Dynex Capital Inc (DX) 2014 Q3 法說會逐字稿

Good morning, and welcome to the Dynex Capital, Incorporated, third quarter earnings conference call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Allison Griffin. Please go ahead.

Thank you. Good morning, everyone. The press release associated with today's call was issued and filed with the SEC today, November 4, 2014. You may view the press release on the Company's website at www.dynexcapital.com under Investor Center, as well as on the SEC's website at www.sec.gov.

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-or contemplated by those forward-looking statements as a result of unforeseen external factors or risks. For additional information on these factors or risks, please refer to the annual report on Form 10-K for the period ending December 31, 2013, as filed with the SEC. The document may be found under the Company's website under Investor Center, as well as on the SEC website.

This call is being broadcast live over the Internet with a streaming slide presentation and can be found through a webcast link under the Investor Center of the website. The slide presentation may also be referenced by clicking on the Dynex Capital third quarter 2014 earnings call link also on the presentations page of the website.

With me on the call today, I have Byron Boston, CEO, President and Co-CIO, Thomas Aiken, Executive Chairman, Smriti Popenoe, EVP, Co-CIO, and Steve Benedetti, EVP, CFO and COO. I now have the pleasure of turning the call over to Byron.

Good morning, and thank you very much for joining us this morning. Let me first state the facts, and then I will give a brief, high-level overview of what is happening at Dynex behind the numbers.

We're happy with our third quarter results, as book value was stable while we generated a solid 11% return on equity based on core net income. We did not experience any surprises in the third quarter. Repayments did not surprise us, rate movements did not surprise us, and spread levels did not surprise us. We told you at the beginning of this year that the global markets have become increasingly more complex and, hence, this is not the environment for taking outsized risk positions.

As such, we have made several small portfolio adjustments to better position ourselves for a continued environment where central bank activity plays a major role in capital markets, the full impacts of new government regulations are yet to be realized, and the interconnectedness of the global financial markets makes future moves in asset prices highly uncertain. Nonetheless, we are confident in our approach to this environment, and we continue to manage our capital with the same level of discipline that we have exhibited for the past decade.

We have been very consistent at Dynex in our approach to managing our capital. The core of our strategy has been discipline and capital deployment. When risk spreads were wide in agency ARMs, we bought as many as we could while adhering to a disciplined approach of specified pool selection to ensure our prepayments would be better than average.

In 2011, when risk spreads were wide in the CMBS sector and most investors stood on the sidelines, we deployed as much capital as possible to capture the excess returns offered from potential spread tightening. We have experienced spread tightening of 300 to 500 basis points from the wide levels that we enjoyed when we deployed capital in 2011.

Today, in keeping with our disciplined approach, we have begun to adjust our portfolio because risk premiums globally in most asset classes have become so tight. Our first move has been to move up in credit quality and to increase the liquidity of our balance sheet. In addition, we have made multiple adjustments in our repo book and the structure of our derivative portfolio to maximize our returns in this dynamic environment. Both Smriti and Steve will give you more specifics on our results and the structure of our portfolio today.

As I've stated, we are very happy with our third quarter results, as they demonstrate that despite the unusual nature of the global markets, we continue to generate attractive net income for our shareholders without taking too much risk. With that, I'll turn it over to Steve.

Thanks, Byron. I'll cover slides 4 and 5, for those of you that are following the presentation. My comments are going to be referencing a number of non-GAAP financial measures, which are detailed on slides 27 and 28 in the appendix to the deck.

For the third quarter, we reported GAAP net income per common share of $0.52 and core net operating income per share of $0.25. GAAP net income includes gain on sale of investments of $9.1 million and mark-to-market gains on derivative instruments of $4.8 million. As Smriti will discuss later, the gain on the sale of investments was primarily related to the sale of a portion of our Freddie K mezzanine CMBS investments, which we have continued into the fourth quarter.

Core net operating income was $0.25 for the quarter, equal to our dividend and comparable to the second quarter's $0.26. The $0.25 per share represented an 11% return on adjusted common equity, as Byron mentioned, and an 11.9% return or yield based on yesterday's closing stock price.

Adjusted net interest income, another non-GAAP measure, was $19.1 million versus $20.1 million due to the smaller earning asset base partially offset by a smaller hedge book and lower repo costs. You may recall that adjusted net interest income includes the period cost of our hedges, which our GAAP results do not, and we prefer this measure when we analyze the net spread income that we are earning on our investments.

Adjusted net interest spread for the third quarter was 193 basis points. We saw a 4-basis point decline in repo costs during the quarter along with a 3-basis point decline in hedge costs offsetting a 6-basis point decline in asset yields.

