Dynex Capital Inc (DX) 2011 Q1 法說會逐字稿

Good morning, and welcome to the Dynex Capital, Inc. first Quarter Earnings Conference Call and Webcast. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Thomas Akin, Chairman and CEO. Please go ahead.

Thank you, operator, and welcome to all our investors to the Dynex first quarter 2011 earnings conference call. With me today are Byron Boston, Dynex's Chief Investment Officer; Steve Benedetti, our Chief Operating and Chief Financial Officer; and Alison Griffin, Dynex's Investor Relations. Alison will read the forward-looking comments, please.

Thank you, Tom. We would like to remind you that 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, plans 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 considerably 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 May 5 and our Annual Report on Form 10-K for the period ended December 31, 2010 as filed with the Securities and Exchange Commission. These documents may be found on our website at www.dynexcapital.com under Investor Relations.

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

Thanks, Alison. Overall, the first quarter results were complicated by our equity offering, which closed in early March and reflected several other factors that I would like to elaborate on further.

One, we raised $90 million late in the first quarter and while we had pre-invested some of this capital, the majority of the bonds that we purchased did not settle until late in the quarter and made no meaningful contribution to earnings.

Second, our stock went ex-dividend shortly after our secondary offering and the additional shares dragged earnings down for the quarter.

Our net spread narrowed in the quarter, reflecting CMBS prepaids and increased agency prepaids.

Fourth, prepays on agency collateral were a little higher than we expected in Q1 and we've already seen this moderate. And prepays for April were substantially lower and have come in at 17% CPR versus 21.9% CPR that we saw in the first quarter. We have modeled this and it's in line with our expectations.

Five, we believe earnings for the remainder of 2011 should be on track and should improve from the first quarter, as we continue to deploy additional capital and move our leverage slightly higher.

Six, we've added a sizeable amount of swaps during the quarter in part due to asset purchases and in part to continue to lower the overall risk of the Company.

Seven, our book value decreased from declines in a non-agency CMBS, as a result of prepayments and declines in agency hybrid ARMs purchased during the quarter primarily. Book value has increased since quarter-end and the agency hybrid ARMs have recovered in price, as have our CMBS investments.

We realized that investors have a choice in mortgage REITs. We have positioned Dynex to be a high-quality, short-duration option with little extension risk. Because of this positioning, we have not purchased 15-year or 30-year mortgages and continue to focus on short-term assets.

We want to be one of the least risky return options for our investors. Interest rates will continue to show volatility and we have fashioned the DX portfolio to be respectful of this volatility and offer a positive return over a vast scenario of interest rate possibilities.

At this point, Dynex has a market capitalization near $400 million and we have achieved critical mass in the marketplace. We have completed two equity offerings in last five months. These offerings have substantially increased our capital base and lowered our operating costs as a percentage of capital. These offerings have been accretive to earnings of Dynex and we have no plans to add additional capital that is not accretive to both earnings and book value.

We want to thank all our shareholders for their continued support and confidence in DX management.

And with that, operator, I'd like to open the call up for questions.

(Operator Instructions) Steve DeLaney, JMP Securities.

Thank you. Good morning everyone and, Tom, thank you for that candid overview of the near-term challenges in 1Q, but also the positive outlook going forward. Appreciate that.

Thanks, Steve.

There was one -- you have these legacy securitized loans and I know you had one move into serious delinquent status, an $8 million loan. Could you guys just give us a little color about the nature of that particular loan and sort of what you see, your path to resolution to bring that to a resolution and get that money back on an earning asset?

Yes, I'm going to have Steve answer that question. We are -- there are -- I'll just say this to start out is at -- remember these loans are very old seasoned loans and this is a loan that is coming due fairly soon. And I do think there is a reasonable amount of gamesmanship that's going on in some of these loans as they come due with basically our borrowers who are trying to fashion the best deal they can for themselves and I don't think this is any different than that. But, Steve, maybe you can explain it further.

Yes. Hi, Steve.

Hey.

I think Tom actually did a pretty good job of sort of explaining what's going on here and say mixed-use property located in Denver, Colorado. The loan was originated in the late '90s. It is a loan that's actually participated in a couple of different deals. So it's a little larger. As Tom mentioned, the maturity is mid-2012 and this default by the borrower frankly, in our view, is really positioning himself around that maturity.

