Dynex Capital Inc (DX) 2015 Q4 法說會逐字稿

Good morning and welcome to the Dynex Capital fourth-quarter and annual earnings conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Alison Griffin, Vice President, Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us. The press release associated with today's call was issued and filed with the SEC this morning, February 17, 2016. 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.

Before we begin, we wish to remind you that this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, forecast, anticipate, estimate, project, plan and similar expressions 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 our annual report on Form 10-K for the period ending December 31, 2014 as filed with the SEC. The document may be found on our website under investor center as well as on the SEC website.

This call is being broadcast live over the internet with the streaming slide presentation, which can be found through our webcast link under investor center on our website. The slide presentation may also be referenced by clicking on the Dynex Capital fourth quarter 2015 earnings conference call link on the presentation page of the website.

With me on the call today, I have Byron Boston, CEO, President and co-CIO; 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. Thank you very much for joining us today. Our results for 2015 were mixed as we generated a solid dividend return to our shareholders that was offset by a larger decline in our book value. Let me point out a few key things.

First, to better understand 2015, it is best to put our results in the context of our strategy over the past two years. In early 2014 we became concerned about the complexity and fragility of the global financial environment. As a result, we sold the majority of our lower credit quality investments and reinvested our cash in AAA securities and securities backed by government agencies. By improving the credit quality and liquidity of our balance sheet, we materially reduced the impact of an extremely volatile year in credit spreads.

Credit spread widening, especially in the CMBS sector, was a major reason for our decline in book value in 2015. We also positioned our portfolio to continue to generate solid net interest income, as represented by our steady $0.24 dividend payment throughout 2015. Although we're not happy with the decline in book value, we continue to stay focused on long-term results and we do believe -- which we believe will be heavily driven by generating net interest income over the long-term.

Second, let me say a few words about funding in the repo markets. Since the beginning of the year, we have received questions about rumored problems in the financing markets. Let me assure you that we have no problems financing our positions and the impact of being denied membership into the Federal Home Loan Bank system has been overblown. In fact, the home loan bank issue does not materially impact the outlook for our business.

Third, despite the periodic declines in book value, we continue to remain focused on the long-term. Since 2008, we have experienced two other major bouts of book value decline due to wider spreads. In each situation, we continued to hold our positions and to invest capital at the wider spreads.

As you can see in the attached charts on slide 4 and slide 5, we earned an above-average dividend yield over time and it helped cushion the impact of volatile spreads and it was a major driver of returns over the long-term. So if you look at our slides going back to 2003, and especially if you look at it in 2008, you can see that we incurred spread widening in 2013 and in 2011. We held steady to our strategy, and over time, as we still believe today, the strategy proves beneficial over the long-term.

So with that, I'm going to turn it over to Steve Benedetti and Smriti Popenoe, who will give you a lot more detail regarding our results.

Thanks, Byron, and good morning, everybody. I'm on slides 9 and 10 for those following the presentation.

As Byron mentioned, results for the quarter and year were mixed. For the fourth quarter we reported core net income of $0.25 per common share while we incurred losses of $0.55 per share from the net decline in the fair value of our investments and hedges. Together, these resulted in a comprehensive loss to common shareholders of $0.30 per share for the quarter. Core net operating income to common shareholders increased $0.01 per share from the prior quarter as share repurchases and favorable prepayments on our investments offset a smaller investment portfolio during the quarter. Our total economic return was a minus 2.9% for the quarter, consisting of a $0.24 dividend and a decline in book value per share of $0.48.

On slide 11, we provide a reconciliation of common shareholders' equity and book value per common share for the fourth quarter. If you look at the chart on this page, the decline in book value is due to declining asset values net of hedges from a combination of higher rates reflecting our net interest rate risk position during the quarter and wider credit spreads on our securities [in sympathy] with the broader market sell-off in risk assets. Approximately $0.26 per share of the decline was from higher interest rates and approximately $0.28 per share was from wider spreads.

Offsetting these items was $0.05 in benefit, primarily from the repurchase of 1.5 million common shares during the quarter at a weighted average price of $6.63. Our total economic return was minus 3.9% for the year, consisting of $0.96 dividends per common share and a decline in book value per share of $1.31 on beginning book value of [$9.02].

For the year, we reported core net income of $0.93 per common share. Core net income benefited from a higher average earning asset base and favorable hedge positioning, while the book value decline was due to spread widening on assets versus our hedges and, to a lesser extent, the increase in interest rates during the year. Smriti will provide additional details in her comments on spread and book value performance for the quarter and for the year.