Just as a reminder, gain on sale of investments is included in taxable income, which exceeds distributed income on a year-to-date basis by approximately $1 million. We've continued to sell the Freddie K investments in the fourth quarter and have generated an additional estimated $11 million in gains. We expect to distribute a portion of the gains in the fourth quarter to offset the decline in earnings from a temporary lower investment base. The remainder we expect to keep in book value by utilizing our tax NOL carry-forward.

With respect to prepayments, we saw a modest increase this quarter in our Agency RMBS, but this increase had only a nominal impact on our reported results, and our longer-term prepayment expectations remain unchanged.

In adhering to the market views on -- to our views on market risk, we've continued to reduce our leverage to 5.2 times shareholders' equity of 930 from 5.7 times last quarter due primarily to the asset sales during the quarter as we've built our liquidity and investable capital position. We did reinvest pay downs received during the quarter, mostly in CMBS IO investments where we continue to favor their risk-reward profile. At September 30, our investment portfolio was $3.7 billion, versus $4.0 billion at June 30th.

With respect to book value, it was higher by $0.02, to $9.14 for the quarter. Spread tightening on our hybrid ARMs more than offset widening on our CMBS, and our hedges benefitted from swap spread widening and their position on the yield curve. Hybrid ARMs tightened the most given their seasoning, as the securities remained well bid given their short duration profile.

In general, our portfolio is seasoning and rolling down the curve, which also benefits valuations. Book value for the year has increased by $0.45, or 5%, and we have generated a total economic return of almost 14% year to date when considering dividends declared and paid.

I'll now turn the call over to Smriti, who will talk about our investment portfolio performance outlook and strategy.

Thanks, Steve. I'm going to discuss the specific actions we took last quarter and then tie that into the investment environment outlook and strategy. Let's start on slide 7. As Byron mentioned, 2014 has really been about understanding the macroeconomic environment and adjusting strategy to fit what has been a complex, interconnected series of facts, events and circumstances.

We have characterized this environment as really having three parts -- the first being the crisis, the second the period of quantitative easing, and then, finally, the period when the fed eventually removes liquidity and stimulus as the economy grows. We've also stated that this wasn't the environment in which to make big bets, but that the increased volatility, including the fed exit and global uncertainty, would create opportunities.

So last quarter, consistent with this view, we did see a window of opportunity and made several adjustments to our position. First, we took profits in two sectors of our Agency CMBS position, monetizing on a net basis about $19 million in gains. As we've highlighted on our prior calls, approximately 60% of our capital has been invested in the CMBS market, with a focus on the multifamily sector and, specifically, in the Freddie Mac multifamily securities. We have also been active in the Agency CMBS IO sector.

As shown on slide 8, Dynex was among the earliest investors in the multifamily sector coming out of the financial crisis, particularly in the single-A rated tranches when spreads were significantly wider. We were also active in Ginnie Mae CMBS IOs. That's the chart on the right-hand side. We built a substantial position even as spreads narrowed, and we continued to participate in these sectors until late 2013 and held our position until last quarter.

We began our sell program in mid-August, and the majority of our positions were reduced by the end of October. The sales were compelling for two reasons. When we built the position, we earned economic returns from both spread tightening that resulted in book value gains and interest income. As we look ahead, given how far spreads have moved in, we only see the benefit of net interest income with little to no book value upside from spread tightening, so the risk is truly asymmetric.

The interest income benefit from holding these positions is more than offset by book value losses if spreads were to permanently widen. I say permanent, because we believe temporary spread widening and risk is an inherent part of the REIT business model. In our view, we're entering an environment where the probability of permanent repricing is more likely, and therefore, the risk-reward profile is more asymmetric.

On the Freddie Mac multifamily credit tranches, the credit curve has flattened so much since our entry point, it really made sense to monetize our gains in these lower, riskier tranches and to go up in credit quality.

So what does this mean for Dynex shareholders? First, it means we've monetized a portion of our book value. Second, our current position is substantially less exposed to permanent spread widening from our riskiest positions than in prior quarters. Third, it means our liquidity and available capital positions are strong, giving us the ability to withstand a spike in volatility as well as use those spikes as an opportunity to put capital to work. Finally, it means management has financial flexibility.

We view the monetizing of embedded gains as simply pulling forward future earnings. As Steve mentioned, we have the option to use our tax net operating loss carry-forward against these gains to pay dividends. This would supplement any temporary decline in core earnings from the lower balance of earning assets. This also affords us time to be patient and opportunistic as we assess the current environment for the best long-term risk-reward investments.

