Q1 2024 Dynex Capital Inc Earnings Call
Thank you for standing by.
My name is jail and it will be a conference operator today at this time I would like to welcome everyone to the di next capital Inc. First quarter 2024 earnings Conference call.
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After the Speakers' remarks, there will be a question and answer session. If you would like to ask a question. During this time simply press star followed by the number one on your telephone keypad.
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Thank you I would now like to turn the conference over to Alison Griffin Vice President of Investor Relations you may begin.
Alison G. Griffin: Good morning, and thank you for joining us for our next capital's first quarter 2024 earnings call. The press release associated with todays call was issued and filed with the SEC. This morning April 22024.
You May view the press release on the homepage of the <unk> website at <unk> capital Dot com as well as on the Sec's website at SEC Gov.
Before we began 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 our disclosures filed with the SEC, which may be found on the Diamond website under Investor Center as well as on the SEC website.
This conference call is being broadcast live over the Internet with a streaming slide presentation, which can be found through a webcast link on the homepage of our website.
Slide presentation May also be referenced under quarterly reports on the Investor Center page joining me on the call as Byron, Boston, Chairman and Chief Executive Officer, Murphy, <unk>, President and Chief Investment Officer, and Rob Collagen Executive Vice President Chief Financial Officer.
It is now my pleasure to turn the call over to Byron.
Thank you Alison.
We delivered a solid two 1% total economic return for the quarter and as a company. We continue to execute on building our company with our long term strategy and vision.
Listed on the New York Stock exchange in 1989, <unk>, the longest tenured mortgage REIT.
The company in 2008 with a goal of developing a new strategic plan for growing diagnosed capital balance sheet paying a steady above average dividend and to protect our shareholders' capital over the long term.
During this period, we have guided our shareholders through multiple extraordinary market cycles, we have consistently made the necessary decisions to adjust our people processes and technology.
Alison G. Griffin: And strategy to continue to perform all future environments. We have successfully refresh the skill sets of our board of directors multiple times and focused on developing the talent of our team to reduce key person risk and to increase the probability that we continued to pay our dividend and deliver attractive returns.
One of the strongest factors in our success that we have always been guided by a core set of principles and values. Our goal is not to win at any cost, but we will do what is ethically correct to guide our shareholders through all market environments.
Over the past eight years global risks have continued to intensify and the <unk> team is ready.
<unk> and well prepare.
I will now turn the call over to Rob and Smriti to further elaborate on our performance for the quarter and to further explain how we are positioned to continue to perform as the future unfolds.
Thank you Byron and good morning to everyone joining the call. This morning.
Rob: <unk> delivered an economic return of two 1% for the quarter and.
Book value ended the quarter at $13 20 per ton.
Common share.
The drop in the 10 year Treasury that started last October began to reverse course as the expectations for federal funds rate cuts began to date.
While the 10 year Treasury was up approximately 30 basis points from the end of the year book value was essentially flat.
This quarter, we raised $87 million of new capital, which was deployed in February and March when spreads were wider.
The reduction of book value was about 7% in the quarter related to this capital raise.
We had one other item affecting earnings this quarter.
Fly with the accounting standards for share based compensation, we had an accelerated vesting condition.
The impact of this acceleration compared to a standard vesting schedule reduced earnings by <unk>.
And I expect this to recur annually in the first quarter of each year going forward.
Beyond that we delivered exactly what a mortgage REIT should deliver in a period that had lower volatility.
We delivered a stable book value and a healthy dividend.
We also announced the renewal of our stock buyback program, which allows us to buy up to $100 million of common stock and $50 million of preferred stock.
Our previous program expired at the end of the quarter than.
And we need to always have a program in place to ensure that we can support the stock price and buy shares if or when or common or preferred shares priced at an extreme discount.
In the first quarter Treasury futures remained our preferred hedging instrument.
Hedge gains and losses are a component of REIT taxable income and will be part of our distribution requirement with other ordinary gains and losses.
This quarter, we realized the hedge loss, which reduced our aggregate gains, but we still have a large cumulative benefit for the portfolio.
Post quarter end, our hedges continue to perform well as rates continue their march upwards.
And then the inverted yield curve environment like we have now we expect our hedges have a positive carry which will support earnings.
Please see page six in the earnings release, covering the hedge portfolio and page 11 in the earnings presentation for more detail on this topic.
With that I'll now turn the call over to Smriti.
Smriti: Thank you, Rob and good morning, everyone.
The global economy continues to transition to the post pandemic new normal.
We have been planning for an evolving environment.
Volatility in periods of calm.
Smriti: In the near term our risk management framework includes tail risks for modestly higher policy rates and much lower rates overall as well.
We remain highly cognizant of geopolitical risks, especially elections here in the United States.