From a hedging perspective, the average notional amount of net current pay fixed hedges during the quarter was $566.5 million at a pay rate of 1.16% versus an average notional of $662 million at a pay rate of 1.3% last quarter. At December 31, we had $480 million of current pay fixed interest rate swaps at a rate of 1.06%, with an additional notional amount of $325 million in swaps beginning in January 2016 at a weighted average net pay fixed rate of 1.94%.

Leverage at the end of the quarter was up to 6.5 times share holders' equity versus 6.4 times last quarter, despite the drop in our borrowings. Leverage declined 0.4 times from lower borrowings but increased 0.15 times from share repurchases and 0.35 times due to a lower equity balance from the net changes in fair value on our assets and derivatives that I previously discussed on slide 11.

As most of you are aware, the FHFA adopted a final rule in January, which forces the termination of our [captive] as a member with the Federal Home Loan Bank of Indianapolis in early 2017 and requires us to repay advances in the interim upon their maturity. We have approximately $257 million in advances maturing tomorrow, which are being replaced with repo financing at competitive returns on capital with the balance maturing in October.

With that, I will turn the call over to Smriti.

Thank you, Steve. For the call today, I'll begin by focusing on our performance for last year and last quarter and then turn to our current positioning and outlook.

In the first quarter of last year you heard us describe the investment environment as complex. In fact, if you look at the charts on page 15 in our deck, in the four quarters of 2015, we actually had a mini bear market, a mini bull market in the same year, with curve twists of all types. A bull flattener in the first quarter, bear steepener in the second, bull steepener in the third and we ended the year with a bear flattener. If you're not familiar with these terms, we've included a definition on page 41. We saw interest rates at times buffeted by domestic factors and, at times, driven entirely by non-US flows and factors.

In the second half of the year, rate movements were accompanied by a broad-based repricing of risk premiums. Spreads widened across the board with risky assets taking the biggest hit. The list of exogenous events in 2015 is long, but the critical one was the dramatic falling-off oil prices. As Byron mentioned, we did assess this environment as complex, but one in which we had the opportunity to earn net interest income in high quality assets, specifically those that would suffer less in a spread repricing.

We approached this year with an up in credit, up in liquidity strategy, allocated capital selectively to assets and aggressively to share repurchases when the opportunity presented itself. And we decided to maintain our swap hedge positions for 2016 and beyond. With this strategy and economic backdrop, as Steve mentioned, for the full year we generated a total economic return of minus 3.9%.

Our book value performance in the fourth quarter and for the year was driven mostly by our long duration position, spread widening and assets and spread tightening on our hedges. Specifically, our asset values were impacted by price drops on post reset hybrid ARMs, which are floaters. This happened particularly towards year-end because the sector felt some selling pressure. And a broad base spread repricing across the CMBS sector. As you can see on page 16, we saw widening across the board in all types of asset classes, but particularly in CMBS areas in which we are invested.

So this begs the question. What is driving spreads? In our assessment, spreads are wider across many asset classes due to the confluence of a number of factors. First, fundamental factors. Investors have reassessed the probability of getting paid back, specifically in the riskiest securities, and they've repriced those bonds. Those names that are closely associated with the fall in energy prices suffered the most.

Spreads on all risky fixed income securities have widened in a similar reassessment of risk [versus reboard]. If you look on page 16, you can see at the very [tights] in June of 2014, high yield spread sat at 397 basis points. As of 12/31/2015, they sat at 746 basis points. That's the riskiest assets repricing. BBB CMBS, at the tights were at 312 basis points. They ended 2015 at 562 basis points -- over a 250 basis point repricing.

Now in contrast, agency DUS bonds, agency multifamily bonds, which is the second item on the list, at the tights were at 39 basis points. They widened about 50 basis points to -- as of December 31. So there's been a widening. The widening has hit the riskier assets more than the not risky assets.

Secondly, there are technical and structural factors driving the widening. Last year, corporations issued the largest amount of bonds on record. Investment grade issuance totaled $1.3 trillion with an average maturity of five years or longer. Net issuance was actually $626 billion, the highest amount on record. That's a significant amount of duration and paper to absorb. We discussed last quarter how some of this issuance was affecting swap spreads.

In the fourth quarter, investors had to contend with this corporate supply, as well as CMBS supply. Pipelines were full and many deals had to be priced in the short window between the market turmoil in third quarter and year-end pressures. Furthermore, the market making function of Wall Street has been severely crippled by the Volcker rule and other new regulations, effectively removing the buffer of temporary demand provided by Wall Street in the face of this type of supply.

Finally, you have psychological factors. Risk aversion and volatility kept many investors on the sidelines, leaving the main factor driving spreads as the seller. When sellers drive pricing in the absence of buyers, spreads will widen. And this happens whether or not the assets are high quality or not high quality. And it usually impacts lower quality assets more severely. You can see that again on page 16.

