Dynex Capital Inc (DX) 2012 Q1 法說會逐字稿

Good morning and welcome to the Dynex Capital Incorporated first-quarter 2012 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 Ms. Alison Griffin, Vice President, Investor Relations. Please go ahead.

Thank you. Thanks, everyone, for joining Dynex Capital's first-quarter 2012 earnings conference call. The press release associated with today's call was issued yesterday and filed with the SEC today, May 3, 2012. You may view the press release on the Company's website at www.dynexcapital.com, under Investor Relations, and on SEC's website at www.sec.gov.

Before we begin, 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, 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 considerably from those projected and are contemplated by the forward-looking statements as the result of unforeseen external factors or risks. For additional information on these factors or risks, we refer you to our annual report on Form 10-K for the period ended December 31, 2011, as filed with the SEC. The document may be found on our website at www.dynexcapital.com under Investor Relations and on the SEC website, www.SEC.gov.

This call is being broadcast live over the Internet with a streaming slide presentation and can be found through a webcast link on the Investor Relations page of our website under IR Highlights. The slide presentation may also be referenced by clicking on the first-quarter 2012 earnings conference call links on the IR Highlights page of our website.

Now I would like to turn the call over to Chairman and CEO, Thomas Akin.

Thanks, Alison. With me today is Byron Boston, President and Chief Investment Officer; and Steve Benedetti, our COO and CFO. It's a busy day. There is a lot going on. I want to thank all of you for attending the conference call this morning.

As you're aware, we released numbers last night. We released diluted earnings of $0.33 per share. Our book value increased from $9.20 to $9.62, and our net interest spread for the quarter was 241 basis points, which is basically similar to our overall net average spread of 245 for all of 2011.

Our annualized return on equity of the quarter was 14.7%. We target right in that range, in that 15% range, and that's right within our tolerances. Overall leverage last quarter was about 5.4, which is a little low versus our target leverage of 6.

As everyone is well aware, in February of this year we raised approximately $122.5 million in a secondary offering, and all of that capital was not fully deployed for the entire quarter. As we stand right now, we are fully invested, and we're back up to our target leverage.

Constant prepayment rate was about 15.4%, but Byron is going to go into more detail on that. The bottom line is we continued to execute on our core constant investment strategy, and that is a short duration, high-quality investments, utilizing modest leverage. We believe that's going to produce a stable return with lower volatility over the long term.

Our current investment opportunity is diversified. There are significant opportunities remaining in the CMBS sector, and we continue to focus on that and the agency sector as well. We believe our track record has been consistent, delivering total rate of return of 12.2% since 2008.

On the next slide, we've got our summary of results, which is what I've just gone over in general. Then, I'd like to turn over the conference call over to Byron Boston to discuss in detail the investment portfolio. Byron?

Good morning. Thank you for joining us. Let's first go to slide 6. And even though some of you may be familiar with Dynex, let me just simply summarize our overall investment approach.

We have a diversified portfolio that includes fixed- and floating-rate assets; agency and non-agency securities, backed by residential and commercial loans. Our portfolio is constructed to perform well despite volatile markets, given our high-quality, short-duration assets.

Our diversified approach produced solid results in the first quarter as our CMBS portfolio increased in value, even as rates increased during the quarter. Our overall book value per common share increased by almost 5%, and we generated a 14.7% return on adjusted equity for the quarter.

We have confidence in our risk profile, as we have steadily generated double-digit returns without extending far out the risk spectrum. Selective opportunities continue to exist to reinvest capital, particularly in CMBS, and our RMBS/CMBS capital allocation model has allowed us to find pockets of value.

Let's move to slide 7. As I go through the slides, I'll ask myself several questions, and I'll attempt to answer them to give you a clear picture of our performance in the first quarter.

As we look at the Dynex portfolio, what has changed since December 2011? Our agency portfolio has increased. That's been very typical after some large capital raises here at Dynex Capital. It allows us to get our capital deployed faster and take a more selective approach toward the non-agency and agency CMBS sector.

There was a minor 1% change in our overall CMBS/RMBS mix. We continued to minimize extension risk. So if you look at our charts and you look at the chart to the right, you will see that -- and if you add the numbers -- 79% of our portfolio will either recess or matures within seven years.

If you look at the lower left-hand chart, you'll see that 67% of our book of business happens to be backed by residential assets, 33% by CMBS assets. That's a slight 1% change since December 2011.

And if you look at the upper left-hand chart, you will take note that the majority of our assets continue to be in the agency sector, both agency CMBS and agency RMBS paper, with approximately 17% of our book being in nonagency securities.

Have you tried to diversify further into nonagency RMBS? The answer is yes, but the opportunities to find high-quality, nonagency RMBS paper is limited, and I'll give you an example. There's one deal that came to the market; we attempted to buy 20 million; we ultimately were allocated 2 million. So we have made our attempts in the high-grade nonagency sector, but the opportunities have been limited.

