Release Date: July 22, 2024
For the complete transcript of the earnings call, please refer to the full earnings call transcript.
Positive Points
- Dynex Capital Inc (DX, Financial) achieved a significant milestone with total equity surpassing $1 billion for the first time in its 36-year history.
- The company raised $125 million of new capital, with a portion already invested and the remainder reserved for future opportunities.
- Net interest income was positive this quarter due to higher-than-expected paydowns on older, lower-yielding assets and the addition of newer, higher-yielding assets.
- Expenses for the second quarter were down, with equity-based compensation expected to recur only annually in the first quarter going forward.
- Dynex Capital Inc (DX) maintains a high degree of liquidity, positioning itself to capitalize on attractive long-term returns in the second half of 2024.
Negative Points
- Economic return was a negative 2.4% for the quarter, impacted by a 20 basis point increase in the 10-year treasury and wider spreads.
- The company issued 10.5 million shares at $11.88 per share, which was below book value, raising concerns about shareholder dilution.
- The macroeconomic environment remains vulnerable to exogenous shocks, which could result in bouts of volatility.
- The company's stock continues to trade at a discount relative to forward returns, indicating potential undervaluation by the market.
- There are risks associated with potential policy changes and fiscal policy shifts, particularly in the context of upcoming elections.
Q & A Highlights
Q: Hi, good morning. First of all, congratulations to Smriti and Rob and all the others that have new positions or just joined. First, I was hoping you could share a bit more about the timeline to invest the new capital that you raised, coupon projected ROE, if you can detail anything around there?
A: Yeah. Hi, Jason. Good morning and thank you for the question. So basically, we have thought in terms of the second half of this year as being an environment that would be appropriate to deploy that capital. ROEs right now on a static basis are between 11% and call it 19% on the higher coupons. Those are good ROEs. We believe mortgages are in the middle of the range on a nominal spread basis. So they've been trading as tight as like [135] versus the seven year and as wide as [155] versus the seven year. We're sitting right in between right now in terms of that range. So still attractive returns, but one of the things that we're very focused on is just coming known-unknowns and unknown-unknowns, as I mentioned in the prepared remarks, and that we believe will actually possibly allow us to add assets at even wider spreads. And that's kind of why we're being patient about the capital deployment.
Q: Understood. And maybe to drill down on that a little bit when you think about the potential for interest rate volatility going forward? What sort of risks are biggest on your radar right now? Whether that's the election, whether that's upcoming Fed policy, anything else out there that stands up?
A: I think what's interesting is that we are in an environment of lower vol. So vols are actually trending down and that's been very positive for mortgages and will continue to be positive for mortgages. So I think that is something versus last year that we feel is a big tailwind for the position. What we're thinking about are exogenous shocks, right. Things that you can't predict, stuff that you don't know that's going to come from something not visible, that's what we call unknown-unknowns. That is one issue, right. The second issue is there is a policy risk, right? So whenever you think about elections, not just in the US, but globally, there are shifts in policy that can come with that. And one of the big things we're focused on is fiscal policy and how that evolves. So that policy risk is it's binary and it's difficult to hedge. And when it does come, you will have these bouts of volatility. And that's the context in which we're thinking about that risk. But overall, the vols coming down, and that is very supportive for mortgages.
Q: Did you say what your current book value was -- if you could just give an update there. And then if the narrative stays focused on the Fed cutting interest rates, I think you mentioned that you see the range for volatility and spreads just being tighter. I mean, how does that factor into the amount of leverage you're applying to the portfolio and where you guys feel comfortable? Thank you, guys.
A: Hi, Eric. Good morning and thank you. Yes, so book value versus quarter end as of Friday is up about 2%. In terms of leverage here, I would really go back to what we're thinking of in terms of the risk environment. Yes. So we're going to use any spread widening to add to the asset balance. Over time, this is an environment where, again, you would expect us to hold a higher asset position versus when spreads are a lot tighter. So over time, I think as the risk environment starts to evolve, our balance --our asset balances should go up. And right now, the position just reflects our view that the second half of the year will have chances to put money to work.
Q: As you guys get bigger in the current coupon, I mean, how do you think about the spread sensitivity to lower interest rates? I mean, just -- especially given the aggressive marketing tactics that we expect to see from the originators looking to refi those borrowers?
A: Yeah. Look that's one of the things that you -- the portfolio has to be constructed for both up rates and down rates in here. We buyback options in the lower coupon positions that we own, right. So yes, there's greater spread to be had in the higher coupons, but there's two ways you mitigate that. One is using specified pools that gives you some convexity protection. The second is just having this diversified coupon position and that's where those options get bought back. So we are very cognizant that even without much of a rate decline in the mortgage market, you can see faster prepays. We've seen that in the higher coupons that we do own. So that is a very clear and present thought process in terms of how we're managing the book, and you'll see we have been active in specified pools. We like the idea of low pay-up specs in those areas as a way to protect against some of that, that refi risk.
Q: Your expenses fell quarter-over-quarter by about $4 million. Can you remind us, was the first quarter a bit elevated and what's a good run rate for that number? And also any of the personnel changes going to impact that number going forward?
A: Sure, Bose. This is Rob. Thanks for the question. Yeah, we had some accelerated vesting on equity comp by about $4 million in the first quarter. So if you just spread that out through the year, there was $1 million a quarter of a bump in Q1. That's a good run rate. We may have that bump going forward, where Q1 is a little heavier than the rest of the year. But if you just move that out over the four quarters, I think that would be a good way to model it out.
Q: Apart from that, this quarter's run rate is reasonable?
A: Yeah. As for the second part of your question, the personnel changes will materially change, the run rate.
Q: Rob, you made the comment about net interest income and how it could increase, I guess, on an accelerated basis if the Fed cuts. Does that comment referred to the EAD? Or does that impact the economic return as well as the Fed cuts?
A: Yeah, it's really both. Yeah, if the Fed cuts or repo rates go down, EAD goes up. And so, economic return go off. So it's like a triple win if that happens. We're not banking on that. Obviously, we can manage through even if those rates don't come immediately or come later then people expect, but if they do come sooner, we'll gladly take a lower repo expenses.
Q: Just hoping you could talk a little bit more about the decision to issue equity -- large amount of equity kind of below book value, how you see the pay
For the complete transcript of the earnings call, please refer to the full earnings call transcript.