So should spreads be wider? Yes, they should be on some assets. There's legitimately greater risk of principal not repayment -- being repaid back. Have some assets been unfairly penalized due to risk aversion or selling pressures? Yes. Now these conditions continue to be in place as we begin 2016 and it should give you an idea as to what was driving book value last quarter. And we'll talk more about spreads later in the call.

Now I'm going to turn to our outlook and our current position so we can flip back to page 13. As you know, we approach our investment decisions in a top-down fashion. So I'll start with the macroeconomic environment.

We continue to believe that the environment is complex and more interconnected globally than in prior times. This is going to bring volatility and opportunity. We also believe central banks will continue to drive asset prices and financial conditions globally. Many developed market central banks are in ease mode. They are ready to move to negative interest rates. The Fed and the Bank of England are in wait-and-see mode.

Emerging market central banks, including the PBOC, are managing slowdowns, contracting credit, possible losses in their banking system as well as currency fluctuations relative to the dollar. The actions of emerging market central banks, particularly the PBOC, as it relates to currency management, will have implications for US treasury yield. Specifically, their actions could act as a limit on how low treasury yields can go as well as a catalyst to push yields higher than would be suggested by fundamentals. The other factors on this page remain driving forces for global yields and they form the basis and thesis of our core position.

Turning to the investment environment, we discussed earlier the reasons for wider spreads. Some assets have actually widened now to the widest in several years, post crisis. Low global yields are a reality for us, particularly as we factor the potential for negative interest rates. Surprises are likely. We said this last year. When in an environment where volatility is the most high probability outcome, we must act accordingly.

And then you have the Fed. The Fed's acted to increase interest rates. The psychology at the Fed is to continue to increase interest rates in the absence of a major impediment. The market has obviously taken a completely different view of this, pricing very little or no hiking in 2016 and 2017. And thus far, financial conditions have put a roadblock on the hiking path for the Fed. And it appears that maybe they won't move in March. We see the US economy as having recovered from the worst effects of the crisis, but it's still vulnerable and fragile to shocks. Now because of this and because of the probability of surprises, it's going to be very difficult to predict outcomes with a high degree of confidence beyond a very short-term horizon.

So what we've just described is a complex environment, economies and a global system that's somewhat fragile, vulnerable to shocks. How are we positioned to deal with this environment? Let me talk about that. I'm going to refer to pages 19 and 20.

Our overarching basis in our investment philosophy is to invest in securities where there's very little risk to getting our principal back. 83% of our securities are agency guaranteed. 93.5% are AAA rated. We believe this is an appropriate posture for this environment. We've also biased ourselves towards assets that are prepayment protected, combined with those that return cash flow to give us the flexibility to reinvest. 46% of our assets are in the agency guaranteed RMBS sector in the form of hybrid adjustable rate securities. Some of these assets are floaters, as you can see on the reset chart on the right-hand side. They reset in somewhere between the next 12 months, the next 8 years.

These assets provide stable cash flows. Compared to 30-year fixed rates, they are relatively less sensitive to fluctuations in mortgage rates. They are relatively liquid, imminently financeable, and while they are subject to temporary spread shock because of supply/demand imbalances, over the long run they have proven to be a good store of value because of their short duration nature. They give us the flexibility to earn income while we rotate out into less liquid sectors or credit sensitive sectors when the opportunity presents itself.

52% of our assets are in commercial real estate. About 25% of that, half of it, are in Fannie Mae guaranteed multifamily bonds known as DUS bonds. They typically have a final maturity of 10 to 12 years and a prepayment lockout of 9.5 to 11.5 years, on which if we receive an early payoff, we actually receive compensation. These bonds are positively convexed, meaning their prices actually go up when rates go down and prepayments are positive cash flow [events]. This helps us diversify the risk on an unfavorable prepayments in our agency RMBS position.

The remaining half of our commercial real estate assets are split between Freddie Mac guaranteed AAA multifamily-backed, interest-only strips and non-agency CMBS interest-only strips. Our Freddie Mac interest-only strips are agency-guaranteed. They're backed by Freddie Mac, issued by Freddie Mac as part of their K-Series program. These IOs return us cash every single month and give us the flexibility to reinvest or retain that cash. Our non-agency securities are backed by AAA-rated bonds. This provides us diversification and additional return enhancement to the agency guaranteed securities. And our thesis in the non-agency market has been to own a diversified set of cash flows across many vintages and issuers.

For both agency CMBS and non-agency CMBS IOs, we are well insulated from high severity defaults, either because the agency guarantees it or because we own the AAA part of the capital stack. So if a loan defaults at maturity -- usually that's when a lot of loans default -- we've usually earned all of our cash investment back in the IO. If it defaults before maturity, either that loan is guaranteed by Freddie Mac and we receive a payment for that reason or, because it's in the AAA part of the capital structure, the loss is absorbed by the equity, or the B tranche, or the BB tranche, and so on up the stack. So this type of protection makes us comfortable taking this type of risk.