Last quarter, we also continued to actively manage our hedge and financing position, the right-hand side of our balance sheet, if you will. Our overall modeled exposure at higher rates is down modestly, and we've repositioned our hedges to have a more neutral position to yield curve shifts. You can see that on slide 9.

On slide 10, you can see on the financing side, we were able to create value by expanding the use of our committed facility to finance our non-Agency CMBS IO position. These actions, combined with active management of our repo tenures and our counterparties as well as our hedge repositioning, reduced our aggregate financing cost by 7 basis points for the quarter.

Also note we have been lengthening the tenure of our repo maturities. This is consistent with our view that financing costs and our Agency position may (inaudible) independent of fed actions due to balance sheet pressures created by regulations such as the supplemental leverage ratio, net stable funding ratio and liquidity contingency ratio.

Where this leaves us is positioned to be able to take advantage of investment opportunities when they do arrive, so let's discuss that, the current investing environment and what opportunities look like on slide 11.

We're still in an era where the cash is still in the system, so it's chasing yield and repricing risk premium across the globe. Over the past few months, we've seen a major impact of this cash chasing yield in terms of the flattening of the yield curve as well as of the credit curve, although we did see in October riskier sectors such as high-yield and CLOs wake up to the possibility that volatility spikes need to be priced in. It is these volatility spikes that create opportunity.

So going forward -- please turn to slide 12 -- we expect to continue to add investments, manage leverage and balance sheet respecting the current environment. More specifically, we see investment opportunity in three major areas -- higher-rated Agency multifamily securities, higher-rated non-Agency CMBS securities, particularly the IO cash flow, traditional Agency RMBS and non-Agency residential mortgage-backed securities.

We are very comfortable with the risk-reward in the first two sectors, and we're actively deploying capital in those sectors. We also see potential opportunities in the Agency RMBS sector, although the critical issue here is the timing of investments. Technicals in Agency RMBS are very strong. Low prepayments, muted home sales activity and the winter seasonal downturn are very positive. Investor demand is also expected to be strong.

The major question mark for us in this sector is how the market will behave without a government backstop in the market. You can expect us to be patient, opportunistic and disciplined, because we believe this sector will have opportunity to put capital to work profitably over the next six to twelve months.

I want to highlight also a few other slides in our standard package. Please turn to slide 14, our equity capital allocations slide. As you can see on this slide, we've compared our position from June 30th to September 30th. Most of our capital is still allocated to CMBS. We've reduced our position in Ginnie Mae IOs, but expect our allocations to IOs to move back up. And you'll see also that our cash position is higher.

On slide 15, the CMBS portfolio quarterly comparison, you can see our single-A rated tranches went from 17.7% to 9.3%. This position is actually down to about 3% of our total equity as of October 31st, pushing that triple-A bucket to 88% through October 31st.

You can also see on the bottom two charts that the distribution across vintages has changed given the sales that we've made in the portfolio. As of June, we owned more securities in the 2011-2012 vintages, reflecting our investments in the Agency multifamily credit. As of September, since we've sold those bonds, our compensation is in the 2014 vintage. But you'll also remember that we've been investing mostly in triple-A's and the 2014 vintage, as we've discussed. Our concerns are around underwriting quality in 2014.

So to summarize what we've discussed today, we took profits on a long-term investment in Agency multifamily credit as well as our Ginnie Mae CMBS IOs. We believe the risk-reward in these positions was asymmetric. We think that this gives us financial flexibility. We can wait for the right investment opportunity. We have the option to defray any decline in core earnings with gains from our NOL carry-forward.

We currently see opportunities in three sectors. We're actively deploying capital in high-quality CMBS. We're going to be opportunistically entering Agency RMBS and non-Agency RMBS. Our risk position is down, both in spread terms and interest rate risk terms, and we have the capital and liquidity to both withstand market volatility as well as to deploy capital profitably when those windows of opportunity present themselves.

With that, I'll turn it over to Byron.

Thanks, Smriti. We tried to give you a lot of information. We want you to understand as much as possible what we're thinking here at Dynex and the decisions that we're making.

But let me close by clarifying a few key points. Number one, just because we see the markets as having become more complex does not mean we are confused about what is actually evolving in front of us. To the contrary, we are extremely confident in our assessment of the current risk environment, and we fully respect the increased level of uncertainty that exists in the markets today.

Number two, just because the markets are more complex does not mean we won't find opportunities to invest. We believe we will continue to see random bouts of volatility in asset valuations on both a macro and micro basis, and we will have the chance to deploy capital profitably when it meets our investment criteria.

Number three, just because we have taken profits on a very successful investment does not mean we are dormant. As we stated earlier, we are making portfolio adjustments that respect the risks inherent in the overall global macro environment.

