Q4 2023 Dynex Capital Inc Earnings Call
Participants
Alison Griffin; IR; Dynex Capital Inc
Byron Boston; Chairman and CEO; Dynex Capital Inc
Robert Colligan; Chief Financial Officer, Executive Vice President, Secretary; Dynex Capital Inc
Smriti Popenoe; President, Chief Investment Officer; Dynex Capital Inc
Trevor Cranston; Analyst; JMP Securities LLC
Doug Harter; Analyst; UBS Equities
Bose George; Analyst; Keefe, Bruyette & Woods, Inc.
Matthew Erdner; Analyst; JonesTrading Institutional Services LLC
Eric Hagen; Analyst; BTIG, LLC
Presentation
Operator
Hello and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dynex Capital fourth quarter and full-year 2023 earnings results conference call. (Operator Instructions)
I would now like to turn the conference over to Alison Griffin, Vice President of Investor Relations. Please go ahead.
Alison Griffin
Good morning. Thank you for joining us for Dynex Capital's fourth quarter and full-year 2023 earnings call. The press release associated with today's call was issued and filed with the SEC this morning, January 29, 2024. You may read the press release on the homepage of the Dynex website at dynexcapital.com 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 our disclosures filed with the SEC, which may be found on the Dynex website under Investor Center as well as on the SEC's 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. The slide presentation may also be referenced under quarterly reports on the Investor Center page.Joining me on the call is Byron Boston, Chairman and Chief Executive Officer and Co-Chief Investment Officer; Smriti Popenoe, President and Chief Investment Officer; and Rob Colligan, Executive Vice President, Chief Financial Officer.
It is now my pleasure to turn the call over to Byron.
Byron Boston
Thank you, Alison. Let me start by saying a few words about our Board member, friend, and great teammate, Dave Stevens who we lost this month. Dave will be true champion of the United States housing finance system and also the American homeowner. For me personally we've worked together for over 20 years through organizations, always locking arms to achieve a common goal. It never feels good to see a friend exit the world of life. We will miss Dave, a great teammate, friend, and most importantly, an absolutely wonderful human being.
While that was top news to deliver earlier this year, I am proud of the remarkable work the team Dynex continues to achieve as an active manager, our team navigated historic volatility with skill. We came into the year with excess capital and deployed the capital in a disciplined manner throughout the year to position us to generate solid long-term economic returns. As a result, Dynex shareholders enjoy industry-leading returns in the current decade.
One full of surprises and immense volatility. Our total shareholder return was 12% last year. Since the start of 2020 to the fourth quarter of 2023, our total shareholder return has been over 10%. This compares to the aggregate bond index ETF, which experienced losses of over 3%. We believe our ethical stewardship of shareholder capital continues to meet investors' needs and produced differentiated results versus peers and other income alternatives.
I study history, and I can tell you that today’s market presents a an agency mortgage-backed securities. No economic buyers like the Fed and the GSEs have stepped away from the asset class. Private capital like Dynex now has the ability to earn more returns in this government guaranteed asset. I'm confident in our team's ability to navigate today's dynamic macroeconomic conditions and produce compelling shareholder returns.
I am coaching them to incorporate the evolving landscape in 2024. We have major elections throughout the world, including here in the US. As the Chairman and CEO, I am focused on navigating our company through gyrations in government policies. The outcome of elections will change the power structure and political dynamics in Washington.
I've been pounding the table that surprises are highly probable. We have seen that very clearly each year since the pandemic. The team factors this into their scenario preparation and thought process. This is why we believe investing in agency RMBS is the most compelling risk reward. The liquidity and quality in agency MBS are needed to navigate this environment. As Smriti will describe in detail. The sector is fundamental and technical backdrop is improving.
While we have the capability to invest across sectors and our balance sheet has been diversified. In the past, we have a strong global risk containment that keeps the bulk of our capital in agency MBS. Dynex has a unique value proposition. We have a seasoned team, a strong track record in extracting long-term returns on the mortgage market and a liquid and tradable vehicle with a tax-advantaged structure. We plan to continue to grow our business and offer our value proposition to more shareholders a s demographics drive more investors to seek income. More of the global population will need an ethical management team to deliver the returns that they need.