So you can think about our asset position as really being mostly agency guaranteed with a high degree of protection against high loss severity events in the non-agency sector. What we're trying to do is preserve optionality to invest while having some prepayment protection. By focusing on assets that have guaranteed principal repayment or structural protection, we reduce spread risk. And you can see that in the way spreads have moved on high quality assets versus low quality assets on page 16.

Now let's turn to capital deployment for the quarter. This is on page 20. A couple of things to note here. First that the balance sheet was smaller quarter-over-quarter. Leverage slightly up, mostly due to a decline in book value. We made a few select investments in the CMBS IO sector as spreads widened last quarter.

I'll now discuss the liability side of our balance sheet. Turn to page 21, please. As you know, we finance our asset position using reverse repurchase agreements. These borrowings are over-collateralized with a margin and daily mark-to-market requirement that insures adequate protection for the lender. This means we're required to maintain this predetermined margin as a percentage of the fair value of the asset on a daily basis with our counter parties. Needless to say, we're highly focused on our liquidity position and our ability and capacity to handle any issue that could negatively impact our borrowings.

As a user of derivatives, we're also required to post cash margin against our derivative transactions. In fact, since we began our security strategy in 2008, I can safely say that we've never failed to meet a margin call or post any kind of required margin on derivatives. Our liquidity and contingency planning includes stress scenarios that would adversely affect our margin requirements. So we're managing this very, very aggressively in a focused manner.

We continue to manage our counterparties with the same high degree of focus. Our strategy incorporates several factors: whether the counter party is domestic or international; what are the regulatory constraints facing the counterparty; our overall relationship with the counterparty across products; the counterparty source of funds; what's their commitment to the repo business; what are their commitment levels for term financing; are they willing and able and providing us with financing for non-agency assets? All of these are factors that we consider when managing our counterparties. And with this in mind, we have over 30 established counterparties against which we are active with about 19 of them.

Part of our portfolio construction is also with a view to the financing landscape. There's a lot of talk about regulation. Money market reform regulation will create additional demand for repo on agency securities. 83% of our book is agency-guaranteed. Balance sheet constraints on domestic banks are pushing them towards financing more attractive non-agency assets. We've worked to source a committed facilities of finance -- what we consider to be our riskiest assets, AAA conduit IOs with Wells Fargo. While we believe the regulatory landscape is changing on the financing side, by no means do we view the changes as posing an existential threat to our business model. Cash is still out there that needs to find a relatively safe return offered by short-term borrowings like repos.

Demand for borrowing is still there from entities like ourselves and many more. The pipes between these pools of demand and supply are being built. Centralized clearing, potential for money funds to join the FICC, direct repo, all of these developments are indications that a connection can and will be made. Even if we have a situation of mandatory minimum haircuts, we would be looking at a scenario where pricing would need to be adjusted, and with that, perhaps, an adjustment of return expectations. But we do not view the developments in the funding markets as wholly detrimental to the levered business model.

And Byron and Steve mentioned the home loan bank issue on the financing side is pretty much a non-event. We have not had any issue reallocating the financing across our current set of counterparties. We have never considered this an important development other than diversifying our counterparties to include a GSC type of entity. And as Byron mentioned, our business will go on with or without a membership in the system.

I'm going to briefly touch on our interest rate risk positioning on the next page. We've chosen to maintain a long duration position through most of last year and into this year. And into this year it has helped us offset a good portion of the continued amount of spread widening that we've seen in 2016. And given the volatile nature of the environment that we're in, you can expect us to manage this position pretty dynamically this year.

So let's talk about Dynex strategy going forward. What can you expect from us? What should shareholders look for in 2016? In terms of earnings, we believe the opportunity still exists to earn net interest income and produce what we consider to be an above-average dividend yield in this environment. You can expect us to focus on our risk position, to manage our risk position, to reflect the dynamic environment. What this probably means is more swap activity and adjustments intra-quarter. That will make earnings probably a little less predictable.

You can expect us to very carefully and deliberately redeploy capital as the opportunity presents itself. The investment environment finally presents real opportunity to take on risk at long-term, attractive risk reward levels. But this is going to require a lot of analysis as well as clear pictures of financing options before we jump in and fully execute. Now our decision to take on this risk obviously will be opportunistic and we'll be reallocating capital using our risk adjusted framework. And part of this capital allocation decision we expect, as always, will include the decision to repurchase shares. We currently have about 9 million remaining under our current authorization and we'll obviously consider reauthorization, should we deem the opportunity to be compelling. You can expect us to continue to manage our financing using the approach that I just described to you, while we explore avenues for alternative financing to the traditional repo market.