And then, finally, number four -- you've heard this before. I just want to reiterate this point. Our shareholders can continue to expect us to manage our capital as a Management team that has a significant ownership interest in the Company.

With that, operator, I'll turn it -- open the floor to questions.

(Operator Instructions) Douglas Harter, Credit Suisse.

First, when you guys talk about looking for sort of pockets of volatility, did the first couple weeks of October present any of those opportunities, or did sort of the rebound happen sort of too quickly, or just kind of how did those first few weeks of October play out?

Hey, Doug, is Smriti. So, yes, we did see the first couple weeks as providing us opportunity, and we were able to put capital to work during that time.

And Doug, let me throw out that the -- it's interesting how these little -- when I made my comment, I tried to emphasize both on a macro basis and on a micro basis. I would consider that one to be more of a macro event where all asset classes seemed to move in terms of valuations, but there are other minor ones that take place on a more micro basis within sectors that also can provide the opportunity to invest capital. I wish we could throw $200 million in the market at once, but I don't think the market's going to give us that opportunity to do it.

Got it. And what are you -- how are you guys thinking about the risk -- the GSE risk transfer market? Is that an opportunity? It's obviously one piece that the supply is growing quite substantially, and so I'm just interested to get your thoughts on that.

Yes, so we look at that sector on a daily basis and at this point don't feel it's still attractive long-term risk-reward. The GSEs are going to be coming out with these deals once a month starting next year, and while the securities have cheapened, we think there's technically a little bit more room to go before it starts to make sense. And I think the other piece of that is can you get long-term, committed financing for that type of security, and that's the other piece that gives us pause right now.

And on a higher level, Doug, we do like residential credit just in general. I think the government has clamped down so hard around lenders that we think the credit just, if you look at it, is attractive. We're waiting for the price to approach levels that we really find attractive. It is great that the agencies are selling off that credit. It'll be great to see them sell more and more, and we believe that at some point, that is a very viable asset class that will reprice itself to a level that we'll find attractive.

Great. Thank you, guys.

Trevor Cranston, JMP Securities.

Thanks, and congratulations on a nice quarter. I guess my question is with the portfolio repositioning this quarter, Byron, you talked a little bit about the potential for a permanent repricing in some of the bonds you sold, I guess the Agency CMBS mezz classes and some of the IOs, but could you just expand a little bit on kind of why you think there's that potential for permanent repricing in those classes but you said that you still see value in kind of the higher credit Agency CMBS and you seem comfortable with the spread risk there?

So if you look at the spread charts that we've got in our presentation, what you'll see is you can see how much spread tightening has taken place. So at some point, we sat in a room, we looked at them and we said -- you know what, there's probably a 10% chance we're going to get maybe 5 or 10 basis points out of this tightening and a 90% chance that one day we're going to look up and these spreads are going to be wider.

We can't predict the exact time, and nor are we trying to predict the exact time, but if all we're going to get at this point is just carry out of the bonds, we might as well pull that carry forward by selling the bonds and then redeploying the capital elsewhere, because the movement widens -- when I look at the globe and I think about the amount of debt that's being raised globally, whether it's on a sovereign basis, emerging markets, sub-prime markets, there's a ton of debt, and so the probability of a permanent correction in risk and credit spreads, it's increasing by the day.

And so we just look at the position and say -- you know what, there's an asymmetric outcome here, 10% tighter, 90% wider. Why do we want to hold the position? From a discipline -- we're being disciplined. We simply move up in credit at that point, up in credit and up in liquidity.

Okay, that makes sense. And with the additional changes since the end of the quarter, I mean, it sounds like you continued to reduce some of the CMBS positions, but you also may have had some opportunities to add some bonds also in the first couple weeks of October. Can you say about where your leverage is today and kind of what level you're targeting getting it up to kind of by the end of the fourth quarter and into the first quarter?

Trevor, I'm not sure we can give you sort of an exact update on where it is today, but what I can say is we've been able to redeploy at least half of what we sold, if not more, in this first -- in the first month of October, and we expect to continue to, so that's -- we used that October widening as an opportunity to put capital back to work.

Okay, that helps.

And part of the problem, Trevor, when we talk about complex, it's just the inability to predict, to give you those exact numbers and look out in the future into a crystal ball and say -- Trevor, right here, December 31, we're going to be at 5.637 leverage. It's very difficult.

Yes, understood. And along with the changes since the end of the quarter, were there any incremental changes to the hedge book in addition, or has that kind of been relatively static since September 30?

We haven't made any changes this quarter to our hedge position. Most of our hedge position actually was early in the third quarter.

