Dynex Capital Inc (DX) 2014 Q1 法說會逐字稿

Good morning and thank you for dialing in for our 2014 First Quarter Earnings Conference Call. With me today is Tom Akin our Executive Chairman, Steve Benedetti our CFO and Smriti Popenoe our Co-Chief Investment Officer.

During the first quarter we continued to manage our capital in a very disciplined manner. We have made no major changed in the assets in which we invest or the overall structure of the portfolio. However, as we mentioned in our prior conference call competition for assets continues to increase and hence our capital deployment in the quarter has been limited. In fact, the global financial markets are very complex today driven mainly by the unconventional activities of a global central banking community. Our goal today is to give you a clear picture of a complex environment in which we currently invest and for our shareholders we would like leave you with the reinforced impression that you can continue to trust your capital with this management team. For the past 11 years we have been very disciplined in our approach, not being swayed by the hot investment ideas that crop up from time to time. Likewise, we have recognized how the current market environment has continued to become more complex. On the one hand, this is a great environment to earn that interest income. Volatility is low. Yields are range bound. Central banks are trying to be transparent. On the other hand, the central banking community has pumped an enormous hoard of cash into the global financial markets that has led to an extreme reach for yield. Risk premiums have declined materially across all asset classes globally. As a result of this dilemma, we continue to scrutinize every investment decision with a much higher level of vigilance. We also continue to examine other strategies to ensure we are not overlooking an opportunity that might benefit our shareholders. As we move forward through this complex environment we will continue to manage our shareholders' capital for the long term; emphasizing diversification, low leverage, conservative liquidity management and prioritizing shorter duration assets and our exposure to the CMBS and multi-family sectors. Steve Benedetti and Smriti Popenoe will both go into more detail regarding our first quarter performance and the current structure of our portfolio.

Thanks Byron. I'm on slide four for those following the presentation. We reported a GAAP net loss per common share of $0.06 mainly due to market value losses on our derivative instruments from declining interest rates along with losses on the sale of securities during the quarter. On a quarter basis we earned $0.25 per common share compared to $0.29 per common share last quarter. Core earnings benefitted from an increase in the adjusted net interest spread to 188 basis points from 177 basis points, offset by a slightly smaller investment portfolio and higher G&A expenses versus last quarter when we recorded a $0.03 benefit in reduced incentive compensation expense.

As we've noted over the last several quarters we present non-GAAP measures in our financial statements as a result of discontinuing GAAP hedge accounting for our derivative instruments which results in our recording valuation changes in our hedges through the income statement while asset value changes are recorded through shareholders' equity. During the quarter we declared a dividend of $0.25 per common share in line with our core earnings and which represents a current yield of 11.7% based on last night's closing stock price. Our leverage continued to decline during the quarter by 0.3 turns to 5.9 times our shareholders' equity as a result of the net deleveraging of our investment capital and the net increase in shareholders' equity of $13 million during the quarter.

On slide five we present some non-GAAP financial metrics including core net operating income per share and adjusted interest spread each for the last five quarters. Reconciliations of these amounts are included in slides 33 and 34 in the appendix. The 11 basis point increase in adjusted net interest spread resulted primarily from earning the full benefit this quarter of adjustments made last quarter to our hedge position. This quarter we net added hedges as we adjusted our exposure to different points on the curve and several forward starting swaps became effective. Also benefitting our net interest spread were yields on our investments which increased principally as the result of changes to our investment mix. Agency RMBS pay downs during the quarter were reinvested in non-Agency CMBS and CMBS at higher yields and higher anticipated returns on our capital. With respect to book value per common share, we recorded an increase of $0.18 or 2.1% to $8.87. I'll now turn the call back over to Byron.

Just to be more specific on some of the issues that we consider making the overall environment complex, if you move to slide seven we've outlined a couple of issues that we think are important to make note of and I'm just going to highlight a couple and then I'll let Smriti go into more detail on the portfolio.