In terms of book value, our book value is still sensitive to movements and spreads. Spread widening has taken a fair amount of its toll on value, particularly for higher rated securities. There are a few factors that we believe are supportive of spreads in this environment. First, sellers are stopping because spreads have repriced. That's causing primary market pricing to actually adjust. The supply of corporates and non-agency CMBS appears to be slowing in the second quarter, and this will help potentially stabilize existing positions.

Second, cash is still in the system. Real money buyers still have cash to be put to work across the globe. In the US, yield and spreads offer an attractive risk return profile in what is possibly one of the few appreciating, or should I say, not depreciating currencies in the world. Okay?

Third, high quality assets in general, when there's a flight to quality, tend to benefit. But you really have to see overall market volatility decline for people to be confident to put money to work. Now this doesn't mean spreads can't widen or won't widen. We just think that some of the catalyst for further widening, particularly in higher rated securities, have dampened down a little bit. We do have the added benefit in our portfolios of seasoning and asset spread roll-down. As our longer duration assets season come down the curve, we benefit from tighter spreads. And if the curve is still steep, which it still is, there will be pricing off of a lower yield point on the curve. So we do have some built-in book value upside there. On the hedge side, any kind of normalization in swap spreads will be upside, although we believe the catalyst for that is not yet present.

To summarize, we think the opportunity continues to exist to earn an above-average dividend yield. The current environment is uncertain. It's going to cause period-to-period volatility in our results. But we don't believe that it affects our ability to be a diversified mortgage REIT and deliver an above-average dividend yield. Higher dividend yields will help us cushion any potential volatility in book value. I would also remind you, we've constructed our portfolio to naturally delever over time, which gives us the flexibility to reinvest. The investment environment is now more balanced with respect to risk and return than in prior years and we believe offers real opportunity to make long-term accretive investments. But uncertainty around economic growth, interest rates, regulatory changes will make us very, very careful before we invest or reallocate capital. At the end of the day, we believe our strategy can produce solid income and we think we can drive long-term results in spite of periodic volatility in book value.

And with that, I'll turn it back over to Byron.

Thank you, Smriti. As you can see, we wanted to give you a lot of detail so you can understand exactly how we're approaching the market today. And without sounding too repetitive, I want to repeat the fact about complex and fragile global markets. Nonetheless, we look to the future with great anticipation. One of the largest challenges will be the impacts of regulation. However, future regulation will have both a positive and a negative impact. Most importantly, we believe market returns will adjust to the new regulatory environment. We continue to believe in the long-term opportunities that are developing in a variety of securitized product sectors, especially in CMBS. I think it's a great long-term core product for our portfolio. As prices adjust, book value may fluctuate, but opportunities will be created.

Please look at slide 25. Just a comparable total return across multiple asset classes. As you can see, 2015 was not a great year for returns across the global landscape. Nonetheless, as we continue to stay focused on disciplined risk management, we believe the future [dividend payments] will help cushion short-term fluctuations in book value. And as you can see, I'm going to reiterate -- show you a chart again on slide 26 and slide 27, long-term charts that I'm constantly looking at are reminding myself to stay focused on long-term returns. And you can see that from either 2003 [or] 2008, these returns are driven heavily by above-average dividend yields. And as such, we look toward the future with great anticipation.

With that, we'll open the floor -- we'll open the call up to questions.

(Operator Instructions)

And our first question will come from Eric Hagen from KBW. Please go ahead.

Thanks. Good morning, guys. Can you describe some of the hedges you have in place to protect from credit spread widening, as opposed to just pure interest rate duration? I appreciated the book value roll-forward, which is basically the genesis of the question. Thanks.

In this type of business model, your best way, your really de-risking method for credit spreads would be to reduce your balance sheet. We've done it in the past, especially if you look back to the 2008 time period.

So, we take spread risk in this business model. We're not hedging out our spread risk. We do carry a long duration position to help offset the impact of wider spreads. Historical correlations would show the spreads widening in a down-rate environment, and potentially tighten in an up-rate environment.

Just to be more specific, as we look out into the future, 2016 and 2017 will be very interesting years for CMBS. We're at the top of the capital stack with agency-backed product and AAA product. We are firmly in belief this is money good over the long term.

As these spreads continue to widen, it creates great return opportunity. And as we look through 2016, we have some new regulations coming on board where you may see some prices readjust. But as long as we continue to invest at the wider spreads, remain in the business, we've shown in the past throughout time that this business model turned out to be extremely profitable over time.

So, we don't hedge spread risk. Spread risk is a risk that we take. Our biggest concern would be that if we had product that really was not money good.

