Dynex Capital, Inc.
Q4 2016 Earnings Call Transcript

Published: 15 Feb 2017

[Operator:]

Good morning. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the Dynex Capital, Inc. Fourth Quarter 2016 Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Alison Griffin, Vice President, Investor Relations. Please go ahead.

[Alison Griffin:]

Thank you, operator. Good morning, everyone and thank you for joining us. With me on the call today is Byron Boston, CEO, President and Co-CIO; Smriti Popenoe, EVP, Co-CIO; and Steve Benedetti, EVP, CFO and COO. The press release associated with today’s call was issued and filed with the SEC this morning, February 15, 2017. You may view the call or the press release rather 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 maybe found on 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, 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 Fourth Quarter 2016 Earnings Conference Call link on the Presentation page of the website. I now have the pleasure of turning the call over to Byron.

[Byron Boston:]

Good morning. Thank you, Alison and thank you all for joining us. 2016 was a year defined by three major bouts of volatility followed by periods of comp. The volatility originated on three different continents

[Operator:]

[Operator Instructions] Your first question comes from the line of Doug Harter with Credit Suisse.

[Doug Harter:]

Thanks. Byron, in light of those comments and you have been saying for awhile that it’s kind of an uncertain world, are you changing the risk tolerances around the portfolio to try to have tighter ranges in book value performance?

[Byron Boston:]

Let me say this. We will as we see the risk factors, we absolutely will. Well, we didn’t, if you look at 2016, the results are almost identical to the duration position that we were running. As we – what we try to lay out here in the appropriate manner is we are looking at the risk factors today and we will adjust and be nimble with our hedging strategy to reflect our risk views. So the answer is yes, when appropriate. What’s important to understand in the point we are trying to make is long-term that we find this transition period is short.

[Doug Harter:]

Got it. And then thinking about kind of where you view spreads today across – kind of across the board and the risks to those in the environment that we are in?

[Byron Boston:]

Spread risk is a risk that mortgage reached there in general. If you look at spreads the last year, spreads on a tighter end of the range. And if we thought spreads were really, really wide to be honest with you that we probably have a bigger portfolio and a larger balance sheet right now, but we don’t. And that’s what we referred to as trying to be nimble and wanting to take advantage of wider spreads. It’s almost been a straight line in 2016 whether you look at high yield, CMBS. Agencies performed a little differently versus if you look at agencies, treasuries and swaps you can come up with two different opinions. But if you think about credit spreads globally, they have – we have been on a steady tightened cycle over the last several months. And in that environment, we become a little more cautious in terms of the size of our balance sheet.

[Doug Harter:]

Alright. Thanks Byron.

[Operator:]

Your next question comes from the line of Bose George with KBW.

[Eric Hagen:]

Thanks. Good morning. It’s Eric on for Bose. Maybe following up a little on the credit spread conversation that Doug was just having with you, what is your base case expectation for how spreads could behave if long rates were to track significantly higher from here and at the same time, we do get a couple of Fed hikes both this year and next?

[Byron Boston:]

So there are multiple paths here, so let’s say if rates go up and the central banks of the globe continued to behave as they are today. I think you are going to end up still seeing significant spread support. And so the key thought to this answer, to be honest with you, is really there are multiple scenarios here, a huge amount, in fact all of them are related to government behavior. Heavily, number one, how will the central bank balance sheet of the globe react to the environment, if they continue to invest money that provides enormous amount of support for spreads. There could be an adjustment in terms of spreads. We at Dynex, we still are not believing in a sustained move and we do think about 3% on the 10-year. The ability of the global economy to handle a material sustained move, higher in interest rate about 3% on 10-year. So we do think there are limitations. It really comes from our view of global debt. Global debt is at an all-time high. We think it will ultimately prove to be a limiting factor in terms of where interest rates can go and ultimately where spread risk resides.

[Eric Hagen:]

Thanks.

[Byron Boston:]

We would add one [indiscernible].

[Smriti Popenoe:]

One more point on that is just that in previous environments, we weren’t sitting with as much event risk around government policy as we are sitting right now, right. So for the first time, you are faced with the potential that the Fed changes its investment policy around their balance sheet, how that impacts the market. It will be the first time and we have said this many times that you won’t to have a government entity involved in the mortgage market, if that indeed ends up being the way they do it. And I think the second thing is just with GSE reform, all of these things have been on the table in the past, but the likelihood of those things changing materially I think really impact your willingness to really take a lot of spread risk in here. So just the level – it’s not that it’s uncertain. And the way I kind of think about it is the number of outcomes as well as the range of outcomes. It’s just substantially higher.