Overall global inflation levels will become an issue over time and they may become a surprise factor as we move forward. But probably the most dominant factor of all is the excess liquidity from the global monetary policy is unprecedented and has led to asset value distortions. Foreign central bank actions plans remain uncertain and could cause unexpected results. We're aware of this and we're operating our company with this in mind. And then finally regulatory policy and the mixture of the regulatory policy with the monetary policy is what all adds in and creates this complex environment. We've all heard a lot about housing finance reform and I want to remind you that Dynex has been, has a 25 year history of making money and a successful operator within the U.S. housing finance system. This will change over the next few years and Dynex will be in position to exploit those changes, but it is very uncertain at this point as to how those changes will come about. And from with this I'm going to turn it back over to Smriti to emphasize some of the key changes, key structure of our portfolio.

Thanks Byron. Please turn over to slide eight. As we mentioned in our previous call, at Dynex we think about markets in terms of fundamentals, technical and psychology. Fundamental trends in CMBS, particularly multi-family, remains solid with rents, vacancies and property prices on a positive trajectory. In the RMBS sector we have seen a market slowdown in origination activity resulting in slower prepayment speeds that we experienced over the first quarter. On the funding side we continue to have access and availability for liquidity at attractive levels. This is being primarily driven by excess balance sheet capacity and a lack of high quality collateral. And finally as Byron mentioned, as evidenced by more than one headline this week the nature and timing of GSE reform is still uncertain with no private stand-alone solution yet in place to replace the GSEs.

Technicals are also strong in the markets we invest in. Continued government involvement, abundance of cash and the quest for yield has really resulted in lower risk premiums across the globe. We're seeing this domestically reflected in the strong demand for RMBS. It's keeping that supply lower for longer than most people thought. We're seeing a lot of competition in primary loan markets for commercial real estate loans. This has resulted in lower conduit and CMBS and multi-family supply. In fact, in the first quarter the market was expecting about $29 billion in CMBS conduit supply. We only got $22 billion. We're also seeing the abundance of cash reflected in repo funding levels, which have fallen almost 10 basis points since their peak in the fourth quarter. All of this activity has led to much tighter spread through the first quarter and up to today. If you turn over to page nine, you can see that spreads on 30 and 15 year RMBS are at their tightest levels since mid-2013. In the case of 30 years the last time spreads were this tight was mid-2010 and for 30 years specifically aside from those two periods, 30 year MBS have not been this tight since 1996 on a nominal basis.

On slide 10 we show this trend has continued in the corporate bond market for both investment grade and high yield markets, emerging markets have gone sideways. And on slide 11 we show the same trend for CMBS spreads.

It's important to understand the market environment in these time periods. In the 1990s and early 2000s spreads were tight due to high levels of leverage from securitization and resecuritization. We all know how that movie ended and in this current environment spreads are tight because of an abundance of cash being pumped into the system by central banks. And we also know that regulators are working to make sure that overleverage doesn't happen again and we do know that when the time is right the Fed will drain all of this excess liquidity.

So as Byron mentioned, the current environment presents a bit of a dilemma for us. As spreads tighten, our book value increases, but it also reduces the return on new capital that's deployed at these levels. A decision to invest capital in this environment really rests on your risk appetite and your yield spreads. So let's talk about spreads first. On the CMBS front, spreads are tight but we still see some value in the CMBS IO sector. This quarter as well as throughout last quarter we saw subscription rates for tranches that we invest in increase two and three fold indicating very strong demand and reflecting the lower supply picture. So the technicals are very strong in this sector. On the other hand, we're also seeing primary market competition driving an expansion of underwriting standards, really a loosening. Where we see this is really manifesting itself as an increase in leverage on each property. While our portfolio has benefitted from tightening spreads and book value has risen, we do see some opportunities to invest but we're treading very carefully to make sure we understand the long term risks at these levels.

In the RMBS market we see spreads continuing to remain tight as long as net supply remains low or turns negative. If you flip to page 22 in the appendix, you can see that new supply has been dwarfed by Fed purchases since July, 2013. Most market participants expect this trend to continue until late this summer. In the ARM market in fact net supply has been negative for some time and is expected to continue to remain so through this summer.