But the CMBS product today, especially with some of the -- as I said -- there's positives and negatives in regulation. One of the positives of the regulatory environment is the goal is to try to reduce the potential for having an out-of-control credit environment.

So, we still believe in the CMBS sector. Spreads may fluctuate. We want to take advantage of the wider spreads.

Okay. That's helpful.

And I always appreciate your macro commentary. Going back to the idea of negative interest rates, how do you think the stock -- and I guess equally important, the mortgage rate sector -- how do you think that survives or just copes with a negative interest rate environment? I don't think it's unreasonable to think that US rates can chase European and Japanese yields pretty far down the curve. Thanks, Byron.

Here's what's changed: If you look back over -- look since 2008, and that's what we've been building in the current portfolio. There are a couple real psychological shifts that, in my opinion, have happened at the Federal Reserve. First one was when they really shifted from the lower to -- really had a desire to raise rates.

So, I say right now, the Federal Reserve Bank, the governors at the Federal Reserve would like to raise interest rates if they could. But they may not be able to. And the thought process was the zero lower balance, as if once they got to a rate to zero, they couldn't go lower. But as we've seen now over the last couple of years -- first, Europe did this, and then now Japan has done this.

Let me just say that in the US, we took some more drastic steps to help in this process. The issue with negative rates, in my opinion, would be that fiscal policy can truly make a difference. So, the question will come: How can we get to fiscal policy changes that will alleviate the need for negative interest rates? And fiscal policy in the US can truly make a global difference.

Well, if you look at the current election, you would say -- gee, Byron, it's years away. But if you think about a scenario where, in fact, the US would have to go to global rates, you're probably in a situation where all kind of drastic measures will suddenly appear and be willing to be considered.

So, I continue to believe that if you have a negative rate environment, our financing costs will not go negative. Our financing costs will decline, and that will obviously potentially be a positive.

One of the biggest concerns would be pre-payment risk. And that's why we stick with the CMBS sector. We have had an opinion with some concern about the global environments for really some time -- actually since 2008 -- never really changed that opinion.

I always say the structure of global finance doesn't really make sense. It's unsustainable. It has to change. There has to be corrections. And we've had that.

We've had one in 2008 here in the US. We had another in trying to deal with the European debt crisis. And now we're right in the middle of a European -- I mean, of an emerging market adjustment.

What will be the ultimate impact of those? There's still a question mark around that. I do believe before we get to negative interest rates in the US, which would be a drastic step, I think other steps may be taken in Washington that may alleviate that overall need. And I would also think that when you really look at the current level of employment and how close we are to having a decent level of economic activity -- again, I still believe those will provide some cushion to ultimately getting to a negative interest rate environment.

And I think also from a positioning perspective, Eric, it's also a very compelling reason to maintain a long-duration position.

And then let me emphasize again -- the CMB -- because I don't think I completed that thought. The CMBS product is pre-payment protected. So, one of the key benefits in 2015 was we really had a positive pre-payment experience. Our CMBS position offsets any negative in our ARM and hybrid ARM portfolio.

And we had a positive experience in two ways. One, when our CMBS product pre-pays, we are compensated. The second reason is that, in our ARM portfolio, we hand selected specified pools in this portfolio, and it's outperformed. You can compare our average pre-payment speed on our [average] ARM portfolio versus others in the industry.

So, again, lower rates -- one of the largest risks is pre-payment risk. And it can become really significant if you were to, say, take the 10-year down 50 basis points. We will be in good shape with the amount of capital that we have allocated to the CMBS sector.

That's really helpful. As always, guys, thanks for the commentary.

Thanks, Eric.

(Operator Instructions)

Our next question will come from Douglas Harter of Credit Suisse. Please go ahead.

Thanks. As you guys mentioned, you could still see some volatility in spreads in this environment, and how you look to balance book value volatility versus generating net interest income?

Hi, Doug. Here's what we've done in the past: I want to use 2011 as an example, because in that year -- you can look at our quarter to quarter, and you'll see some declines in book value steadily. As spreads continue to widen out, we continue to invest money. We stuck with the sector, and over time it proved to be a very, very, very valuable investment.

Likewise, I have a lot of comfort in the CMBS product, especially at the top of the capital stack -- especially this agency CMBS product. So, we harp on CMBS. We lean on CMBS.

But let's say another opportunity evolves someplace else. We have no fear of reallocating capital. The other sectors would be agency, fixed rate securities. There's the hybrid ARM security.

We're probably going to be slower in terms of trying to reallocate the lower credit product until we get more comfortable with that adjustment process. That kind of rippled through. You saw high yield widen out. You saw investment grade credit widen out.