We have -- what has changed in terms of our overall duration picture? I mentioned a second ago, we have continued to minimize extension risks. However, we have found more attractive opportunities in the 7-1 and 10-1 sector versus the 5-1 in season, 5-1 sectors that we have built our portfolio between 2008 and, let's say, 2010.

If we move to slide 8, and let's continue to look at the portfolio, has our credit quality changed since 2011? The answer is no. We continue to focus on high-quality assets. Let me draw your attention first to the top chart on the right. You'll note that this chart you've seen before.

We continue to emphasize CMBS -- what we call CMBS 2.0 and 3.0. Most of our investments are all -- have all been originated since December of 2009. Our prior to 2000 category happens to be assets that Dynex has originated, and the 2000 to 2005 category are assets that we originally financed through the government TALF program.

We have avoided the 2006 and 2008 period, because we consider that to be the worst underwritten and structured bonds in the history of the CMBS market. As you notice, the lower credit quality -- lower chart on the lower left, our credit quality -- 91% AAA, 4% AA, 4% A.

And then if you look to the upper left-hand corner, we have been willing to take prepayment risks in our portfolio. Our prepayment opinions have not changed. We have not adjusted our strategy. We continue to structure our portfolio to mitigate prepayment risks, and as you can see, the 76% of the premium exposure on our balance sheet has explicit prepayment protection. That comes from the CMBS securities, which are all structured with either some form of legal lockout or yield maintenance that will compensate us for any type of premature prepayment activity.

5% of our portfolio was represented by post and near reset paper. The prepayment experience on that book of business has been excellent, with average prepayment fees of 10% or lower. And then the remainder 19% of our book of business from a premium perspective has been protected or covered by our selected securities strategy, which I'll go into detail on the next slide.

You flip to slide 9, you'll see what type of strategy-specific characteristics that we continue to emphasize. We've used these charts before. We have continued to seek out pools that have low third-party originated loans, Dynex portfolio having 37.9% of our portfolio exposed to what we call TPO-originated loans, versus 50% to 60% for the universe of ARMs as a whole.

And let me clarify something. You've heard low-balance loan stories in the marketplace. You've heard of state-specific stories in the marketplace. In the hybrid ARM sector, for the most part, there are no specified pools. So originations did not segment low balance loans; they won't segment state-specified pools. The majority of the hybrid ARM pools are what I would call mixed pools, combining a variety of different loans.

We take the time and look pool by pool in a very micro manner to minimize both characteristics that are associated with faster prepayment speeds. Our favorite, again, low third-party originated loans, interest-only loans, and emphasizing non-owner occupied properties.

If you go to slide 10, let me ask you, have we changed our focus on multifamily securities? And the answer is no. Dynex has been as heavily involved in the multifamily sector for 20 years. If you'll note on the slide to the right, 67% of our CMBS portfolio is backed by the multifamily loans, 33% backed by other sectors.

Our overall credit quality, 81% AAA, 12% AA -- most of the 12% of that single-A bucket has come through the Freddie Mac aid program. Again, these are loans -- these are securities that have come through a very disciplined process -- disciplined agency process. It is the only non --consistent, programmatic, nonagency program in the marketplace.

Although the multifamily sector has very strong fundamentals, we are more alert today in our due diligence of this sector. We were one of the early investors in this sector. We've been involved now in building this portfolio since 2009.

However, the majority of the marketplace is now taking notice of the multifamily sector. Cap rates have dropped considerably, and we are aware that this is the type of environment where bad credit and investment decisions can be made. Hence, our surveillance and due diligence has increased. We continue -- nonetheless, we continue to find value in the multifamily sector.

Let's move to the next slide. What are the performance facts, and what story do they tell? First, to the left -- the upper left-hand chart. Our prepayments results have been excellent. Why do I consider them excellent? Our average coupon versus many others in the industry is higher, and yet our average prepayment speed across the portfolio has actually been lower than many others.

What have we done to make a difference? I mentioned a second ago we selectively pick our pools that go into our portfolio. However, we emphasize diversity. We've methodically structured our portfolio not to be exposed or only exposed to any one sector, or as we consider it, any one type of borrower.

As a result, our average speeds have been lower and declining over the last 12 months. We do expect speeds to increase as most originators continue to try to ramp up their HARP programs. Nonetheless -- and our prepayment assumptions for our portfolio are conservative and higher than our actual experience.

Nonetheless, we continue to believe that we will not see a 2003-type experience in terms of prepayment speeds. We believe they will trend up, but we do not believe that they will be uncontrollable, and we believe our portfolio has been constructed to minimize our overall experience.

Let's move to the chart to the right. Are we at book value? What do these facts tell you? We have continued to generate solid mid-teens ROEs without taking on excessive risk. Our overall leverage for the balance sheet has been below 6 for this quarter; our overall target are in or around plus or minus the smaller amount, around 6.