I'll now turn it over to Rob and Smriti to give you the details.
Robert Colligan
Thank you, Byron, and good morning. Dynex delivered a solid quarter with an economic return of 11.8% and 1% for the entire year, an d total shareholder return was 12% for 2023. Over the year, we added to our portfolio manager hedge book and raise new capital.
Last year was another historic year for bond markets. We experienced the highest yields since 2007, major banking crisis and continued geopolitical unrest with a major new war in the Middle East. Against this backdrop, we started the year with leverage of 6.1 turns and assets of $5.9 billion as well as excess capital from our capital-raising activities i n 2022. We had an explicit strategy holding higher levels of liquidity versus capital on borrowings.
Spread widened dramatically several times during the year, driven by the failure of Silicon Valley Bank and other financial institutions i n the first quarter, the debt ceiling crisis in the second quarter, portfolio sales of Agency RMBS by the FDIC, which lasted through the third quarter and macro volatility in October and November.
As volatility increased and spreads widened, we opportunistically added to our portfolio, methodically increasing our portfolio from $5.9 billion to $7.4 billion. In addition, as pricing between TBAs and mortgage pools collapsed when the FDIC failed, we took the opportunity to rotate our portfolio from about 50% pools and 50% TVAs to 80% pools and 20% TVAs going into year end. This improved our inventory profile and help us lock in attractive yield higher coupon specified pools.
Last year, we increased our Marketing and Investor Relations outreach and selectively raise capital throughout the year at a modestly accretive price-to-book ratio, which we also deployed during periods of wider spreads. We expect to continue our marketing and investor outreach efforts in 2024. Our decision to opportunistically add to the portfolio throughout 2023 to maintain our investment position in the fourth quarter was a very clear benefits of book value, which increased over 20% for the low. As we discussed on our last quarterly earnings call.
Given the volatility experienced throughout the year and especially in the fourth quarter, we maintained our hedge portfolio and positioned for a steeper yield curve environment. The portfolio hedge cost was recognized immediately in book value, although we expect to receive a benefit of lower financing costs in the feature as is currently priced into the market. As I've mentioned on previous earnings calls on the topic of hedging, hedge gains and losses are on REIT-taxable income. That will be part of our distribution requirement with other ordinary gains and losses.
This quarter, we added to our realized hedge gains that will carry a benefit into 2024 and future years. As we move into 2024, we expect hedge gains will support earnings. Please see the table on page 6 in the earnings release for more detail.
Finally, as you'll notice, we reduced our G&A expenses this year by actively focusing on expense management.
I'll now turn the call over to Smriti.
Smriti Popenoe
Thank you, Rob, and good morning, everyone. I'll begin with a brief discussion of the critical decision made in 2023 for providing thoughts on the investment environment and outlook.
As Rob mentioned, we executed our strategy of adding to our portfolio at wider spreads throughout 2023, post the S&L crisis, during the debt ceiling crisis, over the summer as the FDIC executed pool sales. And most importantly, we held our position through the volatility in late October. Overall, we grew our exposure to Agency RMBS over the year by 30%, increasing our leverage to come and buy the same proportion.
Our investment team emphasizes a great deal of patience and discipline. During the October volatility, w e leaned into our liquidity and risk management to pull it through instead of selling assets at losses a s many others were compelled to do. These decisions position shareholders to capture significant upside returned from tightening agency MBS spread to treasuries.
Turning to the macro environment, we continue to construct our strategy and for an environment with why distributed outcomes. The market are focused on the Fed's monetary policy and the potential for substantially lower policy rates as r ealized inflation falls towards the Fed's 2% target. Currently the market for pricing and 150 basis points of rate cuts in 2024. These would have a direct and very positive impact on our future financing costs as we carry about $7 billion in financing relative to about $4 billion in long-term hedges. For every 25 basis point of realized lower financing costs, our total economic return improved by 2%, all else being equal.
