Dynex Capital Inc (DX) 2013 Q4 法說會逐字稿

Okay. Good day and welcome to the Dynex Capital Inc. fourth-quarter 2013 earnings conference call and webcast.

All participants will be in a 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 Alison Griffin, Vice President, Investor Relations. Please go ahead.

Thank you Maureen. Good morning and thank you for joining the Dynex Capital fourth-quarter 2013 earnings conference call. The press release associated with today's call was issued and filed with the SEC today, February 19, 2014. You may view the press release on the company's website at www.DynexCapital.com under Investor Relations and on the SEC's website at www.SEC.gov.

With me today is Executive Chairman Thomas Akin; President, CEO and co-CIO Byron Boston; EVP and co-CIO Smriti Popenoe; and EVP, Chief Financial Officer and Chief Operating Officer, Steve Benedetti.

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 in or contemplated by the forward-looking statements as a 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, 2012 as filed with the SEC. The document may be found on our website under Investor Relations, as well as on SEC's website.

This call is being broadcast live over the Internet with a streaming slide presentation and we 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 fourth-quarter 2013 earnings conference call link also on the IR Highlights page on our website.

I would now like to turn the call over to Tom Akin.

Thanks Alison, and thank you all for attending the 2013 full-year conference call and fourth-quarter update. As a veteran bond investor of over 30 years, there have been few periods as volatile as the interest rate environment observed last year. In particular such volatility, while the Fed funds rate remains anchored near 0%, I don't think has ever been witnessed. Ben Bernanke uttered three little words in may, "possible Fed tapering", and the rate route was on. Most institutions got caught off guard as four years of low rates made most investors complacent about the risk of higher rates.

Earlier in May, prior to Ben Bernanke's proclamation, investors' concerns was more around how to manage an ever-lower yield environment. How quick things changed. Originators had pipelines full of new or refinanced mortgage loans, investment banks were enjoying the carry trade, and huge unhedged positions laid in the marketplace. The retiring baby boomers were fully committed to income investment.

Talk of normalized yields changed and rates such as 4% to 6% and 10-year yields were bantered about as if they were fait accompli. The direction wasn't questioned, only the magnitude of the move. It was no wonder that levered mortgage REITs saw price declines of over 30% and cratering dividend yields. The first three quarters of 2013 saw in-REIT book values drop precipitously.

At Dynex, we have always adhered to several simple basic rules of the road. Limit your risk by limiting your duration, leverage and diversify your portfolio. Simply said, the best way to avoid volatility is to not buy it to begin with.

The Dynex portfolio was designed to perform in a variety of market environments, both good and bad. We've always held a healthy respect for the dangers of leverage, no matter the volatility. We have never purchased a 15-year mortgage or a 30-year mortgage as they have not offered the proper risk-return trade-off for the Dynex portfolio.

There is no question that the increased volatility today will make it more expensive to hedge an in-REIT portfolio. However, the glass is half-full as well. Despite the negatives, solid returns still exist in the marketplace with limited downside risk and solid cash flows. The anchored financing rate for the next two years should give ample opportunity to create cash flow for our shareholders. We continue to focus our efforts there and continue to build a portfolio for the long term.

Now I'd like to turn it over to Byron Boston to discuss the portfolio in detail.

Thank you Tom. Now let's turn to our portfolio and for 2013. I'm starting on Slide 4 if you are following along in the web.

2013 began a transition for the global fixed income market. Despite the many changes and surprises that developed, we at Dynex Capital maintain the strategy that we deployed from inception in 2008. We pride ourselves on the fact that we have not had to make major changes to our business model or our strategy. We have managed for the long term by constructing a portfolio designed to perform in a variety of market environments. This is a simple, conservative strategy built limited leverage, limited extension risk, product diversification and high credit quality.