This is a tremendous positive near term technical for RMBS and more so for short duration instruments. As you see on the spread chart on page nine, and I'm sorry to flip you guys back and forth, but 15 year MBS spreads can get tight and stay tight for long periods of time. We could see some spread widening as the Fed exits but it would really have to be a supply story that drives it. So if you add to this situation a very bearish bond market psychology, a data driven Fed with potential spikes in volatility you have the complex environment with Byron alluded to.

As we sit here and assess the situation, our view is that this is not the environment in which to make big bets one way or the other. Success to us in this environment is really being able to seek and find pockets to value to add on the margin and we think we can continue to do that both on the investing and the financing side. Our portfolio generates a solid double digit return with a profile that we feel puts us in a good position to be around when this movie does end and be around for making the sequel.

So going ahead, what does this mean for Dynex? Let's turn to page nine. We're maintaining our disciplined approach to capital deployment. We did make investments in the first quarter. Our portfolio did delever and keep in mind that some of the delevering happens because our equity value goes up. We continue to be focused on generating earnings by maintaining our investments in the current portfolio, but we're very conscious about the spread risk in the environment. We're maintaining our positive duration in the front end of the yield curve. We'll have adequate leverage and liquidity which we'll adjust as necessary. We're focused on creating value through funding in our funding portfolio and we're always going to have this constant disciplined review of risk adjusted returns on the variety of market opportunities that we have in front of us.

Let's change gears for a little bit and talk about our interest rate risk for the quarter. As you can see on slide 10, we show you our risk position across a variety of interest rate scenarios. Is it slide 10? Slide 14.

14, 14.

14. I beg your pardon, on slide 14. We show our profile over a number of different scenarios, parallel shift as well as non-parallel shifts. We've said before that the market never really shifts in a parallel fashion so we've shown the impact to our asset position net of hedges across a number of different scenarios. Versus last quarter our position is down slightly in terms of risk, so up 100 last quarter. Our assets net of hedges would have gone down 1.89%. That number this quarter is 1.46%. I'd like to bring your attention to two specific scenarios in the bottom chart where we actually stress our portfolio with increasing interest rates in the front end of the yield curve where we have our long duration position and in those scenarios as well our risk is down versus last quarter. Specifically in the up 25 scenario where the front end moves up 25, the back end does not move up. Last quarter our assets would have gone down net of hedges 0.3%. This quarter it's down about a tenth of a percent to 0.2%. So we do have a lower risk position versus last time. As Steve mentioned, we opportunistically added hedges in the seven year part of the curve. Some of the forward starting swaps also helped us in reducing this exposure.

The next few slides I'll just focus on a couple different things before I turn the call back over to Byron. On page 15 you can see that our equity allocation again primarily in the CMBS sector, the RMBS sector allocation went up versus last quarter really as a function of our liquidity management activities. So it's not because we added capital to the RMBS sector. You can also see that our net premium is primarily invested in the CMBS sector on page 15.

Page 16 what I would point you to is the bottom right chart you can see an increase in our non-agency CMBS IO position versus last quarter. As we've mentioned this has been the sector that we've primarily seen value. And on page 17 in the RMBS sector we continue to really have nice roll down in this portfolio, no real changes versus last time.

Page 18 which is our financing book, really a couple things to note here; our repo funding costs did decline in the first quarter as the cash markets we covered from the spike in the fourth quarter. As you recall there were debt ceiling crises, other factors that caused repo rates to spike. This quarter we've actually reduced our contractual maturities slightly. Over the last quarter we had a three basis point decline in the average cost of funds and since the peak in the fourth quarter we've seen repo rates really come down about 10 basis points. Availability of liquidity has not been an issue and most of our counter parties continue to show capacity here.

That's it for me. I'll now turn it back over to Byron.