We expressed our view last quarter about the unsustainable use fiscal trajectory. This remains a factoring relates to possess unique.
Therefore, our investment and capital management strategy continues to be designed for a bumpy ride.
Smriti: We remain focused on high quality liquid agency RMB, yes.
Which offer compelling long term risk adjusted returns.
Portfolio is positioned to meet our long term target returns at today's spread levels.
We see bouncing volatility as opportunities to add assets.
Spread tightening any eventual fed eases or tailwind as an upside, but they are not necessary for us to generate returns.
<unk> MBS return attractive and accretive today versus our cost of capital we expected volatility in economic data to be a major factor driving MBS spreads.
So far this quarter, we have seen higher volatility versus last quarter and as a result, our models have option adjusted spreads approximately 15 basis points wider across our portfolio.
We remain well off the Wides of agency MBS seen in November 2023 in October 2022.
We feel the range of MBS spreads will be narrower going forward.
<unk> for the sector has improved substantially since the fourth quarter of 2023 with the return of banks.
In addition, it is expected that the fed will soon be announcing a reduction in the pace of its quantitative tightening campaign and while this reduction may not impact MBS directly.
The change, which add to reserves to the banking system is yet another positive for the sector.
We expect a short term technicals have higher supply will push spreads wider all else being equal and this might be exacerbated by market volatility.
Over the medium and long term. However, we continue to expect tighter equilibrium spreads for agency MBS in the absence of severe disruptions. We would regard any short term widening as they did bring opportunity.
I'd like to cover our thoughts around capital raising in this environment.
All our capital decision, making is driven by the same top down macroeconomic space thinking that drives our investment process.
Primary criterion when raising capital is whether we expect to earn a long term investment return that meets or exceeds the long term level of the dividend.
In today's investment environment. We believe there is a compelling opportunity to earn this type of return in agency MBS. This is driven by the transition from the risks being housed on public balance sheets like the fed to private capital like thanks.
In other words, we believe the total economic return from our growing and scaling the business in a healthy investment environment.
Exceeds the cost of capital is accretive to shareholders and lays the foundation for the market to put a higher valuation on our unique platform.
As always we stand ready to buyback the stock in extreme disruptions and here again.
Alright, the marginal return on buybacks versus investments.
Every decision has a long term lens on it.
Finally, we believe there are significant strategic benefits to growing the company building resilience and scale is an important strategic goal to ensure the longevity of our company.
Moreover, factors such as index inclusion can drive additional shareholder return and liquidity in the stock.
Our view remains that todays spreads offer compelling returns enhanced by tighter long term equilibrium mortgage spreads.
We remain focused on delivering long term total economic return to our shareholders I'll now turn it over to binary.
Thank you Samantha our company is uniquely positioned for this environment today.
Today, we are generating income from our government guaranteed asset class with flexibility and expertise to pivot across the credit spectrum.
We have an experienced team with a stewardship mindset.
Disciplined process and a track record of excellence our actions are guided by our long term strategic process that we believe will continue to drive shareholder value well into the future.
We're growing our income generating company as the demographic need for stable income is increasing due to the aging of global populations.
In the U S. The need for income is expected to rise as the baby boom generation moves through retirement.
I just returned from an educational trip to China, Hong Kong, and South Korea and observed similar trends in those countries.
These demographics support the long term value of the <unk> platform, providing further upside to shareholders I will be sharing more on this piece.
Piece later this week, we thank you for your interest in dynamics and look forward to speaking with you again next quarter I will now open it up for questions.
Thank you the floor is now open for questions.
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Your first question comes from the line of George <unk> of <unk>. Your line is open.
Hey, guys. This is bose good morning. Thank you for the first question and thanks for the update on spreads quarter to date can we also get an estimate of where your book value is yes.
Yes good.
Good morning, Bose So the book as of Friday again these are unaudited.
Not fully closed numbers.
At $12 26.
So that's down about 7% and Thats really commensurate with the 15 basis points of spread widening and OAS terms.
Okay, Great. That's helpful. Thanks, and then in terms of your.
The current spread so where would you estimate the current Roes are.
You noted it's above your cost of capital and when you think about your cost of capital is that essentially the common dividend or how do you see your cost of capital.
<unk>.
I'll answer the first question first we are seeing marginal returns on agency MBS anywhere from <unk>.
<unk>, 9% on the low end to 18% on the high end, so high double digit Roe.
On the current coupon mortgages.
The cost of capital is.
An interesting question.
Smriti: <unk> of it in terms for common shareholders obviously.
Smriti: The dividend yield.
Smriti: <unk>.
And on on when we're thinking about optimizing sort of the balance sheet itself. It's a blend of.
The common preferred and then any other financing vehicles, we use witches, which is right now it's the repo market.
We're really looking at a blended cost and again.