For the last 10 years, our shareholders have been able to trust the management of Dynex to manage their capital. As owner-operators, we treat the capital as our own. Our results reflect these efforts. In 2013, we paid out dividends of $1.12 per share on core earnings of $1.17 per share, which equates to a core ROE of 12.2%.

Additionally, our board approved a $50 million share repurchase program which we utilized throughout 2013 to support our stock price and as we saw value in repurchasing shares versus reinvesting capital. We have $42.1 million in remaining authorization to repurchase shares as we see fit.

Our shareholders can also take comfort in the fact that senior management of Dynex further invested in the company by taking incentive compensation in stock for the year 2013.

As many of you are aware, we made some significant additions to our personnel and title changes within the senior management ranks. One of our most important strategic goals in 2013 was to enhance our human capital and our succession plan for senior management. We achieved both.

First, we hired Smriti Popenoe as EVP and co-Chief Investment Officer as of January 2013. Smriti has had a long-term relationship with Dynex. She assisted us in developing our core strategic plans in 2010 and again in early 2013. Prior to Dynex, Smriti has had multiple senior roles in the financial services industry from fixed income portfolio manager, SVP and senior investment officer for Wachovia Bank's balance sheet, chief risk officer at PHH Mortgage. Most importantly, she was my partner in starting a de novo mortgage REIT in 2004 which we took public via an IPO in March of that year, and successfully managed through the most recent bear market in fixed income. We believe we are in an environment where experience and seasoning counts. We have added talent and we have added experience to our senior management ranks.

Second, Tom Akin has become Executive Chairman and I have assumed the title of CEO and co-Chief Investment Officer. This is an important step for our shareholders as we have effectively implemented a succession plan that ensures that we will not move -- we will move no continuity in vision and management of our company.

And then finally, we have also strengthened our Board of Directors by adding two professionals with long-term careers and experience in managing fixed income assets and commercial lending.

I am now going to turn it over to Steve to discuss our financial performance in detail.

Thanks Byron. Most of you on the call understand that we have discontinued GAAP hedge accounting for our derivative instruments. As such, we now present non-GAAP measures in an effort to present our financial results for easier comparison historically, and with others who continue to utilize hedge accounting or might also present some measure of core earnings.

GAAP net income was $0.35 for the quarter versus a loss of $0.13 per share last quarter. Core net operating income per share was $0.29 compared to $0.27 in the third quarter.

On Slide 5, we present the non-GAAP financial metrics, core net operating income per share and adjusted net interest spread each for the last five quarters. As a reminder, core net operating income equals GAAP net income excluding gains and losses from hedging activities and asset sales and as such is intended to present net interest income in our investment portfolio less the current period costs of hedging interest rate risk and less operating costs.

We earned $0.29 on a core net operating income basis, exceeding our dividend of $0.27. For the year, we earned $1.17 in core net operating income versus a dividend of $1.12 per share. Core net operating income for the fourth quarter included a positive $0.03 contribution from reduced compensation expense.

Adjusted net interest spread increased by 12 basis points as we adjusted our hedges to reflect our macro view, and as such, our effective borrowing costs declined by 22 basis points for the quarter.

As far as asset yields are concerned, we saw slower prepayments on our agency RMBS which we had been anticipating since May, given the sell-off in rates. As such, over the second, third and fourth quarters, we had adjusted prepayment speeds leading to moderate reductions in premium amortization over those periods. Our RMBS weighted average yields for the last two quarters -- two-plus quarters, have already incorporated the lower prepaid fees that we saw this quarter and our corresponding expectations.

In spite of the sell-off occurring in the quarter in rates, book value increased during the quarter by $0.10 per share from $8.59 to $8.69. Spread tightening on our assets and gains on our derivative positions more than offset the rise in interest rates for the quarter, helping to increase book value.