Thank you Smriti. I would like to leave you with a few concluding thoughts that I want you to remember about Dynex Capital. The current market environment is complex. We said that, started to mention that in our last conference call for the fourth quarter for 2013. We're trying to emphasize that today. Uncertainty around economic growth, regulatory changes, market reaction and global market imbalances require discipline and vigilance. But here's a real key for Dynex; our investment strategy and thesis has not changed. Our portfolio continues to generate an above average dividend yield with a conservative profile. As you're aware, we have continued to earn and pay a $0.25 dividend as our portfolio continues to season nicely and roll down the curve. This is only $0.04 lower than our peak dividend payment over the past six years. And as Smriti just mentioned, funding costs have recently declined and there is excess capacity in the system. So we continue to look for opportunities to diversify and expand our overall financing sources. And then finally, as I think about the future, Dynex started operations in 1988 and we have been a successful participant in the U.S. housing finance system for 25 years. There are very few entrepreneurial REITs like ourselves that have weathered every financial crisis since the 1980s. The U.S. housing finance system will go through a transition over the next several years and we believe there will be multiple opportunities for Dynex to continue to grow and deliver solid returns to our shareholders. Longer term, we see opportunities for investments in both residential and commercial assets and in markets currently dominated by the Fed or the GSEs. At the conclusion of QE3, private capital for the first time will need to replace the government as the dominant purchaser of MBS. That's one of the simplest strategies that we can pursue in the future. In addition, as the U.S. housing system is reformed there should be more opportunities to invest in residential credit.

We can be very thoughtful and patient in our evaluation of these opportunities to further diversify our investment and fund these strategies in the future because our portfolio continues to perform well today. We want you to trust that our experience has taught us to manage for the long term and not to take too much risk at any point in time. We believe there will be opportunities to continue to generate above average dividend yield for our investors, but we are moving forward in a very cautious and deliberate manner. And with that, operator, I'll turn it back over to you for questions.

Thank you. We would now like to begin the question-and-answer session. To ask a question, please press star then one on your touch telephone keypad. If you are using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time we will pause momentarily to assemble our roster. Our first question comes from Douglas Harter from Credit Suisse.

Thanks. When you look out into the next couple of quarters, how do you see that interest risk moving? Are you comfortable with where it is today? Do you want to tighten it up more, loosen it up a little bit?

Yes, here's an interesting one, Doug, and I appreciate the question here because that's why we use the word complex. When we think about the future and you say do you want to tighten up your interest rate risk, one of the main ways that you hear in the marketplace is well do you want to take your duration gap to zero. If you take your duration gap to zero with swaps, your dollar futures or some other traffic derivative instrument that's fine. You may have taken your duration gap to zero but you've taken on another set of risk and that's why we've used the world complex because on the one hand you could say let me take my duration gap to zero because I've got some idea that interest rates may go to 320 to 350. But if rates drop on you with that position, you may find yourself in trouble as some other participants found themselves in 2011. So we're not making, as I think Smriti mentioned, any large bets in either direction. We're very comfortable with this position as it sits today. We've deliberately structured our exposure to the front end of the curve. Even though you'll hear a lot of noise over the next year, year and a half with predictions with what the Fed is going to do, we believe this is the best structure for a portfolio where durations are uncertain. We've leaned on the CMBS sector because durations are more certain in that sector and it gives us more confidence in our overall hedging strategy. So let me just address, I know a lot of buzz in the market, there's an enormous amount of people who are short at this point in time in the marketplace because they've got this belief that interest rates are going to go to 3% to 3.5%. We believe we've got our portfolio structured in the right manner with the right assets to deal with this complex environment. Anything else on that?

I mean, I think the other point I would make is that that's not to say that we're not ready to make the change if it becomes appropriate, we just don't see it yet at this point. We're ready to make the change if we believe that that's the right thing to do.

But it's really important for you to understand that if someone says they've got a zero duration gap and they're hedged with swaps versus mortgages, they've simply taken on another basket of risks.

Right. And you guys for a while, rightfully so, have liked the CMBS market. As you show on slide 11, those spreads have tightened a fair amount. How do you think about the attractiveness of those returns today?

So on the margin let's say in the first quarter we were able to put on positions at 11% 12% return on equity base case yields and those spreads have really tightened in to where the marginal returns are in the 9% 10% at this point, so not terribly ugly yet. And so that's really where we see the opportunity at this point. We can still find bonds that will give us this double digit return.