And Trevor, I'm going to take that question just for an opportunity to address something that I know is always in the marketplace, especially in 2014. Everyone has been so hot and bothered about higher interest rates. At Dynex, we started in 2008 with the belief that rates would be lower for longer than most people expected. Now, we haven't changed our opinion.

Now, what lower means can by right in the 2% to 3% range in terms of rate, but what it does mean for us is we have not adjusted. Basically, we followed our duration gap. And I know many of you in the analyst community have been focused on, well, do they have this amount of hedge versus repo or do they have a zero duration gap, and we haven't changed. We haven't fluctuated. We have not been really concerned with the rate environment as much as we've been more concerned with the spread environment, so I'll just leave you with that.

Okay. I appreciate the comments. Thank you.

Jason Stewart, Compass Point.

Just another question on the multifamily. Is the reacceleration of lending out to GSEs part of -- is that factored into your equation, or are there concerns perhaps deeper that you're seeing deal structures weaken?

So that's a technical factor, and, obviously, if they do continue to lend, there's more supply. I would say really what it was is a more macro call. We've seen spreads on those single-A rated tranches just come in so much relative to our entry point, it started to make sense to take some profits, right?

And so at some point, I'm not going to rule out if they do cheapen up and they cheapen up enough to where it starts to make sense for us to reenter that trade again -- I'm not going to rule that out, but it really was basically looking at that position and saying it's come too far for us not to take a profit here.

And then let me plug, again, a macro comment around this, which is we still like the multifamily sector. We think there are some underlying demographic trends there. We're very, very supportive of the multifamily sector.

But the fact of the matter is when we were buying bonds in 2009, 2010 and 2011, those bonds were structured better than the bonds that -- or the loans that are being made today. There are a ton of lenders in the marketplace with a ton of cash.

So we still are involved in multifamily. We are still involved with the Freddie K deal. We're just not -- we've just reduced our exposure to the A level and lower, right, because we have some triple-B bonds also in our portfolio, so we just simply went up in credit. And if we do see an adjustment in spreads such that we do reenter that lower credit space, we'll be very cognizant of the fact that loans made in 2014, 2015 will not be the same as loans made in 2010, 2011 and 2012.

Okay, that's good color. And then a broader question that sort of relates to, I think, some of your macro thoughts there, the reintroduction of greater than 95 LTV loans that are GFCs, how does that play into your view of single-family RMBS? And maybe, perhaps, if you want to elaborate into multifamily if that has an impact there, that'd be helpful.

Yes, I think the -- so that's going to be a technical issue, because you would think that if they allowed greater than 95 LTV loans to be made, that that would incrementally impact supply, and that's really where, again, the two or three things that are negative in terms of technical for the residential mortgage-backed security sector -- one is the fed's not going to be buying, and then, two, what happens if there's really sort of an increase due to an expansion of the credit box? So from a technical standpoint, that results in more supply. Hopefully, that creates a spread-widening opportunity for us, right?

Fundamentally, though, I'm not sure that that's the real problem facing the housing market right now. If you look at what home prices have done over the last five years, it's been an incredible recovery, double-digit increases. I'm not sure it's necessarily just the level of rate and the down payment that's causing buyers not to come in. There's a serious demographic shift that's happening. You've heard a lot of people talking about the student loan debt of first-time home buyers.

All of that actually leads us to sort of reaffirm our faith in our multifamily investments. As we've said, 60% of our capital is in CMBS. We're a big believer in the multifamily story, and we think it's supportive of that. So I wish the government all the luck in the world in terms of getting a sub, but it just feels like structurally we're going the multifamily way.

And then let me just throw in this one plug on this, because I do have a burr in my saddle about the amount of debt globally, and there's a lot of talk about growth and how sustainable growth happens today. If the only way we're going to really generate growth is by getting the American consumer to borrow more money, whether it's sub-prime auto, sub-prime houses or sub-prime credit cards, one of the problems we have here at Dynex is we just can't see how that's a sustainable situation.

Great. Thank you.

Mike Widner, KBW.

I wanted to follow up to just make sure I understood a couple of things that you had said. You mentioned putting some of the capital back to work in the first part of October. I didn't catch whether you had sort of indicated where you thought the best opportunities were and where you might have put that capital to work.

We've been buying non-Agency CMBS IOs on the triple-A side mostly. We've also -- and we mentioned this last quarter, but we've been making investments in some of the new single-family rental deals that are out on the triple-A side as well. So those are two areas we see opportunity right now.

