Dynex Capital Inc (DX) 2016 Q1 法說會逐字稿

Good day and welcome to the Dynex Capital, Inc. first-quarter earnings conference call and webcast. All participants will be in a listen-only mode. (Operator Instructions). Please note that this event is being recorded. I would now like to turn the conference over to Ms. Alison Griffin, Vice President, Investor Relations. Please go ahead.

Thank you, 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, April 27, 2016. You may view the press release on the Company's website at dynexcapital.com under investor center, as well as on the SEC's website at 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 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, 2015 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 a streaming slide presentation, which can be found through a webcast link under Investor Center on our website. The slide presentation may also be referenced by clicking on the Dynex Capital first-quarter 2016 earnings conference call link on the presentation page. I would now like to introduce and turn the call over to Byron Boston, CEO, President and Co-CIO.

Good morning and thank you very much for joining us today. I'm going to briefly review our performance for the quarter, discuss the global macro environment and provide our outlook.

For the first quarter of 2016, we declared a dividend of $0.21 per common share, generated core EPS of $0.22 per common share, experienced a decline in book value of $0.17 per common share and generated a total economic return of 0.5%, or approximately 2% annualized.

The first quarter of 2016 was a continuation of the market volatility that we saw in the second half of 2015. Risk premiums widened and correspondingly asset prices weakened into February. And for some assets, they are the lowest prices since 2011 and only to partially rally through March and into April.

Our book value was negatively impacted by the wider risk spreads, but that negative impact was more than offset by net interest income from the investment portfolio. Today, there are many factors impacting global capital markets, including large amounts of global debt that is negatively impacting overall global stability and economic performance, extraordinary government involvement in the capital markets via central bank interventions and regulatory changes; technology that has connected us all globally; a global currency war that is having unintended consequences could create or exacerbate instability and could limit how much interest rates can rise.

As a result of these and other complex factors, we continue to expect bouts of market volatility that will be followed by periods of calm as global governments continue to intervene. This has been the pattern for the past several years and we expect this pattern to continue.

This is a good environment to generate net interest income, but disciplined risk management and capital allocation will be key. Over the past three months, we have reached out to many of our shareholders to listen to their thoughts and concerns. We heard several key themes that I want to address in my comments this morning.

First, our business model is focused on providing solid, quarterly, current income to our shareholders while seeking to maintain book value over time. With this focus, we expect to provide an attractive return profile by maintaining our risk posture at an acceptable level.

Second, we believe that above-average dividend yields as provided by Dynex will be a major driver of investment returns for the next 5 to 10 years. This is especially true in this low rate environment.

Third, demographic trends are favorable for our business model in terms of providing us investment opportunity at favorable returns. Housing in America remains a growing sector with investment opportunities that fit our mission. This has been the basis of why we invest in multi-family and single-family housing assets. Furthermore, the world's aging population is a growing factor driving the huge demand for assets that generate current income, potentially providing us the ability to grow.

Fourth, we are positioned to take advantage of the current environment. As I just mentioned, we've been very concerned about global macroeconomic risk. Our most notable strategy in this regard has been to maintain a long-duration portfolio position. As rates have fallen, we have benefited and that helped offset some of the losses from wider credit spreads. However, over the past nine months, the losses from diverging movements in the prices of our assets and hedges have more than exceeded our gains from the drop in interest rates. We continue to maintain a long-duration portfolio position as we are skeptical that a move higher in interest rates will be sustainable given high global debt, moderate inflation and mediocre global demand.

In fact, if interest rates do rise, we will be willing to reduce our hedges further and add to the duration position. We believe this strategy will support our ability to generate income in the months ahead.

Our diversified asset strategy benefits us in the long run, allowing us to earn higher net interest income while cushioning the portfolio in a variety of different environments. This is particularly evident in the last few quarters as we have benefited from prepayments in our CMBS portfolio, which have helped boost our quarterly returns.

A key tactic we have taken over the past quarter has been to modestly deleverage our balance sheet to build liquidity. The reduction in our dividend to $0.21 per common share reflects this deleveraging process, along with the impact on our financing costs, the 25 basis point increase in Fed funds in December.

Fifth, we take a long-term view with our business model and our strategies. As a result of the market environment, we have experienced more book value volatility than in the past, but we continue to believe in the high-quality assets that we own and the solid cash flow they generate. We do expect to make portfolio adjustments over time and redeploy capital from lower yielding assets with limited upside into those that have more positive return profiles.