So Doug, and in a circle basis we were putting a ton of cash in the market in 2011 in CMBS when spreads were out over a 500. We've ridden this entire move in in terms of spreads here at Dynex, and that's been an exciting ride. So we don't get excited when spreads get this tight but here's the dilemma, part of what I've mentioned in terms of complex. The biggest driver, what's underneath the big movement in spread it's not only CMBS and then every asset globally pretty much so, the fact that the central banks have pumped an enormous amount of cash into the global financial system. So there's a ton of cash globally seeking yield. If you want to look at the really unusual situations look at what people pay for Spain, Italy or Greek bonds at this point in time. So the spread environment is complex, but here's what we do respect is that it's very technical and the global central banks have not stopped pumping this type of cash into the system. And so to have a real meaningful long term move in rates in our opinion would be when you start to see those central banks drain cash from the system and I think we're a long ways away from that. So I'm saying this differently than the buzz word in the market which is the Fed will be accommodative for an extended period of time. I'm simply saying the actual draining of cash from the system by the global central banks will be a monumental event for the global economy and I don't think the global economy will be in shape for that type of draining of reserves for some time in the future.

Great. Thanks Byron.

Next question comes from Trevor Cranston from JMP

Hi. Thanks. One follow up on the point you've been making about spread tightening, I appreciate the comments about the global liquidity in the system, but I'm curious specifically on the agency CMBS sector, spreads have tightened a pretty meaningful amount and it almost seems like the tightening has accelerated recently. So I was curious if you guys have any kind of view on what's been driving that, specifically the agency CMBS sector and if you've seen acceleration in the tightening recently and how that's kind of impacted the book value since quarter end?

Right. So we have seen an acceleration in the tightening since quarter end. Here's the deal with a lot of these sectors; in 2011 the Freddie K program was pretty much an unknown program. It's taken a long time for those bonds to be accepted in the marketplace, for people to understand them, for the repo market participants to really understand and finance those securities. And I think what we're seeing right now is just a broader acceptance and market knowledge, quite frankly, of these bonds. Over the past month, though, it does seem like there's been a rapid tightening in these securities. I mean, we've been hearing about a large buyer of these securities. That's what we think is driving it. But it's not surprising to us. I mean, these are agency securities. They go through a very, very stringent underwriting process at Freddie and Fannie. We don't love the levels at which we could potentially buy them but it's not unreasonable that investors should find these bonds attractive.

And then the point that Smriti's making, Trevor, is that there's a certain amount of the Freddie, the Freddie Ks are unique. So we were one of the earlier investors in the Freddie K program. We've been at it now for four to four and a half years or so. And it was an unknown product three, four years ago. And so a certain percentage of the tightening is a function of more investors becoming more comfortable with the product with one example. The product is not included in the index.

The P&I bond.

Yes, the P&I bond is included in the index. That draws more attention to the product. There's more research now being written about the product. So there is a larger investor base that has shown up for the product. But another factor that also has taken place, so this May in 2014, the market has surprised most participants. Not only has the absolute yield level surprised most participants, but for those individuals who let's say they weren't necessarily short the market, but they had cash and they were waiting for higher yields there are some participants that are throwing in the towel. There are shorts that are covering their positions and there are guys with cash who are just capitulating and putting money into the marketplace. So again, back to why we keep emphasizing the word complex is you just want to make sure that you understand the environment in which we're operating and some of the challenges back and forth that we debate in the walls of Dynex about how to deploy the next margin of dollar.

Got it. That's helpful context. Then on the funding side, there's a few companies now on the mortgage REIT sector that have announced that they have formed subsidiaries that have become members of the FHLB system. Can you guys comment on if that's something that Dynex in particular has looked at and how you think that might fit in with your portfolio that exists today?

So I look at what I've seen in the marketplace and there have been a few announcements of other REITs that have joined the FHLB system. We do view that as a very positive development. Many of those entities are different than Dynex Capital. We point out to you earlier that for the last 25 years we've been part of this housing finance system. So when I look at Dynex and the business that we're involved and our overall focus, we're not a hedge fund that maybe I don't know had issues in 2008 and suddenly decided they wanted to start a REIT. We're not a fund company that, again, woke up one day and suddenly decided they wanted to be a REIT. We are a mortgage REIT fully focused on the U.S. housing finance system and all the products that come with it and we believe our future strategies will be completely focused in making money through the U.S. housing financial system. So I think it's a positive because the Federal Home Loan Bank is in the same business that we're in. And so we are considering this. We are evaluating this and we are developing more information about it.