Our long term level of the dividend when we think about the cost of capital.
Speaker Change: Okay, great. Thanks, a lot.
Okay.
Speaker Change: Your next question comes from the line of Doug Harter of UBS. Your line is open.
Alright. Thanks, just first to clarify that book value update you gave how does how does that treat the April dividend.
Debt net of the April dividend.
Okay great.
And then just just more on the capital raising.
You talked a little bit about the returns youre seeing on the cost of capital, but I guess, just how do you think about what is an appropriate.
Payback period or kind of just if you could just help us a little bit more kind of through the thought process.
The attractiveness of.
And kind of your decision process to to raise capital and deploy that.
And then just along those lines.
That's kind of how you think about is it total is it just the return as of the spread you're buying it out or do you contemplate the potential for tightening widening and kind of how you think about the risk reward from that perspective as well.
Absolutely so.
I'll just say.
Right off the bat, we believe our company should eventually trade above book.
The reason is that the value of the infrastructure. We've created here at the company is not being reflected in the valuation that's number one.
However in the short term, we are raising capital because of the compelling returns.
And our long term view of those returns.
Alright.
In terms of what the payback period is and so on and so forth.
When we are raising.
As I mentioned in my prepared comments, we're really evaluating the long term Roe versus the long term level of the dividend when that is accretive it makes sense for us to raise.
In our in our theoretical process, we don't give ourselves credit for spread tightening.
Those payback periods, which can range anywhere from 152 years become a matter of months. When you include spread tightening.
So for example, if you look on the page in the deck, where we talk about our risk profile.
A 10 basis points tightening in OAS has a 5%.
Increase in book value, which is which is instantaneous right. So.
Once you factor in spread tightening those time periods to earn back any kind of dilution becomes that much faster, but we're not counting on that and thats really upside.
Over the long term if we expect.
Spreads between the asset returns and the dividend yield to be accretive over time.
Thats good enough reason for us to to raise.
Does that answer your question Doug.
It does.
Just I guess just along those lines.
How are you thinking about the impact of.
You know kind of issuing below book to kind.
Kind of how that affects that trading in the short term and how that might impact your cost of capital.
And the ultimate goal that you are beliefs that you articulated of getting back to trading at or above book.
I think I think it's very hard.
Sometimes when you are in an environment like the one we're in where mortgage spreads are really at the wider end of the range and we're actually going floating back and forth.
In that wide end of the range, it's very hard to quickly see the payback from these types of decisions okay.
So in the short term I don't expect payback.
In the next one or two or three quarters, where we're thinking about these decisions in terms of $6 seven 910 quarters.
That's when you'll see the payback so at the moment right the.
The market isn't seeing or the or maybe investors not seeing necessarily the value of these things, but I can tell you. The moment, we see a definitive trend tighter in mortgage spreads you will see that payback and at that point I think it starts to become accumulative and virtuous story right now there is still.
A level of uncertainty in terms of not just the level of mortgage spreads with the range of mortgage spreads, which by the way. We believe is going to be tighter over time, but even even now versus last year, we expect mortgage spread volatility to be lower but I think part of this is just.
Investors need to see one or two quarters of that spread tightening come into to sort of buy into it. So I understand why why it's not being priced and right now it doesn't deter us from wanting to.
Wanting to make the right long term decision for shareholders.
Excellent merits to that last point, Doug Doug remember, we manage for the long term and that we've always done that we always will do that we think is the best way to manage a mortgage REIT.
Great Robert.
Sure Doug just one other point.
We as well as others in this space have used the ATM programs. When you think about other capital markets alternatives. The ATM is right now the most.
<unk> way for us to raise capital so while it was.
At a small discount.
The discounts would have been much larger than other forms of capital raising so we're very cognizant of it.
Something that we focus on a lot we don't want to.
Be dilutive, but right now.
ATM program and what we're able to accomplish in the quarter was actually very efficient.
I appreciate all those answers thank you.
Doug.
Your next question comes from the line of Matthew <unk> of Jones trading your line is open.
Hey, good morning, guys. Thanks for taking the question could you talk a little bit about capital allocation and the thought on rotating into the TBA is.
Yeah, Hi, Matt.
So one of the core principles is to have a relatively balanced Cooper.
Coupon profile.
And in terms of just looking at our outlook for interest rates and interest rate volatility.
We're about I would say 50 50 or thereabouts.
In the higher coupons versus the lower coupons.
So we were slightly underweight, the higher coupons coming into the quarter relative to sort of like I would really say.
The real deep discount.
Mortgages.
Higher coupons did underperform in the two episodes of spread widening that we saw in.
February and March and so our allocation is that part of the coupon stack.
Okay. That's helpful and then if youre able to provide leverage quarter to date.
And just your thoughts around how you're thinking about leverage given the volatility that we've seen over the past couple of months.