As you can see, we generated 14.7% ROE. Our book value increased from $9.20 to $9.62. If we look down to the bottom and consider our net spread, why did our net spread decrease from 2.56% up to 2.41%? It's a function of math. As in other past capital raises, we emphasized putting the capital to work in the agency sector, spread the lower agency sectors and nonagency sector, and as a result, our average net interest spread decreased.

Again, back to once you consider the ROE -- overall ROE of the portfolio, again, a function of math, with a lower average leverage for the quarter and a net spread of 2.41%. If you move that leverage number up to 6 and you then take the net spread, you'll start to see what I consider the beauty of our strategy, to where ultimate ROE targets will be in the future.

Let's move to the next slide. Are there opportunities to invest capital today? The answer is yes. Spreads have tightened throughout the quarter. Best way to look at this period between 2008 and 2012 is that we've experienced excessively high spreads in prior years.

Spreads are moving more to a more normalized level. ROEs continue to be in the double digits. In almost all respects, those double-digit ROEs are lower than where they may have been in the past. However, our diversified approach affords us a greater opportunity of finding higher ROE investments.

We obviously diversified through the residential sector, and we diversify and seek out opportunities throughout the CMBS sector. We continued CMBS spreads at the end of -- at the beginning of this quarter, and widened slightly, allowing us even more opportunities to find solid investments in that sector.

Let's move to slide 13, extension risks. Why do we worry about extension risks when the Fed is on hold? As far as we're concerned, at Dynex Capital, extension risk is a very real risk, and we at DX have chosen to minimize this risk by emphasizing short-duration assets.

If you look at the bottom chart, we simply try to give you examples of how much a security might expand. 30-year securities, at some point in a higher rate environment, could easily extend between 7 to 10 years. 15-year securities could easily extend three years. For short duration hybrid ARMs, we expect minimal extension.

Our analysis is based on history. Our analysis is based on our own experience, and as such, we have chosen to minimize the overall extension risk in our portfolio.

We move to slide 14. How have you structured your repurchase agreements and your interest rate swap hedges? If you take note to the bottom of the graph to the left, we have structured our repo book with various maturities across 90 days. Some portions of our book -- the largest portion of our book maturing within zero to 30 days. One of the -- I'm sorry -- 31 to 60 days.

One of the challenges that we have is with our hedge accounting. In many respects, it forces us into structuring our repo book with maturities between zero and 30 days, or maturing within 30 days. We have debated and considered the idea of should we make some changes to the overall hedge accounting election.

We have not made any decisions around that. We continue to look to see if we put our shareholders in a better risk position that we make that type of decision. But, as we stand today, we continue to elect hedge accounting for our book of business and, as such, our hedges or our repo book is structured over a 90-day period.

Throughout the quarter, we continued to add to our swap book. Since quarter end, we continued to add to our swap book. We could expect to see our swap percentage slightly increase as we move to mitigate the overall duration risk in our 5 to 7 year part of our overall portfolio.

And as we move to slide 15, let me simply summarize. Our portfolio has performed well since 2008, and the earnings power today remains relatively intact. Prepayment risk is mitigated by superior portfolio construction. As I mentioned earlier, we believe our prepayment experience to date, given our high average coupon, has been excellent and exceeds the industry.

We do expect prepayment speeds to increase as originated continues to focus on HARP 2.0. Our credit risk is mitigated by continuing to focus on highly rated securities, superior loan origination years, and concentration in multifamily sector. I mentioned and I have harped on this multiple times -- extension risk is mitigated by the short duration investment portfolio, with 79% of our investments maturing or resetting within 7 years, and there continues to be attractive investment opportunities.

We're happy with our first quarter, and in many respects, you can simply say that we've continued to do what we've always done, and as we look forward to the future, we look forward with great anticipation of continuing to deliver solid double-digit returns. With that, I'm going to turn it back over to Tom.

Thanks, Byron. Then the final slide is basically the Dynex value proposition, slide 16. And just four points I'd like to make quickly, and that is that we do have high insider ownership, which we think aligns the interest of the shareholders with the management of Dynex.

Our portfolio strategy has been consistent for the last 4 years. It will continue to be that consistent. As long as we can find the securities that up offer low volatility and high returns, we feel that it is a value-added proposition for our shareholders.

And, finally, we are committed to the diversified investment strategy. We feel like if you're going to go in the fight, I'd rather fight with two arms than just one. We like the fact that we can use agencies and non-agencies.

And then, finally, we think the last 4 years we've delivered success, have shown our commitment to our strategy and to our shareholders. And, with that, I'd like to open up the call to questions.

Thank you. We will now begin the question and answer session. (Operator Instructions). Douglas Harter, Credit Suisse.