[Eric Hagen:]

Right, that’s a very thoughtful response. One more if you don’t mind for me, I want to ask about the agency ARMs even though that portfolio seems to be in runoff mode, what are your expectations for prepayment speeds on both current recent loans and longer reset ARMs? Thanks.

[Smriti Popenoe:]

Yes. I think so there, you are very rightly thinking about that. We – there has been an increase in prepayment speeds. It happened in the fourth quarter. And I think it’s continued here in the first quarter. What we see there is just the steepness of the yield curve is affecting prepayment behavior. And as these bonds approach reset date, as they get to the point where homeowners are actually seeing mortgage interest rates rise and the LIBOR rise, you are seeing people lock-in longer term financing rates. So that’s going to factor in just in terms of, as Byron mentioned, it’s how we are thinking about asset allocation and capital allocation in the future. But for now, it doesn’t appear that the normal seasonal slowdown that you would see in December, January, it’s really sort of making a big impact at least in the op market, to be honest with you.

[Eric Hagen:]

Got it. Thanks for the comments guys.

[Operator:]

[Operator Instructions] Your next question comes from the line of Trevor Cranston with JMP Securities.

[Trevor Cranston:]

Hi, good morning. Thanks. One question on the funding side, there is the – you mentioned in the press release that increase in funding costs had a little bit of an impact in the fourth quarter. Can you talk about what you are seeing in the repo markets so far in 2017 maybe versus where you were seeing things priced in December and towards the end of the year and if there has been any meaningful change there? Thanks.

[Smriti Popenoe:]

Absolutely. Hi, Trevor. So, effectively – so the repo markets really went through a truly big transition in the fourth quarter of last year, okay. We went through the money market reform process. That caused a severe spike, which had basically worked itself through the markets. And right now, what I would say is the ratings that we are seeing today reflect that tightening that the Fed put in, in December, alright? So in terms of the level of rates, you are just seeing yes, repo rates are higher than they were on average and we are probably seeing on average somewhere between 5 to 10 basis points higher versus the average of the fourth quarter, alright? And then in terms of availability, there has been a pretty significant difference. I mean, there is a lot of cash in the markets right now. Couple of reasons one, we think obviously more structural related to money market reform. That money is here. It’s here to stay. We think as that money work through the system. You will see its impact on 1-month and 3-month LIBOR and also coming back obviously into repo rates. And then secondly, you have got two things kind of moving over us coming in the next few months, debt ceiling negotiations. We have got treasury basically tax receipts, things like that, that are causing a lot of flushness in the cash markets right now. But overall, I would say availability is good. Yes, the pricing is higher and it’s just reflecting what we see as the economic effect of that tightening in the fourth quarter.

[Byron Boston:]

And let me add one other thing just a high level comment on the regulatory environment. I am actually excited and very interested to see how we evolve at this point. There are some major personnel changes happening in Washington, DC. And even though government policy is very uncertain at this point, the one thing that I believe that the highest probability event is that regulation will change and we believe that it may have a positive impact here on both sides of the balance sheet. So, we are anxious and excited to see ultimately how that evolves. But what has happened is it has taken the dark cloud from over our heads in terms of the kind of valid nature of the regulators in Washington, DC that could have led to even a potential, more tighter financing environment in the future. We believe that’s off the table at this point. So, we are kind of sitting kind of anxious and kind of excited to see how this changing regulatory environment evolves in front of us. We believe there will be positive opportunities on both the asset and liability side of the balance sheet.

[Trevor Cranston:]

Got it. Okay, thanks very much for the comments.

[Operator:]

[Operator Instructions] At this time, there are no additional questions. I would like to turn the conference back over to Byron Boston for closing remarks.

[Byron Boston:]

Thank you very much. I appreciate everyone joining us this morning. Let me make one final comment just listening to the questions that Doug, Bose and Trevor answered. A lot of questions that you may have will depend on making some type of specific prediction about government policy something that we are not willing to do here today. What’s your main point we are trying to make is that we are nimble, comes to hedging, coming to investment we will adjust the portfolio appropriately. At our long-term behavior, at our long-term principles in terms of how we manage this business are the same and we put the long-term charts in there, so you can just look back and just be reminded of our behavior in the past. And with that, I appreciate you guys joining us and we look forward to you joining us in our next quarterly conference call.

[Operator:]

Thank you. This concludes today’s conference. You may now disconnect.