Okay. Well, it sounds like we can maybe hope to hear more about that in the future, but thanks for the comments.

Again, if you have a question, please press star then one on your Touch-Tone phone. Next question comes from Mike Widner with KBW.

Good morning guys.

Hi Mike.

I think you've answered most of the questions so let me just go a little macro. I mean, you guys are articulating a fairly cautious stance and certainly I think a lot of people share your views of what's going to happen when central bankers pull back on liquidity. I guess though, you're making it sound like this is or your view at least is that the market will have a very difficult time handling this and I guess my question is what are you envisioning that's sort of beyond the Fed? I mean, everyone knows taper is happening and we're probably going to finish the Fed purchases round about October maybe December. But are you talking about a pull back on liquidity that's more than that or are you saying just that or kind of what do you have in mind?

Mike, let me tell you why we use the word complex and I didn't give you any more specifics around it. It's really complex. I'm not worried about our Fed. I've got a pretty good idea about what our Fed is doing or may do in the future. But the United States is part of a much larger, much more complex global financial system. It's what I don't know outside of our borders that concerns me the most and as far as we're concerned the structure of global finance doesn't make sense. It's not sustainable. Changes will have to happen and adjustments will have to happen as the future plays out and we can't predict what those will be. It will be a fools game to try to predict exactly how this will play out so we work through multiple scenarios here at Dynex to try to make sure and see that we've got enough liquidity, that we're in good position to deal with it and we want to make sure that we don't, as Tom Akin would always say, get out over our skis, take too much risk such that we're not flexible enough to deal with situations that happen that were not predicted. And let me just tell you I've been in the business 33 years, Mike. I've been involved in every, I've been in a capital committee, a material capital committee seat in every major financial crisis since the early 1980s and most were completely unforeseen and uncertain. So that's the way we think at Dynex and we're managing our risk accordingly. So we're not sitting here saying oh, X is going to happen on December 2nd at 4:30 in the afternoon. We're just respectful that the global financial system is very complex at this point.

Right. I don't think, the taper doesn't concern us. That to a large degree is anticipated. It's been very well telegraphed by the Fed. It's really these exogenous factors that, and again, our risk position is conservative but we still have 5.8 times leverage. We still have spread risk. We still have a position that, but we think that it's just a position that's going to allow us to sort of live through any of these exogenous shots and come out on the other side and be able to make those investments when that opportunity does arise.

And Mike, at this point what's really great is while we're sitting here managing this position it looks like the same philosophy we had two, three, four years ago. We continue to pay our shareholders a $0.25 dividend yield. I'm sorry, we 'd love it to be a dividend yield, a $0.25 quarterly dividend. And so we're very comfortable. I think the big decision in an environment like this is how much risk do you want to take and you must be a skilled risk manager to understand. As I mentioned a second ago, yes you can take your duration gap to zero with some type of derivative but you've just simply taken on another basket of risk that could hurt very badly if the market moves in the other direction.

Yes. No, that is certainly fair. I guess, and that makes sense. I guess what I'm still wondering about is your tone is certainly more cautious than it might have been the past couple years on average and that sort of implies that you think this, while you predict the day or the exact nature of the event, that you feel like it's closer than it might have been and the likelihood of such an event is high enough that it suggests being more defensive rather than more offensive.

The real big difference, though, and I think that's exactly right because two years ago spreads were a lot wider and it was I don't want to say easier to put capital to work but we were able to put capital to work at more attractive levels. Spreads have tightened so much at this point to where it is more dangerous and that's the reason that we look at this environment and say we need to be more cautious.