And Mike, when we think about reinvestment, let me just remind everyone that we've got a broad opportunity set. Even though you've watched Dynex over the last six years be mainly in hybrid ARMs and mainly in CMBS and multifamily, those are two main sectors that we chose to be involved in, but our opportunity set is much broader. As we look at the future as we're in the markets, we will continue to turn over -- I don't know, Tom's great phrase is turn over many rocks to look for good investments.

We also believe in diversity, so it may turn out that we have more smaller investments just to disperse the risk across a variety of product sectors, which would reflect our concern from a macro perspective in terms of the overall risk environment.

Yes, that certainly makes sense.

And Mike, let me just contrast that to CMBS, especially in multifamily and the Freddie K back a few years ago was so cheap -- we basically, as we say in the old trading phrase, backed the truck up and took as many of those single-A's as we possibly could. We took triple-B's, we book IO, we took everything we could because the spread was so wide. But I'm not sure that that type of concentration is as smart an idea given the overall macro risk environment.

And opportunities like that don't exist. I mean, there are no easy trades.

No, I was going to say it's hard to find spread opportunities like that today, and if you do, let me know what they are. So one other thing, I think you said in your introductory remarks -- and I just wanted to clarify it or make sure I sort of heard the implication right, but you mentioned taking some profits on the CMBS trade and that's essentially pulling some earnings forward. I thought that I was hearing an implication in there that if you guys end up running a slightly smaller or lower leverage portfolio for a little while, that you can think of those profits as potentially supporting the dividend if you temporarily have less capital deployed just because that's what seems prudent at the time. Did I catch that correctly, or am I sort of putting words in your mouth?

No, I think you caught that correctly.

Okay. And let me go back I guess to a broader question, because I always have to ask you guys a broad question. You mentioned being more concerned about the spread environment than the rate environment over the past several years, and I think that was probably the smart move. I mean, obviously, rates have not -- haven't been volatile, but as you guys, I think, have been saying for a long time, lower for longer turned out to be correct and you did get a benefit of the spread tightening.

But spreads are a lot tighter now, as you had just said, and as we think about the rate environment, you guys have been through a couple of interest rate cycles in your day, and I can't help thinking about the fact that every time the fed decides to end or start the cycle again, however you want to look at the cycle, there's a point where the fed has repeatedly, for pretty much 40 years, decided to make the curve flat -- completely flat, if not inverted, when they start tightening, and we've been getting certainly plenty of signals from the fed about, hey, we might start tightening the short end sometime in 2015.

The global economy remains challenged and demographically challenged and things you guys understand, so, I mean, how do you feel about the environment where potentially spreads remain tight and we end up with the short end at 200 and the long end at 200?

I'm going to repeat something. We said it in the spring of 2008 when we started building this portfolio, and this is one I stand real firm on. I don't believe the global economy can handle a flat to an inverted yield curve in the US. I don't believe the fed has the flexibility to do that one. That one I think is an extreme situation, and I think if they pushed it there, they will make the 1937 mistake that they really don't want to make, and I think it will not only impact the US, it will impact the globe.

So that's an extreme situation where they try to push -- I went through the inverted curve in the late 1980s, 1990s, the middle of the last decade. I don't think the global economy can handle that in the US. The global economy -- where's the (inaudible) coming from right now? It's coming from the American consumer. And what are we depending on? The American consumer to borrow money.

So that's a very -- that is one extreme case that I do feel that we can stand firm on. Do I think that they could potentially make an attempt to increase short rates at some point in time? Yes, I think if nothing gets in their way, they're going to feel obligated, like they've just got to go do something of that nature. After they do it one time, boy, I think all bets are off in terms of what may happen.

What was proven in the winter of this year was not the cold winter, per se, but it was how fragile the economy happens to be to any type of exogenous shock. So it's not about the economy's strong or weak. It's the fact that the economy is very fragile and will respond to the wrong type of either tightening or stimulus.

So with that said, given the lessons of history, would you say that the fed has generally made good decisions or bad decisions when it comes to sort of judging how the economy is and how it's sitting? Again, I mean, I think you're right in that the world will have a very tough time or would have a very tough time handling a flat curve. That being said, I wouldn't exactly take the fed's track record as --

Yes.

The track record -- if you go back to the beginning, go back to 1913, the fed track record is not great, and it's not because they're dumb. They're really smart people, but they're people. They're human beings, and they're always finding themselves in an unprecedented time, right? So 1937, they tightened credit too soon, and in 1970, they loosened credit at the wrong time. One resulted in a recession, the other one resulted in rampant inflation, right? And so then in the 2000s, they completely missed what was going on, so they did a great job after 2008, but --

I think you could get some debate on that issue.

Well, just in September of 2008, when they stepped in just to protect the financial system.

Yes, no, I think that's true.