In addition to substantial benefits to financing costs, we believe the eventual lowering of rates would result in nominal agency MBS spread tightening to longer-term equilibrium levels between oh seven treasury yields. We have already seen the reentry of banks into the sector in the fourth quarter, and we expect their participation to increase as a regulatory uncertainty from a balance of the endgame rural and the path of Fed policy rates are clarified. To the extent this scenario materializes, we believe any decline in realized volatility, which we are already experiencing in 2024, would also provide the impetus for tighter MBS spreads.
While we believe these factors position us to capture significant upside in the medium term, we remain very respectful of the significantly different global environment that we operate in. We'll base our long-term economic view on the interaction between rising human conflict, changing demographics, a rapidly evolving technological landscape, including the deployment of a rising global debt levels and unsustainable fiscal dynamics. You have any major developed economies.
In our view, the geopolitical world order has permanently shifted to alter the structural economics setup for the coming decade. Nationalism and protectionism and regional contracts contribute deriving friction costs. Constant driven supply shocks can translate to higher volatility impacting inflation and interest rates as Asian populations demand or how can the time and support costs to provide those services are rising. This is manifesting as a massive budget gap in the US., we view the widening US fiscal gap, I think a significant factor in driving the level of yield and value of the USD over the next two to five years.
The US economy also remains exposed to significant policy risk and the upcoming election year and beyond. We're also mining for known unknowns in China, Japan and Europe as these economies evolve and they have government policy response. As always, we plan for alternative scenarios on exogenous shock and remain open to adjusting our strategy. The broader factors I've just described continue to support the majority of our capital being invested in Agency RMBS, which offer a historically accretive investment opportunities. We believe MBS will perform well and soft landing outperform risky assets. At a high level, we expect equilibrium spreads to be in a tighter, lower range for their support and your time.
Finally, I want to acknowledge the loss on an average quarter of Dionex and fellow Board member base. I will miss him and he'll be missed by all of us at the Company. I will now turn it over to Brian for his final comments. Thank you, Sameer team. I'd like to leave you with the following thoughts. The investment opportunity in Agency RMBS is stored and Dionex is uniquely positioned to take advantage of it with our experience and focus on risk management.
Byron Boston
Our investments last year put us in excellent position to generate solid returns in the coming years. I'm also excited to promote greater collaboration between our executive leadership team and the Board and my new role as Board Chairman. Alongside back to Julia Coronado, our Lead Independent Director and other Board members will work closely together to strategically manage our business and shareholders' capital with consideration of the evolving macroeconomic environment. While visibility is limited to the very near term, we consider multiple exogenous factors that can widen the distribution of outcomes.
Book value preservation is a focus of how the team will generate total economic return. Importantly, ethical stewardship remains at the core everything we do. Thank you for your support, and we look forward to discussing our results with you next quarter.
Now I'll turn the call over to you, operator, for questions.
Question and Answer Session
Operator
(Operator Instructions) Trevor Cranston, JMP Securities.
Trevor Cranston
Thanks. Good morning. Looking at the the repositioning slide a full 31, it looks like you guys are set up to generally do better for us to retire, particularly at the longer end of the yield curve. And that's obviously come to pass so far as we sit in January today. So I was wondering if you could maybe sort of update us on as we sit today, kind of what you're repositioning and your view on the uprate risk versus Denbury risk where we sit today.
Smriti Popenoe
Hi, Trevor, and good morning. Thank you for your question on. So yes, you're right. The hedges are concentrated in the back end of the yield curve, a nd we are positioned to benefit from a steepening yield curve where fundamentally rates go down room and back in late either remain the same or go higher. So a lot of this is driven by the macroeconomic view that we described during the prepared remarks. And really recognizing that while we may have some level of market pricing in the front end, as I mentioned, was 150 basis points of cuts, highly priced in the front end a yield curve, which will really benefit our financing costs. In the long term, w e feel like it makes more sense from given a number of other factors. The handhelds was concentrated in the back end occur.
So in general, we're positioned actually benefit from a steeper yield curve. And then that's what's reflected in the hedge position. And then just gets done in terms of just an update from year end, I believe the book value is up about 1% or so to $13.50 area.