Slide 6 contains a comparison of our hedge position at December 31 versus September 30. We terminated approximately $852 million in current-pay fixed interest rate swaps during the quarter, and another $50 million of forward starting swaps. We also terminated euro-dollar contracts that were forward starting primarily in 2014 through 2016, and we also terminated some longer dated contracts. These terminations are consistent with our view on short-term rates and improved our net interest spreads, as previously noted.

With respect to the euro-dollar contracts, as we noted on our last call, these contracts are based on three-month LIBOR, are forward starting, and allow us to synthetically replicate swap curves and/or hedge specific points on the swap curve where we may have duration risk. As these contracts are forward starting, we include in core earnings only the cost of those contracts that are affected. Like swaps, fluctuations in value of these contracts will be included in GAAP earnings and book value.

I will now turn the call back over to Byron.

Thank you Steve. We are now going to discuss our outlook and strategy. I will start with some comments on the macro outlook, and Smriti will take you through our portfolio position and strategy.

Since 2008, we have stated that we expected short-term interest rates to remain lower and for a longer period than most people expected. We also have felt that the yield curve would remain steep for many years. We continue to hold for these opinions.

We believe that economic uncertainty, regulatory uncertainty, and global market uncertainty have created a very complex environment for economic growth to be able to accelerate to the levels seen in prior post-war recoveries. We see a fragile global economic picture that might withstand minor increases in US interest rates, but will not withstand a major correction back toward rate normalization.

Let's consider a few of the key macroeconomic and policy factors that are at work throughout the global financial system. There are many structural and demographic shifts at play in the US economy today, making it more difficult to forecast economic data. Some examples are the impact of the retiring baby-boom generation and US immigration policy on the labor market. Global inflation rates, global inflation levels are potentially problematic and could become a surprise factor.

We also see significant changes coming in the form of government policy. The uncertainty of the nature and former policy action we believe requires particular attention. Against this backdrop, we have seen spreads tighten, resulting in lower returns. There continues to be far too much cash chasing assets.

As Smriti will discuss shortly, we made selective investments in the fourth quarter, mostly in the CMBS sector, because we feel, we still feel the trends supporting multifamily housing are in place.

I would now like to introduce Smriti Popenoe, our new EVP and co-Chief Investment Officer, and welcome her to her first earnings conference call with Dynex.

Thanks Byron. I'm delighted and excited to be here again working with you, Tom and the Dynex team.

Let me start on Slide 9 by briefly discussing the investment environment and the implications for our strategy. And when I say investment environment, I'm focusing on spread levels and opportunities to deploy capital.

The current investment environment remains supportive of our core investment thesis, a diversified portfolio of commercial MBS and short duration hybrid ARMs. At Dynex, as you may be familiar, we like to analyze the market from the perspective of fundamental technicals and psychology.

The best way I can characterize the overall environment right now is that it is mixed. On the one hand, we see supportive demographic and economic trends in the multifamily sector, combined with home price recovery, slowing prepayments and lower defaults in the RMBS market.

On the other hand, we have watched risk premiums across asset classes decline, causing us to be more disciplined and selective in our investing. As the government begins its pullout of the mortgage market, after the Federal Reserve ceases is large-scale asset purchase program, for the first time since the 1970s, we will not have a government entity be the dominating purchaser of MBS in the secondary markets. Also keep in mind that securitization and credit pricing in the prime agency eligible and prime jumbo markets are yet to function in a standalone manner. These factors give us pause when we think through capital deployment opportunities available today.

As far as market technicals are concerned, here again we see a mixed picture. On the positive side, as investors expected rates to rise, hybrid ARM securities have become more attractive. As rates continue to rise, fewer MBS will be produced, and despite reductions in the Fed purchases of MBS by most estimates, they will still absorb a majority of fixed-rate MBS through the spring and early summer.

On the negative side, we do not see a sizable investor base willing to take down fixed-rate MBS at these levels. Dealers also clearly showed their reduced level of risk appetite last year and we expect all of this will have a major impact on spreads in the absence of sizable demand for MBS outside of the Fed.