We have seen -- [they've quit] providing them financials on the properties, but we've recently seen them in terms of operations of the properties. It's not an operation issue, it really appears to be more an issue where the loan may not be necessarily refinanceable on the terms that the borrower wants to have them refinanced on.

So he's essentially positioning himself for us or some type of potential modification. As you correctly noted, when a loan goes 60 days down, that is on non-accrual. So that loan right now is on non-accrual and not contributing anything to the net interest income for the Company.

And I guess you probably had a little reversal too, if you had anything accrued as of year-end?

Actually, we would have -- that loan would have had some reversal, that's correct.

Okay. So I mean, it sounds like it's a case where you know their property, you've done your -- you've seen the property, but basically the guy is angling for some kind of a discounted payoff and he figures that a delinquent borrower has more leverage than a current borrower. Is it that simple?

Yes, I mean clearly he is exploring his options. We have been -- it's a good-sized loan for us, Steve. We've been all over this loan in terms of looking at what the value of the property is and we're more than happy to take the property back and liquidate it.

Got it. Got it. Okay, thanks. And then just a little color please on the non-agency CMBS, the prepays that required some yield resulted in some lower yields. I'm just wondering, are we talking about TALF CMBS or are we talking about your own legacy CMBS that are maybe just sort of reaching the expiration of their prepay lockouts?

Yes. It's definitely the latter, Steve.

Okay.

Sort of legacy stuff and we're seeing a few prepayments that have -- the lockout periods have run their course on. Not many, but we're seeing a few.

Okay.

And, Steve, remember there's sort of a good news, bad news there. Or the bad news is, the prepays are going to narrow our net interest margin because these loans are prepaid.

Sure.

The good news is that we hold these residuals at pretty big discounts and when we get paid (inaudible) far, that's not a bad thing for our residuals.

Yes. I mean cash is never really a bad thing on a credit-sensitive asset.

Yes. And our rates of return that we're able to still get in the agency market vis-a-vis, that is still not bad. So we're more than happy to take the cash back and at some point we're going to need to rationalize that big discount we have on the residuals too.

Yes. Yes, good point. And one final thing and I'll turn it over to somebody else. Just I guess this is for Byron if he is on. It looks like to me from your WAC of 4.6% and your cost base it's about [105%] that you're still -- you prefer the seasoned hybrids rather than the lower coupon new production. Would you just give us just kind of your quick thoughts on why you like the seasoned trade better than the new stuff?

Yes. I do like the -- it's a function of the -- one of the main risks that we've chosen not to take or try to minimize, Steve, has been really extension risk. And I'd rather take the seasoned bond of a higher coupon and what I think will be our shorter-duration instrument then, the newer paper was the 2.5% to 3% coupon. They really are a very, very low coupon and we're at a point in the cycle where we could remain -- it is highly probable that we can remain in a very low rate environment for some periods.

But we're also in an environment where it's highly probable that there would be some adjustments in rates at some point. And I think they're still really low coupons, whether they happen to be in hybrids or whether they happen to be in 15 years or they happen to be in 30 years, they're going to extend more than most people think.

The hybrids are a better off because they have a very set reset base. I just prefer owning the premium security, take legitimate premium risk and continue to enjoy what we've enjoyed, which is a lower than average prepayment experience.

And just real quickly, Byron, why did -- I guess I heard on Capstead's call that Freddie did another little cleanup of delinquent loans, but can you explain why you think, given that we have generally seen prepays kind of slowing since that spike in kind of November and December, why you think the hybrids kind of spiked a little bit in first quarter and why they're coming back down?

It wasn't that big of a spike, (inaudible) take that much of a move, it was that the fourth quarter looks phenomenal in terms of where our number is. We never had -- just rolling back one year to the buyouts, we never got as high as many of the -- other than the industry in terms of buyouts. That was just a function of the way we selected certain pools for the portfolio, so maybe our prepayment speed peaked at about 30% CPR.

On average in the fourth quarter, that number really dropped into the low teens. And so the way I like to think of it is, we experienced a phenomenal run in the fourth quarter. And you saw some move back up in the first quarter, there were additional buyouts that went through a lot -- let's talk about as the WaMu buyouts that went through the system, but it was not an onerous number by any stretch, but it was higher than the fourth quarter and our experience as of last night showed a decline, a solid decline back into the high teens.