And it's less margin for error. That's basically what's Smriti is telling you. We were buying CMBS IOs 550 to 575 off the curve a few years ago and these spreads have come in quite a bit. So there's less margin for error. But here's how we're, when you say cautious it's really we're being very aggressive as we look and consider opportunities. And since I know you and everyone else will compare Dynex versus other REITs there are REITs who are starting new strategies and they're going and running after this or running after that. We have made the decision that we're very happy with our portfolio. We're throwing off a nice cash flow from this portfolio and part of the reason is because when spreads were out at 575 we were actually putting on assets at very attractive spread levels. So we've been able to ride this market. We're going to ride the curve, ride the spread tightening and our shareholders can feel very comfortable that they're earning a decent cash flow that we take a cautious approach, but I'm also emphasizing here, so I don't want you to get the wrong impression that we are looking at all the opportunities in a very disciplined manner. You could go through your list. What do you want to bring up? Do you want to bring up MSRs? Do you want to bring up whole loans? Do you want to bring up residential credit risk? We can talk to you about all of those strategies and I'll emphasize that Dynex over its 25 year history has every one of those strategies under this roof at some point in time. So we're not naïve and we're very experienced in these strategies. We're being very deliberate in our approach.

Another minor point you might also emphasize is that our payments, repayments on the portfolio are not that large quarter to quarter. We had $133 million in pay downs. So there's not a tremendous amount of capital that we have to reinvest in this environment unless we go raise capital, so.

I mean, that's the benefit of having the CMBS.

Right. Exactly.

So one final one then. I mean, it sounds like from all your conversation or discussion about spreads tightening and kind of where spreads are relative to where they were and relative to historical levels, I mean, are we getting closer to the end of the bond bubble? Is that kind of in general what you're articulating?

I don't think anyone can predict that, Mike. I really don't think you can predict that, Mike, at all. Because and I'll take, in fact, I will debate anyone on this issue either side of the argument. That's really where you stand then to predict that there's some end of a bond bubble. I think interest rates reflect the current economic situation globally. There are problems from an economic, think globally not just the United States. Not saying oh way, employment's now 200,000 and most of those jobs are at McDonald's. Let's not think just about the United States. Let's think about the global situation when you consider China, Japan, the U.S. and Europe. So making those types of predictions I think are very, very difficult.

But I think Mike, we think about this a lot because a scenario that we really respect is that spreads could stay tight and remain tight for a while before they widen out, before they happen and there may not be a widening out. There may be a grinding widening. We don't know, right. So the dilemma for us, as we mentioned, is really how do you put your capital to work in this situation and our strategy is really to be very thoughtful about the next dollar that makes it in the portfolio and that's what we think works here. There are no easy answers. There's no cheap sector that we can go put our money in and that's the reason for caution. I can't predict when the widening will happen. I may have tighten happen from here, but the fact is every dollar that comes in is just going to be under a higher degree of scrutiny than before because of where we are in spreads.

And Mike I really appreciate you asking this question and giving us an opportunity simply to explain how we think. At the core of this is a principle. Dynex Capital functions as owner operators. We have a lot of our personal money in the company. We are in the same boat as our shareholders. We take it very seriously, our fiduciary responsibility to manage the shareholders' capital for the long term. And what our experience has taught us, you look at Tom Akin's experience, you look at my experience, you look at Steve Benedetti's experience and Smriti's long deep history in these capital markets and our experience tells us to manage for the long term and be very thoughtful in terms of risk, but at the end of the day it's our money and our shareholders' money and we're acting accordingly.

Well, I certainly appreciate all that and I guess here's my final quick one is I'm torn between whether what you're describing is feeling like assets are fairly valued, meaning they used to be cheap and now they're sort of fairly valued and that makes it you're fully valued, however you want to phrase it versus spreads are too tight therefore implying that things are sort of overvalued due to global money pumping, if you will. And so just that subtle distinction between fully valued, which I think a lot of people would say whether it be broader equities or fixed income in general, I don't think you'd get too much argument that things are fully valued. The question is just it doesn't get too terribly precarious until people think that things are sort of overvalued. I'm not entirely sure which side of that little divide you're kind of articulating a view on.