In terms of market psychology, we've seen it all over the place, but mostly it is bearish in tone and moves less or more bearish with the data. This also gives us pause as the data have been coming in mixed as well, giving a pretty unclear picture of the true state of the economy.

So turning to Slide 10, what does this all mean for Dynex? First off, it's great for our current portfolio. Hybrid ARM spreads have tightened and credit fundamentals continue to support our multifamily investments.

Second, the mixed environment means we have to be much more cautious when investing capital at these levels. As such, we are operating with lower levels of leverage and higher levels of cash in capital. We have been very selectively making investments in the CMBS market in specific cash flows that we believe continue to offer value.

In terms of our strategy going forward, we expect to maintain our current investments which offer good stable cash flow and the opportunity to roll down the yield curve. We expect to maintain a positive duration at the front end of the yield curve, and to continue our discipline on assessing risk-adjusted returns and deploy capital opportunistically. This would include repositioning the asset and hedge portfolio as necessary.

Turning to Slide 11, we show the modeled impact of various interest rate scenarios on the market value of our assets net of hedges. This looks like a complicated page, but I'll take you through the different tables.

You can see we've included a nonparallel shift in interest rates, because really it's rare that the yield curve moves in a parallel fashion. Typically, the yield curve flattens or steepens.

So if you take a look at the tables, I'm going to ask you to note the pattern in the market value changes. When we shift rates up in a parallel fashion, up 50 basis points for example on the top right-hand side of the page, the market value of our assets net of hedges is projected to decline by 0.9%.

However, turning to the second table on the bottom of the page, when we shift interest rates in a steepening fashion as in the second scenario on that table, market value only declines by 0.45%, about half of the parallel shift. Similarly, when we shift interest rates in a flattening scenario as in the second to last scenario, scenario six, market value declines by only 0.51%, about half of the parallel shift. The key takeaway here is that the interest rate risk in the portfolio is focused on the front end of the yield curve. And the position benefits from lower rates in the front end of the yield curve.

As Byron mentioned, our view is that the economic uncertainty, regulatory uncertainty, and global market uncertainty have created a very complex environment for economic growth. We don't see it accelerating to levels seen in post prior war recoveries. We actually see a fragile economic picture that could withstand small increases in US interest rates, but not a major correction back towards rate normalization. We are comfortable with this position at this point, given this view on the macro environment, but we are very vigilant on any data or trends that might run counter to this view. And we stand ready to adjust this position as needed.

Now, let's turn briefly to how our capital is invested on Slide 12. This is a slide that many of you have seen before. Again, not much different. Our equity is mostly in the CMBS sector, 91% by asset values and AAA assets. Most of it has a maturity or reset profile of 10 years or less.

On Slide 13, just briefly reviewing our financing picture, liquidity is strong. We continue to have access in availability financing. The move away from hedge accounting has really allowed us to manage our repo book more effectively. We have been moving our contractual maturities up, now at 114 days from 91 days last September. We did see attractive rates in lock in term financing for 90-day periods and we did take advantage of that, and we continue to seek such opportunities.

On the financing side, we are also very focused on the impact of regulation on our 31 counterparties and we are working actively to manage these relationships.

The next few slides are pretty self-explanatory. We put down again the reason for our investment thesis in the CMBS and RMBS sectors. I'm going to just highlight a few points on a couple of the slides.

Slide 15, I want to show you that 76% of our CMBS assets are AAA rated. On the top right-hand side, the majority of our investments are in post-2008 vintages, which have stronger underwriting and collateral characteristics. We have actually experienced LTD upside having made these investments as values have rebounded.

On the bottom left-hand side, you can see our focus is on the multifamily sector. We really believe there's a strong demographic story here that continues to play out.

And on the bottom right, this is a well diversified position across agency, nonagency, I/O and non-I/O securities.