Okay, 17% for the month of April and what was the first quarter, 29%?

It's 21.9%.

21.9%, I knew there was a nine, okay call that 22%. Okay, guys, thanks a lot. I'll turn it over to somebody else and I appreciate these comments.

Thanks, Steve.

(Operator Instructions) Jay Weinstein, Highline Wealth Management.

Hey, good morning guys. How are you?

Hey, Jay.

A couple of quick questions. I was confused and apologize if I didn't read the release correctly. The capital that was basically raised the first week of March, when you say it was deployed into the portfolio, but obviously it didn't generate any income for the month of March. Is that deployed in and of itself or does that include the normal leverage that you would have on the portfolio of whatever times you would have on the agency side?

Well, we did purchase a lot of bonds into the portfolio in March, but the settlement date for most mortgages is late in March. And so really the bonds did not make any meaningful contribution to our earnings in the first quarter and although we had the shares and the dividend to pay, as the stock (inaudible) at the end of the quarter, we really didn't have any income on the other side to reflect and it's really a timing issue more than anything else.

Yes. Let me just ask the question another way, you raised $90 million and again I'm assuming that that will support several hundred million dollars worth of bonds. And so I guess, and what I was wondering is that had you invested the $90 million of capital or the entire several hundred that ultimately it would support or in the process of building that?

Well, Byron, why don't you answer that?

Yes. Jay, can you repeat that? I didn't quite understand that one.

Okay. No, I just -- when you said you've deployed the capital, the equity that you've raised, I wasn't sure if that meant -- again that equity will support a couple of hundred million dollars of bond purchases.

Yes. No, we're talking about it from a fully levered basis.

Okay, that's what I was -- that's all I wanted to know, I couldn't quite tell from the release. Did you calculate or do you have a number of -- how much -- I think you mentioned the word dilution in your comments from the offering for that month, do you have any calculation of how much it was or I don't think I saw the number, maybe you didn't even really calculate it?

Well, as I mentioned, the reason I had so many points here was that there were several things that affected us in the first quarter and all of them put us in the 31 number for the quarter and we believe that we're going to get to a more normalized number now that we've had the prepayments slow up the way we expect, obviously the capital being put to work the way it has, all of these things are going to contribute. But we won't say exactly numbers that we think it's going to get to, we're just quite confident, it's going to be better than we saw in the first quarter.

Okay. I know you've commented about this whole lawsuit and I know it's been back and forth for years.

More than a decade now.

Yes, exactly. So it's been -- it comes and it goes and it goes and it comes, and I know you probably are sick of it and don't like to talk about it. But for those of us on the call that, can you just sort of clarify what this decision was, just kind of what the next step is and I can't really quantify any ramifications financially, but give me as short a description if possible exactly what's going on?

Well, I have a very strong opinion on this as does Steve in terms of these frivolous lawsuits, so I'm going to let Steve to do the politically correct thing and comment on it.

Okay, thanks.

Thank you, Tom. Sure. I'll try to do as politically correct as I can. Basically, Jay, the litigation is at the district court -- the court level, [fraud] court level, the class was served by as a class action against the company and one of its subsidiaries as well as its former President and then myself.

Right.

The next step is for us to appeal the class certifications to the second circuit, which we have done. We should know within the next probably 45 to 60 days as to whether they'll hear that appeal. We will assume that they do and then we will argue that the class should not be certified [any case] effectively if it's not certified, would be -- would essentially go away.

We always try to point out that the same plaintiff and the same law firm files an identical suit against Bombardier Capital in the same court, different judge at the -- almost the exact same time as they filed our suit. In that case, the judge did not certify the class, the second circuit court of appeals upheld that non-certification of the class and that litigation went away. So we've been hoping for that outcome all along. We actually believe our fact pattern is much better than that case. We just look at this as frankly suspect judging. So that's kind of where we are on it.

Okay.

And also we have filed a countersuit seeking dismissal of the lawsuit and also a fraud on the court action regarding some of the statements attributed to some of the depositions we have too, right, Steve?

That's correct, Tom.

Okay. Sorry to stick that thorn back in your side, but -- just a clarification that I need.

Well, Jay, I'll just say this. Unfortunately, in this day and age, litigation and even frivolous litigation is a factor, I think, every company has to deal with.