Trevor Cranston
Got it. Okay. That's very helpful. Generally across the portfolio, particularly in the higher coupon exposures on, if we were to get a rally in rates are here say down another 50 basis points or something, can you talk about what kind of prepay response you'd expect with, for example, in 5.5%? And what kind of protection area of those pools?
Smriti Popenoe
Yeah, absolutely. Yes, tilting. Yes, one of the big things we did last year was rotate into higher coupon specified pools and there was a pretty significant collapse in those pay offs over the summer. So we have gone into prepayment protected pools in those coupons. Having said that, right, if you get a serious rallied back down to where mortgage rates are down to 4% or lower, a lot of that protection will be compromised j ust simply because these will be building new loans and mortgage rate than it would be. We'd expect to see pretty fast speeds.
Given the primary rate that would really create a lot of prepayment less than five enhancement. Is anything below that can happen. So that's what you'd have to go through in order to really create a big prepayment response. We still think that the convexity protection that we have is a meal, and we'd have a benefit from it. The reason we've stayed in the low payoff specified pool is that to the extent that you might have lost a significant amount of payoffs and in general diversified coupon positioning, you can see we actually have less than the 5.5 and six coupon than we do it at the lower coupon is because we are respecting the fact that a quick drop down in rates could create a pretty significant response in those coupons.
Trevor Cranston
Got it. Okay. That makes sense.
Operator
Doug Harter, UBS.
Doug Harter
You talked about kind of the ongoing attractiveness of the agency market, do you envision yourselves raising additional capital to try to take advantage of it could be leveraged to fire on? Just how are you thinking about possibly expanding the portfolio in this environment?
Smriti Popenoe
Hi, Doug, and thank you for the question. Look, I think Byron mentioned that this is a historic opportunity, and it's a persistent opportunity. We remain in that environment and so to benefit our shareholders in this kind of investing environment, it makes a lot of sense for us to raise and deploy capital. So that that was our strategy. At the end of '22, we had I think in '22, we raised over $250 million in capital. That capital that invested in '23. We raised a little at more than '23. I think that continues to raising and deploying when you have accretive investment opportunities is a good strategy in the long-term for our shareholders. We're going to continue to do that.
I think on to the extent that the government continues, we will keep doing. The returns are still in the mid teens ROE. So we feel we feel very, very good about that right now.
Doug Harter
Can you just remind us how you think about when you say accretive, how you think about that is that you have accretive to book? Is that accretive to returns? And kind of the thought process you go through before deciding to raise capital.
Smriti Popenoe
We think about everything you described. one is the place the impact of any kind of a capital raising. We think about mostly the long term return potential in the capital investment relative to the cost of capital gluten. Right now, you're able to earn a double-digit return from the carried on mortgages relative to hedge it without incorporating any kind of spread tightening. So when you add the spread tightening potential into the future, you're really at high teens, low 20s long-term return. So we do those types of returns in the context of a marginal dividend yield being in the 12%, t hese are great investments. So that's how we think about it.
In the long term, will the shareholders to benefit from that made us raising and deploying the capital. We believe the answer is yes, we are capable of making the decision to raise on that.
Byron Boston
And, Doug, just t o add a little a little color to that. You also asked the deleverage. We do have the ability if we see an opportunity to take leverage up and then add to our capital base at a different time. I do think the market, given our performance will give us opportunities to raise and grow. But sometimes it's not exactly the right timing, right? Over time, o ur price-to-book has gotten smaller, That gap has gotten smaller. The market's understanding our performance. We will have the ability to grow.
But if it's not exactly the right time, we'll temporarily take leverage up and backfill it with capital and be very judicious about that throughout the year and going forward.
Operator
Bose George, KBW. Please go ahead.
Bose George
Just wanted to ask about hedging just with the rotation more in two pools versus TBAs. Does that change anything in terms of how you view the use of treasuries versus swaps? Are you just touched on that?
Smriti Popenoe
Not really. We still see the capital cost of using interest rate swaps to be about twice as much as we plan on using Type two pieces. On a capital injected basis, there was a real expense and hedges on label and that flexibility in times of stress from. So our macro view that really drives the selection of the hedges. Having us be in pools really doesn't make a difference of. Yes, we have on the hedging in the repo markets relative to the studios, but we still feel like we're in right hedge structure.