Turning to Slide 17, these two charts may look complicated, but what we are really trying to say here is to show you the difference between pre and post-2008 credit support. What this shows is that the rating agencies are actually now showing more discipline by requiring more subordination as the risk in the deals increases. At Dynex, we are vigilant about this because we have actually seen a lot of cash chasing investments in the CMBS sector particularly in the multifamily area. And we've seen terms and loan conditions and underwriting standards slip a little bit. We like to track this to make sure that we get comfortable with the credit subordination, even if our investments are at the AAA level.

On the RMBS front, as you all know, we have been extremely focused on the hybrid ARM market. As we discussed earlier, the investment environment here is truly mixed. On one hand, slowing prepayments and negative net supply are positive factors, but they are offset by the potential negatives of new supply and the impact of the Fed's exit from the RMBS market.

A couple of points to note on our portfolio on Slide 19. First the maturity amongst the reset profiles again fairly well distributed. On Slide 20, we show RMBS gross and net issuance. And the key point to note on the left-hand side chart there is the amount of negative net issuance in the 5-1 hybrid ARM sector, and modest net issuance in the other sectors really contributing to the positive technical in hybrid ARMs. On the right-hand chart, you can just see the prepayments in our hybrid ARM portfolio dramatically dropping off in the fourth quarter of last year.

Turning to Slide 21, I would just like to summarize the key points. First off, the macro environment of lower short-term rates and a steeper yield curve continues to provide us an attractive opportunity to earn carry. Second, the uncertainty of economic growth, regulatory changes, market reaction and global market imbalances require discipline and vigilance. We are behaving very much in line with that. Risk-adjusted returns are lower as we've seen these risk premiums decline, and they are lower than the extraordinary opportunities of several years ago as well as since mid-2013. At this point, we are maintaining a positive duration gap focused on the short end of the yield curve while maintaining lower leverage and opportunistically increasing our exposure to CMBS versus RMBS. And over the long-term, we do see opportunities for investments in both residential and commercial assets and in markets that are currently dominated by the Fed or the GSEs.

I will now turn it back over to Byron.

Thank you. If you go to Slide 22, and you take a look at the upper right-hand box, this is our long-term view. Let's but the last year into context. We show our historical performance using a number of metrics -- total return, dividends and our core return on equity. We've been able to generate a double-digit return, but more importantly, we've been working to do so with stability over a long-term Horizon. As you can note, dividends remain relatively steady, between $1.00 and $1.15. Our return on equity has been solid double digits.

And more importantly, if you look over to the left, our long-term returns, really important to us that you take note of the fact that our shareholders have been able to trust this Dynex team through a variety of market environments over the last 10 years. As you can see, our five-year return, solid 73%, four years 43%, over the last three years 25%.

And let me summarize our message for today. We have added to the experience and talent of our management team. We are maintaining the long-term focus of our company. And as I just stated a second ago and I'll repeat again, for over 10 years, our shareholders have been able to trust this team to prudently manage the risk exposures of a company through a variety of market environments, including the 2008 debacle.

We are aware that our portfolio is unique in the sense that we've got these short duration hybrid ARMs married with a solid CMBS portfolio, of which a majority of that portfolio carries an agency guarantee. We believe that we are the highest yielding CMBS portfolio and one of the most stable agency portfolios as a whole. We are nimble, focused, and very disciplined in our approach. And most importantly, we are optimistic about our ability to manage our portfolio through this new transition environment and to capitalize on the investment opportunities that we believe will be available in the future.

With that, operator, I'd like to open the call up for questions and answers.

(Operator Instructions). Trevor Cranston, JMP Securities.

Hi. Thanks, and congratulations on a nice quarter. I guess my first question is related to your interest rate exposures that you show on Slide 11. You made some changes to the hedge book this quarter, and you show, even after that, a fairly small exposure to kind of the curve flattening scenario with the short end going higher in particular. I was just wondering if you could comment on if this kind of reflects your optimized portfolio currently, or if you would be willing to take a little bit more exposure to that flattening scenario and potentially lift some more of your shorter-term hedges, just how we should think about that.