Yes, well, for sure. It's always mentioned somewhere in those 10-Ks. You never kind of know when it will rear its head and especially -- and that goes back long before I think you were even involved in the Company if I remember correctly, but it's been a pretty long time. Any kind of general market outlook sort of comments on -- I mean what are you seeing? I know you said you added swaps, which is at least making some sort of statement about what you think is going to happen in your industry. I always like to hear what you generally have to say from your perch in the sky.

Well, I know Byron wants to comment on our overall duration math, so I'll let him take this.

Okay.

Jay, we have -- what we run at Dynex is a defensive portfolio. In other words, we respect the fact that this is a very low rate environment. If you list those three years ago, we said the rates had remained lower than most people think for a longer period of time.

However, we have never been willing to put all our money in one direction and we've always maintained a defensive portfolio, especially since we were able to generate solid double-digit returns and yet maintain a short-duration, high credit quality portfolio, and we continue to do that. In the first quarter, we had more interest swaps.

We do believe that the probabilities have shifted a bit to such that you do have a higher probability. Let's say like this, the day that rates change and you start to enter a new environment will be the surprise. It will not be as much as the fed will attempt to be very transparent. Ultimately, the things that shift the market and has been throughout history, it will be a surprise. And so our portfolio is designed and built around that fact.

From an outlook perspective, we continue though, however, to look at the environment. We make a statement every week in our investor's meeting. Global risk remains high, it remains extremely high and are multiple fault lines of situations that can create an environment where a Ben Bernanke remains on hold.

So one of the drivers of earnings for mortgage REITs, largest drivers happen to be the low cost of financing and a steep yield curve. And as far as we're concerned, we still believe that environment will continue to exist, but we want to be defensive and be prepared for the fact that, ultimately when that changes it will catch the market by surprise.

All right, that's fair. Thank you. I appreciate your time.

Thanks, Jay.

Henry Coffey, Sterne, Agee.

Yes, hi. I got knocked off a couple of times and missed some of the stuff. I understand you did review some of the [past issues in UK]. Looking forward, you've got a nice situation with your NOL, which allows you not to distribute 100% of your earnings and also you've said in the past kind of limits your interest or willingness to issue more equity beyond what you've done.

Can you give us a sense of where you're likely to take dividends relative to earnings and where you think the Company can grow without adding any capital over the next three or four quarters, given some of the things you shared on the call so far?

Sure, Henry. There are limitations to the amount of capital that we can take before we start having to amortize our tax loss carry-forward. At this point, it's fully usable versus any gains that we might have outside of our dividends. Steve, what are those exact numbers or a good guestimate of where we stand vis-a-vis the rule?

Yes, hi. The ownership limit is greater than 50% shift in the equity ownership of the Company over a three-year period. Tom, at this point right now, we're sort of in sort of the mid-40s, so call it 45% today. So I think that's the answer you're looking for, right?

Yes.

Yes, I think, Henry, the way to look at is, probably if we were to raise more capital, we would then have limits on the amortization of our -- well, we would have to amortize that tax loss carry-forward over a period of time, which -- they expire in 2019, so that's eight years. So it would be another decision that we would have to add to the list of decisions we'd be looking at to add more capital. One of the things we at Dynex really like to have is, have the optionality on our side. We would lose that optionality and we would not do that lightly, I guarantee you.

So what's the likely growth prospects of the portfolio, churning over assets and moving into better spreads, better ROE assets or assets with less-rich characteristics or do you think that this is an environment where you're willing to go out and grow a little bit more leverage?

Well, I think we've stated that we would like to add a little bit more leverage. We have a portfolio that's -- a lot of our bonds are resetting and therefore, we believe that as these bonds become current resets we, one, do not have to hedge them, and two, we can add more leverage to that sector of our portfolio.

So we naturally see our leverage going up. As you know, we've been one of the lower leveraged high-quality portfolios out there. We've seen our peers go substantially into higher leveraged positions. We see it going up, but at this point we're still working with the number around six, is where we're headed to. Byron, do you have anything to add on that?

Yes, I do. Hey, Henry. Here's something a real -- I think it was a very important point, which is we have a very short-duration portfolio. If you look at the percentage of assets that roll within 36 months, we're probably at the closest to half the portfolio. And we just believe that we may be holding too much capital against those positions. A lot of the current reset ARMs are money market type assets.