Bose George
Okay, great. Thanks. And then some of the you mentioned the benefit of rates going down and peanut tier spread. Can you just go over that again? Is that a benefit to the economic return or to GAAP EPS? So you could just kind of a little more detail on that would be great.
Smriti Popenoe
Yeah, the long term. So you know how we think in total economic return path on if you want to decompose our and it's really we think in terms of like the bulk of the things we can cross sell all else being equal, if the financing costs go down by 25 basis points and nothing else changes will say that for the yield curve doesn't change your view on that. The positive benefit would be 2% in economically time. So you could just in terms of financing costs going down is about 2% on the total economic return.
Bose George
Okay, great. Thanks. And then just one last one. Just what are your expectations just for longer term in a mortgage spreads? You talked about spread tightening being just touch on where it goes in in a sort of the cadence.
Smriti Popenoe
Yes. Look, I think there's something very important happened in the fourth quarter, right? That the Fed stance on monetary policy changed in December and even call it a pivot. But once that happens, stocks, corporate bonds and agency MBS in, they all benefit from that change in stance for that. That's the first to last year. Banks were a net seller.
They sold about $250 billion in mortgages. The Fed net sold about $300 billion and monitor. All of that is shifting, if the Fed steady as she goes from being a tightening, stand to a neutral stance and potentially even using stance, you have the possibility of banks starting to come back in that that's already happened. If you looked at B of A's results this past quarter, they were a net buyer of $17 billion and margin. All of that kind of shift the technical within the mortgage market.
And then we've also we've also seen housing activity in terms of turnover is starting. It picked back up again, if the modern existing home sales numbers. The turnover activity is starting to rise again. A ll of this two points to equilibrium spreads more in sort of like 100 to 140-basis-point range over the five-year treasury relative to the one 140 to 190 that we're sitting right now. Is it going to happen today tomorrow. So this all could happen right. You get on a decline in terms of yields? We think that that is using all about. So we're not saying it will happen, w e're saying there's a real possibility that it could happen both factors in play now where the fundamentals and technicals have shifted.
So the maintenance plan is actually, you know, lower if you will, in the sense that you instead of being number one, 40 to one 19, maybe you were sitting in the one 21, 60 panel kind of range that that's kind of how we're thinking about it. But in the long term, as banks come back in, the market gets back to the curve steepen, all of the things that's important. It ends up tighter and lower spreads on an equal equilibrium basis.
Bose George
Okay, great. Thanks a lot.
Operator
Matthew Erdner, Jones Trading.
Matthew Erdner
Hey, good morning, guys. Thanks for taking the question. Can you talk about the relative attractiveness of TBAs first cash at the moment? And looking at the balance sheet, you guys have a lower cash position since 2023, c an you talk about that and that's where you've been deploying that across the coupon stack?
Smriti Popenoe
Yes. I think you saw us on the need to be a person versus pools firm that relative attractiveness.
Matthew Erdner
Yes.
Smriti Popenoe
Okay. So right now, I would say the story in TBAs depends on the coupon from the higher coupons are still coming through at a level that is on the lower band, lower than on fixing some of the higher coupon debt financing and edit rate that is about equal or slightly higher number than coal in the Valley coupons like the fourth quarter, those are actually trading very special relative to cause that actually behooves you to have a TBA position within those coupons in the lowest coupons.
It's actually very difficult to figure out just because there's no production in the twos to it, et cetera. So that just depends on what's happening in the lowest coupon. But right now than specialists in the role is actually eliminated two before coupon in the 4.5 coupon. Everything else is either children on top of pools are slightly above calls. And in terms of cash versus unencumbered assets, they I think that was your other question on. We've continued to keep a fairly big allocation to our liquidity position.
And Rob can give you the exact number of what we closed the closed the year at, but one on cash earns close to 5.5% here. So it's not being a drag on earnings as it was when we you should read through into Europe from which, you know, at that point, we would be more inclined to hold or assets that yielded higher. So at this point with cash rate so high, we don't hesitate to hold cap. If that was your question with earnings.