I think, Trevor, we have given you the -- it's a real important thing as we do from a top-down perspective. The reason we wanted to go into our macro, it would ultimately will lead you down to how this portfolio is constructed. We feel most comfortable to have duration exposure in the short end of the yield curve. And as such, we aggressively manage our risk exposure in the long end of the curve. So over time, if factors present themselves globally, because we are in that type of environment where we have to make adjustments and changes, we'll make those adjustments and changes as appropriate. Right now, we feel very comfortable with this position.

And so I mentioned this in the last call, I want to say this again because I think it's really important, because I know many of you an analyst community, you want to predict book value, you want to predict earnings.

In the last call, I said the ability of you to predict book value and even earnings in some situations of all the mortgage REITs probably has decreased. And it's not because any problem with you guys. It's really the function of the market environment. This is very unique. We said it with three words. We said economic uncertainty, regulatory uncertainty, and global market uncertainty combined together to create a very complex environment.

We are not going just sit on our hands through this environment that dictates we need to act very prudent as risk managers. And that's what we will do. We will make adjustments to this business appropriately. But we try to give you as much information to see how we are positioned today and exactly why we are positioned this way.

Got it. That's helpful. And on the asset yield side, Steve discussed I think in enough detail kind of what was going on with the agency book and slower prepay speeds. It looked like the other component of the kind of slight drop in the asset yield was on the nonagency CMBS bucket. Can you comment on what was driving that drop and kind of how we should think about that number going forward, and also where you are seeing yields on the new investments in the CMBS base you are putting on the books?

This is Steve. I'll take what happened and I'll let Smriti talk about the forward-looking yields. In terms of what happened in the fourth quarter, we have some old legacy bonds that have been a part of the company for quite a while, as you probably remember. And over time, those bonds have opened up in terms of the ability to prepay and they have been modestly prepaying down. That would have been a whack drift as well as reducing the overall yield for the non-agency CMBS.

I'll try to answer your question on the CMBS yield. So, generally, I'm going to quote you ROEs.

Okay.

We are leveraging these somewhere between 2 or 3 times. And on the margin they are probably between 10% and 11% ROE at this point in AAA rated bonds, probably 11% to 13.5% of credit sensitive bonds. So low single digits.

Got it, okay. That helps. And then I guess the last thing, Byron commented on the fact that we like to try and predict book value. Can you guys give us any color on what you've seen, what changes in spreads since quarter end?

It's still a very -- Smriti said it, but (inaudible) said it best. There's a lot of cash chasing assets. Spreads are firm. If you really summarize the last year, last summer look like a blip. Spreads kind of -- we had a technical move out and they have come back. So spreads have come back in.

Book values, we don't give exact numbers out, but book value is obviously improving and moving in a positive direction.

And again, I will repeat something I did say before, is these moves of 1% to 5% in book value, this is kind of par for the course. It's the way the business goes and we are not jumping up and down when it moves up 3%, nor are we sitting and losing our shirt if it goes down 3%. We're trying to manage this company again over the long-term. But the fundamentals, Trevor, are supported, given the way we structured the portfolio and book value, at this point in time.

Okay. Fair enough. Thanks a lot.

Mike Widner, KBW.

Hey. Good morning guys. I guess let me first just follow up on Trevor's question there going back to Page 11 of the deck. Just a little bit of clarification. That percent change in net asset value there, is that before or after the effective leverage?

It's before.

Okay, so to get to a real book value change, we still need to multiply that by leverage, effectively.

That's correct.