Then you saw the CMBS lower credit product widen out. And if there's any issues with financing, it will probably be in the lower credit products, as opposed to the higher credit products. So, we're going to lean and stay at the higher end of the capital stack. If you take agency CMBS out, and widen it in step with non-agency CMBS, I think it's a great investment, especially if the 30-year and 15-year fixed products remain within a tight band of credit spreads.

So, that's why I look to the future with great anticipation, because there's a ton of scenarios that may evolve here, but I am an absolute believer in this business model generating an above-average dividend yield. And what do I mean by an above-average dividend yield? It doesn't mean GE, steady-Eddie, same dividend or increasing dividends over time. That's unrealistic for this business model, for anyone in this industry. The dividend levels should fluctuate.

But when I say above-average dividend yield, I'm comparing it to the average on the S&P or the average on the Russell 2000. And our business model is made to generate that type of cash flow to our shareholders.

So, yes, CMBS spreads may fluctuate. I think there's some debate as to exactly how this will happen. I think 2016 and 2017 will be the most interesting years. And then you have this huge drop-off in 2018 in the amount of loans that are coming up for refinancing. So, I think it may be a great opportunity to accumulate a solid balance sheet, of really attractive assets with good credit quality and good pre-payment protection over the next year or two.

Along those lines, Byron, if we were to go through a period, unlike 2011 where spreads don't snap back or they continue to widen for an extended period of time before the ultimate quality of the assets gets reflected, I guess what is the risk that you get stopped out in some of those positions, given that you are a levered investor?

That's why I stay at -- that's why I like the agency product. That's exactly why we sold our product at the end of 2014. If you recall, we had a large position in BBB and A rated CMBS product.

We sold the entire position because we said spreads were too tight. The global financial environment is too complex. And, therefore, it's too risky to have those assets on short-term financing. It's better --

The one other thing on that though, Doug, is that -- you're right that spreads could widen. But you don't ever want to get stopped out of these positions because you're managing your liquidity and your capital for those contingencies. So, as you're adding a riskier asset onto your balance sheet, your liquidity and contingency planning has to incorporate a scenario that those spreads could go wider. Right?

One of the things that -- why we've been able to do what we've been able to do, maintain leverage at our current level, have the asset position -- is that liquidity and capital management. One thing we've always said is -- hey, spreads widening is actually a good thing for us. It's not great for our current position, but it's great for marginal investments. Right?

So, you want to be able to manage your liquidity and capital position to have the liquidity and capital available to invest when that happens, and to be able to manage that cycle appropriately. And you know what? Timing is everything in this business. So, you don't want to be too early to the game. You don't want to be too late to the game. And obviously, how we assess the environment is going to be a big factor in when we invest.

And if you look back over time, Doug, you'll see that -- go back to the 1998 crisis or the 1994 crisis or early 1990s when you [did] have a real estate collapse. The agency product can truly perform differently than the non-agency product, especially in terms of financing being available for those products versus other product sectors.

So, I don't disagree with you. That's what our risk management -- and we talk about disciplined risk management. And our best example of that would be the move that we made to get -- to sell all of our A rated and BBB rated product, and move up into more -- move our book more toward an agency-based portfolio.

Great. Thank you.

Our next question will come from David Walrod from Ladenburg. Please go ahead.

Good morning, everyone.

Hi, David.

Good morning, David.

Just wanted to talk about the share buyback a little bit. I believe you said you have $9 million remaining on the current authorization?

That's right.

We do.

You talked a lot about your investment opportunities that are available now. Can you lay out how you think about putting money to work in those opportunities versus buying back your stock at these levels?

Let me just say, David, we bought back a fair amount of shares last year, at a time when spreads were much tighter on a relative basis to our stock. At this point, there's been a major adjustment in credit spreads. And so, returns are more attractive.

And when I think about the long-term opportunity that may evolve here for investing our capital in the fixed income markets, I take a little bit of a different view than maybe I took five or six months ago because I do think there are going to be some really attractive opportunities on the fixed income side. We've been disciplined about it to say -- let's just look at really where the return opportunity comes in. But from a long-term operational perspective of a company such as ours, the opportunity sets have changed versus six months ago when our stock was cheap and spreads were really, really tight.

Okay. That's helpful. Thank you.

Our next question will come from Jay Weinstein from BELR. Please go ahead.

Hello?

Jay?

Can you hear me?

Yes. Good morning.

Good morning. I was going to suggest you change the word complex, which you've used, to something along the lines of even less predictable than it normally is environment. But that's a different issue.

That's actually -- that is really -- the result of it is that when you say even less predictable, it means surprises are very likely. And, Jay, I had a lot of conversations in 2014 when I first started using that word complex -- I was challenged on that issue. No one's really challenging me on it at this point.

We've had a ton of surprises through the year of 2014 and 2015. And I think the bottom line is it's really less predictable.