Sixth, our dividend policy is driven by long-term considerations of the business and our shareholders. In the past, we've utilized our net operating loss carryforward to retain earnings instead of distributing them. Today, we are distributing more than we are earning from a tax point of view.

Let me comment on the tax character of the common stock dividend for the quarter. For the first quarter of 2016, we estimate that approximately 46% of the common dividend for tax purposes will be treated as a tax-advantaged return of capital as noted on slide 37 in the appendix.

Finally, take a look at charts on slides 12 and 13. I like to show these charts as a reason to take a long-term view of our business. As many of you know, the Board and management team have meaningful network exposure to Dynex and as a result, we will continue to manage our Company as owner operators. Our focus will continue to be on long-term cash flow and return goals and not on shorter-term market fluctuations. And with that, I will open the call up to questions.

(Operator Instructions). Douglas Harter, Credit Suisse.

Can you just talk about I guess how you guys went through the January/February timeframe? Did you add any assets during that period and how you are viewing the wider spread opportunity versus volatility in those decisions?

Sure. Let me just point out that Smriti Popenoe and Steve Benedetti are also on the call and they will chime in when appropriate on various topics.

Throughout this period, in January, obviously, it was extremely volatile. We are well-positioned from a liquidity perspective. We did not adjust our strategy in terms of trying to reduce our leverage of balance sheet. We simply allowed prepayments to come in. Our balance sheet did delever slightly.

What we did do though, we did take advantage this quarter of when rates did rise back up toward 2% to increase our duration and reduce our overall cost of hedging. We will continue, as I mentioned earlier, to look for that opportunity and we like that strategy in the sense that, when we look at the globe, the 4 or 5 points I brought out earlier in my comments, we're very serious about, especially number one about global debt. And we think it will have a huge impact going forward and so that leads us to a decision to continue to maintain this positive duration gap, and we do believe we have room to reduce our hedging costs more. And as we reduce our hedging costs, again, that will support our ability to generate income.

So thinking about whether we were on the edge of our seats to deploy capital at the widest spreads, no, we do not deploy capital at the absolute widest spreads and we are not sitting here overly concerned about it. The yield levels on some of the assets we look at, the high-quality assets such as the DUS paper are still the same. So spreads are kind of moving around, but our yield levels are still the same.

So again, from a risk/reward trade-off, you may not remember, but back probably one or two years ago, we said the biggest risk here is of surprises, and it's not the time to take outsized risk. We still continue to feel that way. We still believe that one of the best strategies we could deploy here over the near term will be to reduce our hedging costs.

Got it. Thank you, Byron.

Bose George, KBW.

Good morning. First on book value, nice job protecting in the quarter. Can you just break out some of the different buckets how they performed versus each other?

Sure, I can take that. We do have a chart in there showing that book value breakout between rates and spreads, so that's a chart you guys can look at, but also just turn to page 7 and 8, that's where we really talk about how the different parts of the portfolio performed. You can think of the agency ARM 5/1 spreads as a proxy for our hybrid ARM book. It isn't exactly how our portfolio performed, but it's pretty close. So over the quarter, you can see between 12/31/2015 and March 31, those widened about 10 basis points. DUS bonds look like they tightened in very slightly and I think overall in terms of marks between the on the run and off the run, you may have seen a little bit of widening.

The biggest difference in terms of spreads between year-end and quarter-end from March 31 was really in the CMBS sector. That sector continued to underperform throughout the quarter and what I will point out to you is that, intraquarter, probably in February, we saw much wider spreads than where we ended the quarter, and especially in the CMBS IO sector at this point, both agency and non-agency, there's been some movement back in since quarter-end, but really the higher-quality assets is what's been outperforming here, Bose.

Okay, great. That's helpful. Thanks. And then just in terms of where you see the best incremental value at the moment?

Yes, I think what's happened here is that you've seen high-quality assets really outperform in this last few weeks. And if you just focused on spreads, you might think that there's been a missed opportunity or things aren't as attractive as they were. What I will tell you is that, in general, we see the yields on our assets being pretty much the same as they were between now and year-end. So CMBS IOs are in the 3.5% to 4% range; agency DUS bonds are in the 2.5% yield range and so at this point, there's opportunity across the board and really the decision that you are making is when to deploy that capital, when to put your hedge on and how you are going to take that net interest income over time.