And so when we think of increasing leverage, we're simply looking at it from the perspective, are we holding too much capital versus very, very short-duration assets. And so when you compare Dynex versus others in the industry, if Dynex is sitting at an 8x on these really short-duration assets, very different that carrying 8x versus 30-year securities or 8x versus 15-year securities or combination of those two.

Does that answer your question, Henry? Operator, I think we might have lost him.

Okay.

I'm still here. Hello?

Mr. Coffey, did that answer your question, sir?

Yes, it did. I don't know what's going on here, but yes, thank you for helping.

Kenneth Bruce, Bank of America Merrill Lynch.

Thanks. Good morning everyone.

Hi, Ken.

Hi. I'm sorry, I joined the call a little late. So I apologize for missing some of your earlier comments and it sounds like you may have touched on this to a degree. I guess the area that I'd like to ask a question really has to do with future capital raising exercises.

You've got a filing obviously that gives you or a shelf that allows you to issue equity in some other forms of capital if you see fit and it sounds like there is some constraints just as it relates to the tax loss carry-forward. So I'm just interested in how you're thinking about growing the equity base. Obviously, the market is very sensitive to this subject. So if you could give me any thoughts around that that would be very helpful.

Yes, Ken, we have discussed that, but I'll just repeat that. We feel that we have gotten the critical mass with the two capital raises we've done recently. We also feel that we are not going to be doing dilutive deals or non-accretive deals to both book value and earnings right now.

We feel very comfortable that our portfolio is positioned the way it should be to offer very low risk for a very, very I think attractive yield. So our interest in doing the increased capital raise is also going to be affected by the fact that our NOL will be probably needed to be amortized if we do a capital raise again.

So all of these things will be taken into consideration in any capital raise that we contemplate. Obviously, our stock is well below I think what we would be able to be at to do an accretive deal. And so we have little, if any interest in looking at new capital right now.

Great, thank you. And then, if I could maybe better understand Byron's comment just a moment ago in terms of the leverage, are you looking to take up leverage, say, beyond 8x on the short-duration hybrids or is that -- or you're running as you, in essence, rotate more capital into the agency strategy that that will just bring up the consolidated leverage as a whole?

Yes, I think -- let's talk about the last point, Ken. And this is a side issue, I appreciated your REIT panel last week in your conference. That was actually very good. So the -- on the last point there, the more -- over the last two capital raises, we have in effect shifted that capital into agencies. That means the total aggregate agency percentage for the Company as a whole has grown materially.

As a result, yes, you would expect us to move -- the overall consolidated leverage to move up. By the end of the first quarter we're simply under-levered. We haven't gotten all of our assets invested. What does it take to get leveraging up? And you could just buy a bond. Our strategies look different than that. We don't like to just buy any type of bond. We like to be very selective to try to ensure or increase the probability that we get the results that we'd like to have.

Now, I mean the way we look at leverage, we look at -- we'll break this down into buckets, there's no one leverage target because the risk profile of all these assets are very different. The really short asset, that means an asset that will roll within 15 months. It's more money market like. And it's a pretty interesting asset because obviously we move some coupons as they roll down, but they actually play a pretty good role in terms of anchoring our portfolio from an overall duration perspective and extension perspective.

Those assets we have started to think, before we thought in terms like 7x a year ago, we do think in terms of 8 times to 9 times x in those assets. And that thought process comes not so much thinking from leverages, but how much capital do I really need to hold against this money market type instrument.

And then we move our leverage target differently -- for the newer assets, we're still thinking in terms of the 7 times to 8 times leverage, and in the non-agency assets we're still 5 times or less in terms of leverage target. But we do break it out and we do think of it very differently. And we think from how much capital, given the risk of this instrument do I really need to hold.

Ken, we are looking very seriously at non-agency bonds and where we would like to add more to that part of our portfolio, but it's got to make sense on a risk-return basis.

Right, right. Okay, thank you very much. Appreciate your comments.

Thanks, Ken.

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

Great. We want to thank all our shareholders for their continued support and we'll remind everyone that our Shareholder Meeting is next Wednesday in San Francisco. And we will also be presenting on Tuesday at the JMP Conference also in San Francisco. We look forward to our next earnings conference call. Thank you much.

This concludes the Dynex Capital, Inc. first quarter earnings conference call webcast. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.