Yes, I'll, let Rob give you the exact.
Change in leverage for the quarter, but in general I.
I would say that the amount of leverage that we have on right now.
Is we're comfortable with this level of leverage for this level of spreads in our.
Our view on the market.
We have.
We have room to add leverage.
The capital raising in the first quarter allowed us to do that.
So we think we can still take leverage up to the extent that we get opportunities to do that.
And again look.
This is the kind of market environment, where you have to not only stand ready to take leverage up but you've got to be ready to take it down because it's just so many of these exogenous shock.
Now our view is that mortgage spreads will really start to trade in a tighter range.
And then how they how much they have.
Means that they've been in 2023 of 2022.
Thats predicated upon.
Banks coming back into the market and there being a much stronger technical bid for mortgages. So the wides may not be as wide as as 'twenty, two 'twenty three and the.
Types, maybe a little bit tighter so youre really getting.
A much tighter level of mortgage spreads to to work with.
So.
That informs why are the Leverages, where it is today do we have with <unk>.
Leverage towards the end of last week was a valley in the half so up a little bit from the end of the quarter.
That's helpful.
The book value being down okay.
Okay, great. Thank you guys.
Again, if you would like to ask a question. Please press star one on your telephone keypad your.
Your next question comes from the line of Eric Hagen of BTG. Your line is open.
Hey, Thanks. Good morning, guys can you maybe elaborate on some of the tail risks that you see in the market right now I think you mentioned something in your opening remarks.
In addition to that maybe addressing some of the conditions, which could drive even more material.
<unk> for spreads and what we what we might be looking out for there. Thank you guys.
Thanks, Eric Thanks for the questions.
Look I think I think the markets are relatively unprepared for a pickup in inflation.
Continuing strength in the U S economy, or a stagflationary type of scenario that results in the fed actually having to put <unk> back on the table, but then the economy actually doesn't doesn't perform so well.
So those are two things on the list when you think of known.
Known unknowns relative to unknown unknowns.
That's a that's a risk that we're taking very seriously here.
We've always called this kind of an evolving macroeconomic environment and its doing exactly that.
No one here at Dynegy is expected inflation that come down.
In a straight line.
You've seen some of our Linkedin posts on on the connection with volatility.
And that brings me to the second part of your question.
Speaker Change: Mortgage spreads are a really very very dependent here on macroeconomic volatility the more volatile macroeconomic data are.
Theres more delivered volatility.
And therefore that in implied volatility go up that affects mortgage valuations mortgages tend to widen in those environments right. So anything that brings mortgage.
Mortgage spread volatility and macro volatility down is very positive for mortgages.
And we actually think that's not that's within the realm of possibility.
The trajectory from 7% inflation to 3% inflation now, we're just talking about 3% inflation to 2% inflation that the volatility of the data is much lower here. So you should see delivered ball start to come down and Thats very supportive for mortgage spreads.
The other part I would say is just the technicals are so much better.
This go around.
We did have some spread widening here in <unk>.
April it's been remarkably orderly, we have not seen a substantial amount of dash for cash kind of run for the hills.
So the mortgages you own that has not happened.
Even though we're seeing the same types of interest rates levels that we saw back in October November of 'twenty, three so that's actually a very encouraging prospect.
And then finally just.
In terms of any other things that would that would cause mortgages to tighten that I talked about the fed tapering quantitative tightening.
That in and of itself may not affect mortgages directly.
But you've got to think on the margin. They are increasing bank reserves banks have been actually investing more in securities rather than loans and anytime there is a bid for that duration or that risk free asset. We think that's supportive of mortgage spreads as well.
Thanks, that's really helpful. Maybe.
Follow up on the spread conversation I mean, you mentioned banks coming back into the market I mean, how meaningful do you think pressure as in other asset classes that might drive that like commercial real estate.
And how do you even control for the actions of larger banks.
And their appetite for.
Mortgages in duration.
So I think the larger banks never actually left the market.
They on the margin there bid drives.
A lot of what's going on in the first quarter Interestingly, it's actually been not the larger banks, it's been the middle tier banks and smaller banks that have wanted to buy a CMO floaters.
That's been that marginal driver of.
Mortgage activity.
In the first quarter.
No.
If to the extent that you get the larger banks stepping back up in terms of the level of purchases I mean, that's it that's a massive tailwind for mortgage spreads, but I don't think that we've actually seen that just yet.
Got it. Thank you guys. So much thank you.
That concludes our Q&A session I will now turn the conference back over to Byron Boston for closing remarks.
Simply put we thank you all for joining US today, we want to remind you that we have a very long term strategy.
And we're always thinking forward as Smriti has explained so thank you again for joining us today, and we look forward to chatting with you again next quarter.
This concludes today's conference call you may now disconnect.
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