We think spreads reflect the amount of cash in the system. We really do. Is it fair or rich or cheap? Relative to history, it's expensive. If you really think about, we did a study going back to the 1960s to figure out where mortgage spreads really ought to be, 30 year mortgage spreads for example. On average, they've traded at about 100 basis points over 10 year treasuries. They're nowhere close to that right now, but they're here because of the amount of cash in the system, right. So versus that long run average, they look expensive but I can see very clearly why they're here, so I have to respect that. Could they go tighter from here? Possibly, as long as there's a lot of this cash out there. So we're not ready to say they're expensive or they look expensive. We're saying let's respect the fact that there's a lot of cash in the system and that as we are managing through this environment be very careful about that factor. And I just have to keep going back to this so the next bond that comes in is going to have to be a bond that we really want in here or that we really feel like is going to give us long term value or we can hedge it in a way that we think adds value to the shareholders.

And then I'll just add, Mike, if the spread levels truly reflect the current environment, as Smriti said, it reflects the amount of cash in the system. The Fed's QE program, if they end QE that's fine. That's not draining cash from the system. If the Fed stops reinvesting their runoff they're still not really draining cash from the system. If the Japanese start a similar QE program and the ECB doing the same you still have central banks pumping cash into the system. So if there's cash continuing to be in the system or cash being pumped in the system these spread levels reflect that cash. And that's basically the point we're trying to make and the great thing at Dynex here is that our portfolio continues to earn a solid return despite taking a more cautious view and the reason for that is simply we've always had a long term view in terms of how we structured the portfolio. I'm sure many people have heard us say it, but just may not have taken note of it, but we always say that we're managing or structured our portfolio to perform in a variety of market environments. So back to the fair, rich or cheap the fact of the matter is spreads reflect the current environment which is best defined by the unconventional activities of the global central banks which have pumped an enormous hoard of cash into the global financial system.

Well, as always I appreciate the comments and the color and I think that we can all agree that probably the only asset out there that looks cheap is mortgage REITs these days. So thanks.

We appreciate that Mike.

Next question comes from Sterling Edmunds from White Partners.

Alright, I appreciate your comments on the complexity of the macro environment and we're in the environment the rates are lower than anybody thought, CPRs are probably slower than anybody thought. The CMBS, RMBS historically tight. We've beat that to death on this call. But can you talk about what tools are in your toolbox to protect book value going forward, specifically related to spreads blooming out from here. What specifically, what actions can you take to protect against that?

I think the first action is not trying to over lever the book of business at this point. So if you look at the way we've behaved since last summer, we've tried to buy bonds at the right price and so let's just use for example an CMBS deal and go back two years ago we would bid for $15 million in the deal and we would get $12 million. Now we'll bid for $15 million and we'll only get $3 million. Well, one decision we can make then is to just simply throw in the towel and run out with our capital and just buy anything just to deploy capital. But as you can see since last summer our leverage went from a peak of 6.7 we're down to about 5.9 and each quarter we have not reinvested the total amount of our run off, so that's one of the key factors is being very selective and being thoughtful about not deploying your overall capital as rapidly. The other part would be what assets are you invested in. Do you have enough diversity in your book of business such that you're not totally exposed in any one sector or totally exposed to any one type of trade? We do take spread risk as a company and we want to make sure we acknowledge that we've pointed that out in prior calls, but we do take spread risk and that's why it's so important to us to recognize that spreads are at the levels that they are because one of your best strategies is to be in those products where we believe spread widening will have a lower probability. And so we believe that we're in those types of products at this point. So we do believe the credit environment for CMBS is very strong and believe that CMBS IOs are probably one of the better places within that capital stack to be. So if there's any type of spread risk we think we're in the better location. We do believe hybrid ARMS, what we've said is that when rates rise that hybrid ARMs would grow in their popularity amongst the investor base. Well we've seen that now. We've seen many investors who were previously buying 30 year specified pools four points above TBA all of a sudden they're adding more hybrid ARMs to their book of business so we do want to be in those locations where we think we may have more spread stability versus other strategies. And that is really one of our biggest arsenals is to take the approach that we're taking and to take the cautious approach that we are towards spreads. And I'm going to reemphasize that we do take spread risk but I do believe the success of this company and any other mortgage REIT will heavily hinge on the risk management skills of the management team.

Okay. That makes sense, Byron. Thank you.

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

Thank you very much for joining us on our conference call today. We really appreciate it and we look forward to our next conference call regarding the second quarter. Thank you very much and we'll see you in about three months.

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