Yes. The previous callers actually asked a lot of really good questions and pre-empted a lot of mine. I just have a couple of questions.

One, your shares seem to trade at a bigger book discount than most of the competitors that I sort of mark you against. And I know that it's never an apples-to-apples comparison because portfolios are different and leverage is different, et cetera, et cetera. But that seems to be relatively persistent -- comments or thoughts on why?

I don't -- Jay, I don't know that we have seen that type of differential over time.

Just really talking the last couple of years, I would say.

I don't know. That may be something we'll have to take offline and look because when we've looked at --

Okay.

We haven't seen that type of differential. I know at certain time periods, because obviously our stock is small or less liquid, some one person may try to move a large position and you see some adjustment in it. But I don't know that we have seen that. I would love to get with you offline to take a look at that with you, and we'll show you what we look at.

It was about 25% as of 5 minutes ago. So, I thought that was a bit higher than most of the rest of the industry. But again, I'll have to double-check it.

Given that you did take a lot of risk off the table in 2014, are you surprised still by how difficult it's been to maintain book value since then? If you had -- with a much higher quality average portfolio that you ran with after that.

Here's the decision that we could have made. At the end of 2014, we had sold assets and we were down to about $3.1 billion in assets.

So, the main way you protect against spread, if you're taking spread, is you just have to liquidate the assets. So, at that point, we could have chosen to just sit there with a lower portfolio, with the proceeds in cash. We would have earned less money.

And as I look at 2015, I scratch my head multiple times looking at it; we would have had a smaller amount of CMBS. We would have had a larger percentage of hybrid ARMs. We still would have taken the markdown on the short hybrid ARMs, which we don't think is a long-term issue, and then the -- which is more of a technical issue.

And then the CMBS that we would have still had on the balance sheet, which would have been high quality -- we would've still taken some widening on it. I'm not sure that we wouldn't have ended up in the exact same -- we would've had lower earnings to offset a smaller move in book value. But it probably ended up in the same place, somewhere between 0% and negative 2%, as long as we had those asset classes on the balance sheet.

I think what asset class would probably perform better, probably the 30-year and 15-year fixed from just a spread basis. They have been in a relatively narrow range -- heavily supported, obviously, from the Fed's balance sheet. And we've chosen instead of that product to invest in the CMBS agency, which did, obviously, lead to a larger book value move.

Were we surprised by the move? The big surprise was really in derivatives -- it was what happened in the swaps market where swap spreads tightened and became -- and the correlations and the relationships changed in 2015. So, that was a surprise.

And so, we have said we anticipate surprises. And what we don't want to do is take too much risk that would obviously take us out of the ball game.

I think -- sorry -- I think the last caller definitely asked the right question about now when you do have a variety of choices, but capital is always limited, and just how do you view reinvestment and investment going forward. That will be, I think, one of the many problems that you'll be facing because you do have -- as you say, you actually have a range of attractive choices, but a limited amount of money that you obviously have to work with.

That's true. And here's what's interesting: We have not been reinvesting money recently because I don't think there's any hurry right now. I'm going to have these choices.

I'm going to have -- just like in 2011. So, we kept investing, kept investing -- spreads kept widening, spreads kept widening -- kept investing, kept investing, kept investing. We were all the way to the wides and so we bought the wides because we continued to stay involved in the marketplace.

At this point, I think we've got time to think about what's the optimal point or selective in terms of what we put to work. And again, because we've got that big CMBS portfolio, yes, we're getting cash every month. But it's not like owning 30- or 15-year fixed where you're getting probably a ton of cash, and you're just forced to have to plow a lot of money back in the marketplace.

So, we are being selective. Long-winded way of saying we're being very disciplined and selective in the process. I do think the CMBS opportunity is going to be 2016 and 2017. After that, on a long-term basis, you may find that the product drops off.

For those of us without a [Bloomberg], it's been very difficult, again, to kind of track credit spreads for the assorted types of things in your portfolio. Is there a decent way, other than bothering you all the time, on how to actually just keep track of where they have gone? For instance, year to date, I assume they've widened. But again, I don't know, the last couple of weeks -- probably been a little bullish. I just don't know how to track it.

That one may be another one, Jay, for us to follow up with you on.

Okay.

Because if you're trying to think of the CMBS product and the hybrid ARM product, we are in a little bit of an off-the-run sector. So, let's put our heads together on that.

Okay. It's not that critical anyway. All right, well, I appreciate it, as always. I'll hopefully catch up with you soon.

Thanks, Jay.

(Operator Instructions)

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Boston for any closing remarks.

As I said before, we look toward the future with great anticipation. And with that, we thank you so much for joining our conference call. We look forward to speaking with you next quarter. Thank you.

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