Okay. And also I guess my other question is I'm struggling with -- and you guys are not unique in this, but there is certainly more use of euro-dollar futures today than there was, say, a year, two years ago. And as we all try in vain to mark things to market during the quarter, it's important to understand what those contracts are. And so from that standpoint, I guess I'm just struggling to understand or to make sure I understand what's actually being reflected in the tables. And maybe if I start with Slide 6, I guess the thing for the euro-dollars, or really for how you disclose this in general, it's not clear to me is euro-dollar futures, as I understand them, are generally one-quarter contract. They're three-month contracts. So when I look at a number here like 1904 that you have under the 2017 and later euro-dollar futures, what does that -- I just don't know what that actually means. Or similarly, in the press release, you do it on an effective each year, but again I don't really know quite what that means. Are we counting things four times if they are active all four quarters, or does it mean they are active the full year or I don't know. Any elaboration you can give would help me understand what I need to mark to market if I'm going to mark these things.

This is Steve. What they are, what we are trying to do is people like to understand these things in terms of close to swap equivalent as they can. So these are the -- and what we're disclosing in the press release and in this table is the weighted average notional balance outstanding for a particular year. So, you're absolutely right. These are 90-day contracts, and so if for example we had $100 million for each of the next four months or next four quarters in let's say just 2014, the average outstanding would be $100 million. We wouldn't show $400 million in this table. We would just show $100 million. Does that make sense?

I think that makes sense. And then so if I am looking down at the 2017 year, if I am looking your press release where you have just over $1 billion, for all -- so I can basically model, if I wanted to model that, I could look at the June 2014 -- or sorry, 2017 contract and just assume $1 billion of those or I could spread across the four quarters, but like you said --.

That's right.

I think I get that. That makes it a little easier. And like you said, the swaps are different. As I look at -- again, if I'm going to the press release and I look at that swap, that list of swaps, I mean, for the most part, it's $790 million effective in 2015. I guess as I would look at that, I would sort of start from the bottom, and it looks like you've got about $38 million, $39 million of what are effectively 10-year, and then sort of work backwards from there. It doesn't look like you've got a tremendous amount of forward starting swaps. So, again, I'm trying to sort of draw -- you're trying to put these two together on the same page in the same table, but they are not the same things obviously.

Yes, you're right, that's exactly the way to think about it. We have most of these are going to be current pays and they are going to be burning off over the ten-year period. There's one small forward starter. But I think, if you just look at sort of when these things are effective, you can say $39 million is effectively a ten-year swap. And you can market to that because we are marking these things every quarter so they are effectively marked, so 2023 is effectively today marked like a nine-year swap. So change in that will allow you to compute the change in the book value versus the swap.

Perfect. Now all I have to do is actually mark them. But I appreciated that. I'll get out and let anybody else ask any questions, but I definitely appreciate the clarity.

Jason Stewart, Compass Point.

Thank you for taking the questions. Let me start with just a comment that you have in your release. You have given us some great color but your statement that you favor the CMBS sector over the hybrid ARM sector just stood out to me given the performance of hybrid ARMs. And maybe you could elaborate on what factors in the CMBS sector and whether or not it's credit sensitive versus agency. Any more color there would be helpful.

So, again, we own a lot of hybrid ARMs. And so those, we've seen those positions tighten in and actually see the marginal returns on a fully hedged basis for hybrids somewhere in the 7% to 8% area. And we are assuming about 8 times leverage. So, we see them as actually be more expensive on a fully hedged basis.

On the CMBS side, we have been pretty selective in terms of what we are buying. We like the CMBS I/O cash flow. That is something that we disclosed in our release. We've been making selective investments there. That's on the senior side, so those are AAA bonds.

We are also investors in the multifamily sector, and that's been actually both on the credit sensitive side as well as -- actually that's been only on the credit sensitive side and the I/O side there as well. But these returns on the CMBS we see as being in the low single digits to up to 13% on some of the credit sensitive tranches. And that's where the returns are today. Hybrid ARMs have tightened in a fair amount and the CMBS juts looks cheap relative to the hybrids.