Matthew Erdner
Yeah, that's helpful. And then talking about the supply and demand technicals with the Fed getting towards the end of Q3, do you guys have an opinion on the Fed gets back in the market a nd when that might occur?
Smriti Popenoe
Look, we can only go by what the Fed is communicating that you asked me the cadence on with respect to QT. floating open gave a speech in January on that I think is what kept a lot of us off. From what we can tell their interest in it thing, foreign and state of tightening based on what they call the least comfortable level of reserves, right. The biggest part of QT moving into thinking about is that there's that puts a floor on QT and puts a floor on lots of things.
It puts a floor on the amount of duration coming into the market on that. And of itself, I think have been very supportive for mortgage mortgage spreads, even if the green but only in treasuries that takes out that takes out a yielding assets out of the market, it creates crowding out private capital, and that creates the demand for securities or not. The other possible outcome of the end of QT. Is that deliberate volatility goes down because the fed back and saying securities in the market, that's also really supportive of mortgage spread, and that those are the things that I think arm just add to the idea that benefit and the shift in the technicals in the mortgage market.
Matthew Erdner
That's helpful.
Operator
(Operator Instructions) Eric Hagen, BTIG.
Eric Hagen
Do you guys feel like there's good liquidity and funding market put on longer dated repo right now to take advantage of what's pressed into the forward curve? And what's the shortest that you can envision running the repo book if conviction does around the Fed cut a maybe sooner rather than later?
Smriti Popenoe
So really isn't the way we're thinking about financial number one, our value availability of financing is not an issue. We continue to have counterparties offer us financing. more able to fund our term on. I think we reported on a weighted average term to maturity original term to maturity is like 78 days. We're not having any trouble on running longer longer-dated financing, anything like that. So availability has been just fine.
There has been pressure around quarter end, as you've seen, right, like since September, there was a lot of pressure. December, there was a little pressure. So in general, we're trying to manage around those buying time by funding out term, so that hasn't been a problem for us. And so yes, there is the ability to lock in financing to the extent that we want, and we significantly with the markets, pricing, et cetera, et cetera.
You've seen us manage this look for a long time, Eric, and we're always balancing two things. one is whether there will be quarter-end pressure and balance sheet pressure or event-driven pressure versus the risk of kind of running an overnight shorter maturity box. And we currently land somewhere in the middle. Some of our financing is going to be locked up in terms. Some of that is going to be in not locked up and maybe rolling out a little sort of.
Typically we have not been an overnight ERM overnight funds there, and we're very we rarely have taken us anything lower than 30 days out. So we are looking to take term at opportunistic levels, and we see that in the marketplace. In general, we tend to be more focused on avoiding funding disruptions, and kind of trying to make money after assets, anything bucket. It's a risk that we just don't feel like it's good for us to expose our shareholders to. So we end up actually just really respecting where we get our financing and making sure that it's locked up before we get there. Any kind of from economically term benefit that we can get from thinking about the Fed exportation versus that we would be moving hedges to help us take advantage of that.
Eric Hagen
Yup. I appreciate that response. We're still a full year. We actually have a little bit more of the full year, but how are we thinking about the fixed to floating rate preferred stock into the floating leg next year? And maybe how you think about the cost of the capital structure overall spreads are tighter wider and what the Fed's going to do?
Yes. I mean, don't forget, I'm a big a big part of that, if not all about is a part of the hedging that we do on on on the liability side, right? So from an economic perspective, we feel really good about the fact that that that entire on that entire issue is hedged out without features position in January.
So again, it's going to be a question of what are the available opportunities? Where can we refinanced? We want to I won't go through that will go through the exact thought process as we approach the call today. Thank you guys so much pressure.
Operator
Do you have no further questions at this time. I'll turn the call back to Byron Boston for any closing remarks.
Byron Boston
Thank you very much for joining our call today. Just remember, we have a long-term view, skilled risk management discipline now, but allocation of capital, very experienced team. And most of all, we take a very ethical approach as to how we manage our business. So thank you for joining us, and we look forward to speaking to you again next quarter. Thank you.
Operator
That will conclude today's meeting. Thank you all for joining, and you may now disconnect.