Thank you. Byron, I was hoping you could talk a little bit about the various I/O investments that you guys made during the quarter?

Sure. One of the -- we have found a lot of value in CMBS I/O over the last, let's call it, say, year and a half or so. At the beginning of the quarter -- the last 6 months of last year was somewhat of a dream in the sense that spread widened considerably in CMBS, and we wanted to put a lot of money to work.

As we entered January 2012, spreads continued to remain wide, and we continued to take advantage and emphasize this sector. For those of you who are not familiar with CMBS I/O, I want to emphasize that CMBS I/O is different than residential I/O. These are credit I/O securities. We are not exposed to voluntary prepayments that you see on the residential side of the business. We are exposed to involuntary prepayments, meaning that we are exposed to default risk.

Why have these securities remained cheap? When the CMBS sector -- when a dealer brings a deal or a Freddie Mac K deal, which is where we've accumulated most of our I/O exposure to the multifamily sector, most accounts that are demanding the most senior bonds in those structures are demanding PAR bonds.

As a result, there is a sheet to deliver a PAR bond; dealers have to structure what we consider to be -- and many in the industry -- a cheap I/O. We have taken advantage of this. We have been heavily involved for some time on both the agency and non-agency I/O sector.

So we've continued to -- it's a very strong part of our business, Doug. We have -- both Ginny Mae, Fannie Mae, Freddie Mac and non-agency I/O, with the majority of that being backed by multifamily loans.

Just to clarify, is this a new investment that you made this quarter, or did you just sort of break out the I/O separately this quarter?

No. We continued throughout this quarter to invest in the CMBS I/O sector.

Yes, Doug, in prior quarters it just would have been buried into the CMBS line.

Perfect.

So it's just been broken out this quarter.

Great. Appreciate that. Thank you.

Yes, and Doug, I would just add -- it's been -- again, we started building the CMBS portfolio in December of 2009. And I would probably argue that we are one of the longest, most consistent purchasers of the CMBS I/O over the last two years.

And the reason I say that is just the amount of competition that we've found in some of the new deals at certain times. Needless to say, spreads have tightened since January, and we do find ourselves competing with others for these assets, but they continue to offer attractive returns.

Great. Thank you.

(Operator Instructions) David Walrod, Ladenburg.

You mentioned that the allocation of the agency space was a little higher this quarter relative to the fourth quarter. Then you also talked about some of the difficulties you had placing in a nonagency space. Can we expect that to trend back to more historic levels, or where it was in the fourth quarter, as you're able to find those opportunities?

Hey, David. I'm going to recap again since June 30 of last year. In June 30 of last year, non-agency CMBS spreads widened materially. So from June 30 to December 31, probably 99% of our -- 99.5% percent of the marginal dollar from Dynex went to the CMBS sector.

Starting in January, there has been a large risk on trade throughout the world with all risk assets. The CMBS sector, however, actually lagged a little slower than some other asset classes in January. And we continue to invest in CMBS.

What happens when we do a capital raise is, one, we try to pre-invest capital prior to a raise, but it is far more efficient to focus on putting agencies on your balance sheet and taking our time to subsequently bring the CMBS sector onto the balance sheet.

It has worked excellent over the last two years. We continue to follow that path. If you look back, you'll see that it is December 2010, March 2011, you'll see -- at those times we actually put 100% of our new capital from a capital raise into agencies, and then we get an opportunity later to diversify into the CMBS sector.

In this situation, we still had opportunities throughout the quarter to add money to the CMBS sector, and we continue to have that opportunity today. So we love the diversity it brings between the rezi product and the CMBS product, and we continue to emphasize that.

But I wouldn't describe it as having difficulty finding the assets. It's just that there are more people today in April of 2012, the more we found competition in October 2011. But we still find the opportunity to put money to work.

And, David, the other thing is, remember that a lot of this stuff that we're purchasing is very niche-y, and you don't see large amounts of it come out all at once. So it just takes time, and the agency securities are a placeholder until that paper is found.

Understood. And then a housekeeping question, probably for Steve. Your comp line has run historically for the last two years -- the first three quarters are kind of consistent, and then the fourth quarter that pops up kind of a catch-up for the year.

This quarter -- the first quarter was pretty close to where the fourth quarter was. Should we assume that is a new run rate for comp going forward, or was there something unique in this quarter?

David, this quarter had your typical kind of the first-quarter Social Security, 401(k) kind of type contribution stuff. That bumped up that line by about $160,000 this quarter. So you won't see that on a repetitive basis going forward. Otherwise, that run rate would be what you should expect.

Great. Thanks a lot, guys.

Thanks, David.

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

I want to thank everyone for joining the call. Obviously, today I think everybody in the mortgage REIT space had earnings last night, and I appreciate the calls and callers and questions that we got. We look forward to speaking with everyone next quarter. Thank you much.

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