Dynex Capital, Inc. (DX) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Dynex Capital, Inc. Market Update Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Alison Griffin, Vice President of Investor Relations. Please go ahead.

Thank you. Good morning, everyone, and welcome to our update call. Joining me on the call today is Byron Boston, President and CEO; Smriti Popenoe, CIO; and Steve Benedetti, CFO and COO. 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 such as the amount, timing and funding of future dividends, 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, timing of certain events and the impact of the novel coronavirus outbreak and the Federal Reserve's reactions to it on the U.S. financial markets could differ considerably from those projected and/or contemplated by these forward-looking statements as a result of unforeseen external factors or risks. For additional information on these factors or risks, please refer to annual report on Form 10-K for the period ending December 31, 2019, as filed with the SEC. The document may be found on the Dynex' website under Investor Center as well as on the SEC's website. And with that, I'll turn the call over to our CEO, Byron Boston.

Thank you, Alison, and thank you, everyone, for joining the call. I will make a few statements about the company, followed by our current thinking on the markets; and I'll have Smriti Popenoe, our Chief Investment Officer, give you some specific details around our portfolio. In our view, the price action in our shares, both common and preferred, does not reflect reality and appears once again to be grossly mispriced. There is an enormous amount of fear and imprecise information in the market. Hence, we want to help our shareholders understand where we are today. First, our top-down disciplined macroeconomic process has allowed us to be prepared for the current environment. Our up in credit and up in liquidity strategy has been invaluable. We're operating with our normal, methodical, disciplined process. And with that, I'm going to turn it over to Smriti, she'll give you a few details on the overall structure of the portfolio and I'll come back and give you some thoughts on the market.

Thanks, Byron. We estimate our current book value to be relatively flat to slightly up versus year-end between $17.75 and $18.75 per share as of the close of business Friday, before the action announced by the Fed on Sunday. We expect book value to benefit from the Fed's announced actions to purchase treasuries and mortgage-backed securities. Bid offer spreads are wide in this environment, particularly in the specified pool market. Since our earnings call, we have continued to actively manage our hedge portfolio, maintaining a long-duration position as interest rates declined. We remain with that position and have swaps and option-based hedges designed to protect against higher interest rates. The long-duration position gave us the flexibility to preemptively take profits on the sale of $1.8 billion in Agency 30-year pass-throughs before they widened. By making these adjustments, we have substantially reduced future sensitivity to earnings from prepayments, an important factor in a 1% 10-year yield environment. We also put ourselves in a position to take advantage of the wider spreads we have seen in many years. We have selectively reinvested a small portion of these proceeds in Agency CMBS, which have structural prepayment protection. Our leverage is down from 9x at year-end to approximately 7x after the sales. Our investment portfolio balance today stands at approximately $4.1 billion down from $5.6 billion at year-end. And it now consists of approximately $3.3 billion in Agency CMBS and CMBS IOs, $930 million in 30-year pools and a net TBA short position of $115 million. This brings the allocation to Agency CMBS to approximately 80% of our total balance, up from 50% at year-end. As we mentioned on our last call, net interest spreads have been expanding over the last few quarters. With a modestly smaller balance sheet consisting of more durable cash flows from Agency CMBS, we continue to expect that net interest spreads will cover the current level of the dividend. The Fed's action on Sunday should further enhance our earnings, and we expect that our net interest spreads will widen. We continue to be able to access repo financing. We are not experiencing any increases in haircuts or shortening of repo terms. We have seen the Fed inject substantial amounts of liquidity into the repo markets through their repo operations. Repo rates continue to decline as the liquidity from the Fed comes online. I'll now turn it back over to Byron to give you our thoughts on the markets and our macroeconomic outlook.

Okay. Turning to the markets and our macro outlook. The current pandemic is an exogenous shock to our global economic system. If this shock lingers for a long time, the negative impact will eventually be exacerbated by the large amount of indebted consumers, corporations and governments. At Dynex, we are not doctors or scientists, and hence, it is uncertain to us how the future might evolve. However, we are skilled finance and economics professionals and portfolio managers, hence, we are sticking with our disciplined process of running various scenarios that might play out in the future. We expect governments to continue to respond and dedicate significant resources to stop the pandemic while attempting to mitigate its social and economic impact. In the financial markets, we expect to see continued central bank intervention. The Fed's action on Sunday, which appears to be coordinated, demonstrates the commitment of central banks to ensure efficient functioning markets and proactively supporting the global economy. We are revising our near-term range on the 10-year U.S. Treasury yield from 1.5% to 2.5%, down to 0.5% to 1.5%. With the lower end of the range reflecting more crisis types of situations, we continue to believe that a liquid portfolio with high-quality, agency-guaranteed security is essential to navigate in the coming months. We believe we will have opportunities to invest both Agency CMBS and in Agency 30-year residential mortgage-backed securities at highly accretive long-term risk-adjusted returns. In summary, we estimate our book value is relatively flat to slightly up between $17.75 and $18.75 per share as of close of business Friday, which should benefit from the Fed's action on Sunday. Next, we have reduced our prepayment risk with the sales of residential mortgage-backed securities. In addition, we remain up in credit, up in liquidity and we believe we are well positioned to navigate the environment. With the current portfolio, we expect a wider net interest spread would shift to generate earnings to cover the current level of the dividend. The net interest spread should further expand as a result of the just-announced easing from the Fed. Now you can expect us to remain dynamic on both sides of the balance sheet. You can also expect us to continue to manage our capital with the top-down methodical disciplined approach we have always used. Our leverage is lower, and we have the capacity and financial flexibility to add assets at wider spreads. It is important to note that given the level of uncertainty around the environment and how far interest rates have fallen, we are taking a balanced approach to the future so that we are prepared to manage our business in a variety of scenarios, including those where interest rates rise. Now I'd like to add that during my tenure at Dynex since 2008, we have operated in a virtual environment. We have invested in technology and built durable processes around remote working over many years. As an early adopter of this mode of operation, we believe our people, processes and technology are well positioned to handle the challenges posed by operating during this pandemic. All of us here at Dynex are your co-investors. We are aligned, and we are all working diligently to preserve the value that we have created for shareholders over the years. Please feel free to contact Alison Griffin if you have further questions or concerns. Our contact information is on our website. Our thoughts are with all of you who may be impacted by the virus. Please be safe. Thank you. Operator?

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.