, having the hybrid REIT model, having the people in place that understand the different areas of the marketplace, including credit, is going to be a substantial advantage. And we look forward to 2011 as an opportunity for Dynex.

I appreciate all our shareholders' interest in the call and look forward to seeing you next quarter.

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