So we still see opportunity. We still see things as being biased towards high-quality assets because, as Byron mentioned, we still don't think this is a great environment in which to take outsized risk. Some asset classes look a little bit cheaper relative to others. However, I will say the fundamentals in those asset classes are different.

So for example, in non-agency CMBS, they look cheaper, but there's a reason. There's risk retention rules coming up. There's potential for fundamentals through the energy sector popping into that market that aren't as positive and on the multi-family side, things are starting -- we still believe in that story and we think it's a core part of our strategy, but again there I think caution is warranted with respect to where exactly you are making that bad one vintage, so it takes a little more diligence, if you will. But we think returns are fair here and we are actively looking through to see where capital should be put to work in the long term.

Okay, great. Thanks a lot.

Trevor Cranston, JMP Securities.

Thanks. I may have missed it, but I didn't see a discussion about the prepay speeds, specifically on the agency RMBS portfolio this quarter. So can you comment on that and what your outlook is for prepaids heading into the second quarter? Thanks.

I will go ahead and comment on the actual CPRs for the quarter. They were pretty much right on top of what we forecasted, around 15% CPR, 15 CPR, and at this point, in terms of an outlook, we are not seeing -- when you look at just what happened the first month of the quarter, it's pretty much on top of where we were in the first quarter and at this point, we are not changing anything in terms of our models and such on that.

I think in terms of what we are expecting though, guys -- sorry, Trevor, did you want me to give you just the market perspective on the prepays?

Yes, please. That would be helpful.

So on the agency side, again, we will probably see a pickup in speeds, but it's something that we've incorporated into how we amortize the premium over time. What I think has been really interesting to see is the prepays on the CMBS portfolio, so we've actually seen periodic benefit from that portfolio because the yield maintenance payments come back to us, and that's happening because we have this premium DUS book. So what we are looking for is really almost like a balance between the agency RMBS and the agency CMBS to provide us a bit of a cushion. So prepays (multiple speakers) in general is okay.

Got it. That actually leads into my second question about the prepayment conversation on the CMBS. Is there any way for us to think about projecting that going forward? Is there a seasonal component to the levels those come in at, or is it just sort of random based on when the loans prepay?

I wish I could tell you an easy way to look at it. We go through this exercise ourselves and it gets really lumpy. But I will say about half our book is a premium DUS book and they are seasoned bonds, so we are starting to see a lot more activity in that market now. With cap rates as low as they are, mortgage rates as low as they are, people are starting to take cash out of those properties and we think that this is a phenomenon that's probably going to be here for a while.

In terms of predictability, I'm not really -- I can't really say that it's seasonal or not. It is pretty random, but we know that we have half this book that's sitting in this bucket and we know that there is the potential for it to prepay and at least cushion any of the increase in RMBS speeds, if any. But if we have a methodical way to go about it, which we still haven't -- it's very difficult to predict -- we will definitely share that.

Trevor, let me add one broader thought around this, which is the portfolio was designed -- and I'm only saying this because of some of the feedback and questions I've gotten from some of our investors and just trying to understand the risk in the mortgage REIT business model as a whole, and I know there's been a lot of chatter about prepayment speeds. Over the last eight years, as we've put together this portfolio, we've thought forward in terms of what might happen in terms of prepayment speeds.

Our residential book was specifically selected to prepay to the slow side and then we married that residential book with this commercial book to cushion the overall prepayment experience, which is what has happened. We've got true prepayment protection on the commercial side. It's been a positive as rates have come down. We have leaned on the commercial sector more over the last two to three years because we have been concerned about a steady move down in rates and we continue to have that in the back of our minds, especially if you look at the macro factors that I pointed out at the beginning of my comments.

So prepayment risk is real. One of our largest concerns about 15 and 30 years and why we have not delved into those sectors has been prepayment risk, and so we are happy to have the structure of the portfolio that we have. That's one of the core reasonings behind it. We take prepayment risk, but as the portfolio is structured today, we have truly -- it has cushioned the impact of this environment on our overall performance.

Got it. Appreciate that context. Thanks.

(Operator Instructions).

Okay, operator. If there are no more questions?

Yes, sir. This concludes our question-and-answer session. I would like to turn it back to management for closing remarks.

Thank you all so much for joining us on our call this quarter. We've been pretty steady in terms of how we view the business, how we view the marketplace and in our actions, and we will continue to perform and execute our strategy as we have in the past. We are owner/operators and we look forward to your participation in our second-quarter call sometime in July. Thanks again.

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.