So that decision was a good decision, but if you look back at the other track records, that's one of the reasons why we're concerned. Not now -- you have a global system. We're not only worried about this fed, but we worry about the central banks, the genre I would call in my old, young days Johnny-come-latelies, Japan and Europe's central banks. We've got to be concerned on their decisions, so it's a global issue at this point where governments are involved in free-flowing capital markets. It's changed the game. It's changed the dynamics. And let's face facts, the US fed has not had a great track record, so what do you think about the Japanese and Europeans?

No, like I said, there are a lot of cooks in that kitchen right now, and I'm not sure any of them know what the recipe is.

Right. I think the other thing you want to think about there is even in a flat yield curve environment -- let's just say the market takes us there, right, because the market leads the fed or there's an expectation that we're going to go there. In that situation, the way we think about it is if risk-free rates start to rise, then risky assets have to reprice in order to reflect how much better return you're going to get on lower duration risk-free assets.

And so at that point, it really still is about spread, right? So it is about spread, so even though you have short-term rates rising, if you compare that -- now the investor will be faced with can I buy a two-year treasury note at 2%, or should I buy Agency CMBS at 2.5% or 3%? That's a different trade off, and you're going to -- people will make a different risk-reward decision at that time, and it's going to impact spread assets. It's got to.

Yes. No, I think that's certainly fair. All right, well, I appreciate the comments and filling out the color, as always, guys. Thanks.

Thanks, Mike.

(Operator Instructions) Jason Stankowski, Clayton.

Hey, guys. Great job in taking a little profit and protecting book value and growing it. We appreciate it as long-term holders. I was wondering a couple things. I know buying back stock deleverages certain ratios for us, but is there a level where you guys think about that as opportunity to opportunistically deploy capital?

Yes, Jason, I'll just give you some empirical evidence. I think we had a downdraft last year. Am I right, Steve?

Yes.

When we actually entered the market to buy some of our shares. We didn't get a great opportunity. We only got a chance to buy a small amount before the market -- before the price of the stock turned and went up. I can't give you a specific level to say this is exactly where we sit in the market with a bid, but at some price level, especially if we're thinking -- like you're a long-term holder, we're all long-term holders -- it makes sense for us to make --

It sits on our opportunity set in terms of a use of capital for us, Jason.

Right. That's a great way to put it.

And I think the -- historically, our behavior has suggested a low- to mid-teen type discount before we have gotten active. That's not the suggested. That's -- past results predict future behavior, but that's what we've done in the past.

That's where you've gotten active.

Right.

Okay. And you've talked about a bunch of different asset classes, and I know different people in the space have looked at mortgage servicing, right, and a few different areas where there is possibly some good risk-adjusted returns to be had. I'm just curious if you are still looking at other things in the mortgage or mortgage-related area and if there is anything left out there that could possibly have those types of characteristics, or are we just sort of sticking with what we've done in the past and just waiting for kind of the right opportunities in those asset classes?

Hi, Jason, it's Smriti. So we've actually looked at a lot of opportunities. MSRs is one. We've looked at whole loans, we've looked at commercial whole loans, you name it. We're out there looking to see whether the risk-adjusted returns meet long-term through the cycle sort of criteria that we have set up, and what I can say is as we've been through this process, the regulatory concerns, liquidity, reputation risk, all of those things as of now haven't caused us to come out and say this is an exciting investment opportunity for us to put capital.

We're watching a lot of these, and as Byron mentioned earlier, our investment opportunity set is actually really broad. Even though we choose to invest our capital in these two narrow sectors, we're out there beating the bushes for every potential opportunity, and right now we just don't see that attractive long-term risk-reward yet. That doesn't mean it is never going to be there. We actually think this volatility -- and this is why we're talking about this -- is going to give us a chance to get in and we just need to be ready to do that.

And let me give you some other points on this, Jason. One, Dynex Capital was a pretty decent servicer and originator of loans back in the 1990s, so we've got -- we've had that business model under our roof. It's far more complicated than this business model, and it generates assets that are far less liquid on the balance sheet than we have today. We believe we're placing a huge priority on liquidity given the overall macro environment, so when we look at investments such as an MRS or whole loan, we expect returns to exceed the more liquid assets by some amount that would make it more attractive. They don't today.

Here's the other issue. The closer you get to the consumer, the more you're moving towards a regulatory buzz saw. Whether it's the CFPB or some other regulatory body in DC, they have made it absolutely miserable for most originators. And recently I was at the MBA conference just a couple of weeks ago, and I had a very senior mortgage professionals who runs a very large mortgage origination ARM, and he said -- these people are paying for these MSRs, and they're paying really high prices, and they don't realize the enforcement cost that comes along with the servicing, as you can see from the New York State attorney general attacking and going after some non-bank servicers.