Again, the key word here is relative between the two. It doesn't -- I hope you didn't read that and say we hate the hybrid ARMs sector and we love the CMBS sector. These are decisions that we make on a daily basis in terms of relative value between the two. The overall structure of the portfolio where we've got the short duration married with this credit exposure on the commercial side is just a philosophy that we really like, we still like it today. And so this decision between these different asset sectors or asset classes will vary day-to-day, week-to-week, and on a month-to-month basis.

There's some debate that I could make an argument to say you're in an environment as to where really should the CMBS returns be? Should they even be lower than where they are now because they still really -- potentially some of the demographic trends especially in multifamily are still very supportive. So, I want to make sure you understand it's really a relative between the two as opposed to any statement about any one (technical difficulty) the other.

That makes sense. We certainly can tell by the table you didn't make any sales. I guess my follow up to that was given the move year-to-date in hybrids, could we expect you to make some more sales in that sector? Has it gotten to that level of relative value where it makes sense to actually sell?

We are not ruling out the possibility of repositioning the asset portfolio. We don't think it's quite there yet, but that's something that we watch on a daily basis.

Okay. And then just from a very broad perspective, obviously there were some changes at the FHFA in perhaps the approach to the multifamily programs. Any thoughts that you have on how that will impact the spread environment for K certificates or Fannie DOS?

Yes, there's a lot -- that's a big one, Jason. And there's a lot happening in Washington and a lot of debate around it. Here's the positive. It seems as if, across Washington now, there is an understanding that the multifamily businesses at the agencies work. And there's not a huge desire to just completely rip them apart. Everyone is now acknowledging that they came through the 2008 period in very, very good shape, but today they're functioning in good shape, that a lot of the desires of the politicians of having private capital in front of the government in both multifamily programs, and there are people arguing and debating on both sides of this. Some would like to see the Fannie (inaudible) program where you have counterparty risk with the originators standing in front of the government versus the Freddie K program where you actually are creating tradable securities and selling them into the marketplace.

Personally, I've sat in multiple seats in (inaudible) finance system over the last 30 years. I prefer the government creating tradable securities. So one of the greatest creations in the US has been the TBA 30-year 15-year mortgage market that has allowed securitization and the growth of our housing system. I would love to see the agencies focus on laying off their credit risk in tradable securities in a similar type of fashion. That doesn't take major congressional changes. It's the simple effect. I know they are laying up the credit off now, they are headed in the right direction. I'd like to see them do it more. But I still think it's up for debate. That's why we say regulatory uncertainty, that's one of the largest areas that is still up for debate. With a new director of FHFA, we are not exactly sure which way the specific details of multifamily programs will take, but we are happy with the fact that most people recognize now that they have been very successful.

Thanks for the color. I'll jump out.

(Operator Instructions). Richard Eckert, MLV and Company.

Thanks for taking my call. Just a quick question on the operating expenses. They were markedly lower in the period. Was there any factor there, any reversal of previous accruals or anything like that that might explain the drop quarter-over-quarter?

It's Steve here. The incentive compensation expense for the fourth quarter would have been reduced for the amount of bonuses that were elected by management to be taken in the stock. And that was a little over $1.4 million, or $0.03 a share. And that expense was essentially reversed out that quarter which is why you saw the big drop.

Okay. Fair enough. Another question, Steve, while I have you on the phone, is can you give us an idea of in basis points -- and it doesn't have to be precise -- of what your premium amortization expense in the last quarter was on the agency portfolio?

I can give you the number. It was right around $8 million.

Okay. That's good. I can calculate that. Fair enough. Thanks a lot.

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

Thank you very much. We really appreciate you joining us today on our conference call. We are very excited about our new management team, additions to our board, and the fact that we are a stronger management team today. Our shareholders have been able to trust us with their capital for years. As you can see, we have shown our commitment to Dynex by investing our own personal wealth in our company. And with that, we thank you again for joining our call.

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