Right.

So there's more risk there than return as we look at it right now. We factor in all these issues, and we then take our own experience of having these more complicated business strategies under our roof, and as Smriti said, we haven't found it to be attractive today.

So far, nothing's popped to the surface.

No.

But that's good. You've got to walk away from things that don't make sense. Otherwise, you can destroy value. And I guess, lastly, has there been any development in the marketplace with regard to the Federal Home Loan Bank and-or any other sort of longer-term funding with regard to REITs or folks in our position just in the last quarter or so?

So the Home Loan Bank -- the FHFA came out with a ruling kind of putting on hold that whole movement of let's just only focus on REITs, but what they did do is they increased the comment period to January. Now, the significance of it is I have had direct conversations with the senior people at FHFA, and I have the impression that it is still up for debate and open for development.

So we are submitting a letter along with other mortgage REITs and along with other trade groups. We at Dynex feel very strong that a company like Dynex, where for 26 years we've been focused on the housing finance system, we have made our money focused in the housing finance system, that we should be the type of entity that the home loan banks should want to finance, so we are making that case to the FHFA. Other people are making their cases. They have different stories than here at Dynex.

But as I mentioned earlier, we've been involved in residential, multifamily servicing, originations, securities ownership, agency, non-agency, across the entire board for home loan financing for 26 years. So the comment period is open. We will learn more after the comment period closes in January. We are submitting a letter. I really have the impression that it's still open for development in terms of the ideas.

So stay tuned for the first quarter and see where they come out after the comment period. Okay, great. Good job, guys. Thanks a lot.

Thanks, Jason.

Ken Bruce, Bank of America Merrill Lynch.

My question relates really to -- well, as a follow up to one of the other questions around the dividend in your prepared remarks. Obviously, you pointed out that you've got some net operating loss and net capital loss carry-forwards to take advantage of. Could you just remind us of the amount that you've got that could be sheltered and how to think about how much dividend support might come from that as you look at that going forward?

Hi, Ken, Steve Benedetti here. So the aggregate amount of the NOL carry-forward is roughly around $140 million. We incurred an ownership shift several years ago when we issued stock that limited the annual usage to $13.4 million, and effectively what happens there is that $13.4 million gets released, if you will, every year. So if we don't use it one year, it gets released, and then the next year it adds to the $13.4 million that gets released that year, so it's on a compounding basis. So today, we can use up to approximately $25 million in NOL for 2014, and that'll continue to grow year after year.

Okay. And just so I understand it, you've got -- and I think you recognized something around $20 million in gains thus far, so that would go against the NOL. You wouldn't have any taxable income to show, so that allows you to, in essence, increase your book value, but how is that going to flow back into or otherwise support the dividend going forward?

Yes, so the NOL is after the dividend's pay deduction, so we can use the NOL to offset the income or we can distribute it, and then what's left, use the NOL to offset it.

Great.

And Ken, what we've said over the years, the big key with the NOL is it gives us financial flexibility. That means we can make that decision, and we've got the flexibility to do that. As (Inaudible) has always said, we like to have options.

You like to have options that you can exercise even better. I guess maybe just to -- sorry to belabor this. I'm happy to take it offline. But just as you're kind of looking at the portfolio today, is there a way to frame how much earnings power comes about? Just if you didn't add anything at these levels, it sounds like there's still some -- you had an opportunity to put capital back in the market. You've sounded to me as if maybe that was a passing opportunity, and so you may be sitting underlevered today.

Well, here's the challenge on that, Ken. We believe that -- if we go back to a few years ago, we were investing to get carry plus spread compression. At this point, we're just investing for carry, because we believe spread compression pretty much will happen across the board in asset classes. At any moment, we can, obviously, find opportunities to invest. Again, back to try to predict that will be December 31 is difficult. That's kind of how we describe the macro environment, is being complex.

But Smriti -- I'm going to let her jump in, because she's chomping at the bit to talk about what she's doing.

Well, we just -- earnings assets as of Sep 30, though, were at $3.7 billion versus $4.0 billion on June 30, and we've actually been able to redeploy some of that capital, so this hasn't -- the sales haven't been a massive reduction in earning assets. Maybe that gives you a little bit of an idea in terms of the magnitude to help you frame what might be the base of earning assets.

Okay. Yes, we can -- I'll do some work, and we can talk about that offline. That's helpful to put it into perspective. Well, great. Thank you for all your comments and feedback.

Thanks, Ken.

Welcome.

Having no further questions, 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 for joining us today, and we look forward to having you join us in approximately three months. Thank you.

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