Dynex Capital's CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: Dynex Capital (DX)

Dynex Capital, Inc. (NYSE:DX)

Q4 2013 Earnings Conference Call

February 19, 2014 11:00 AM ET

Executives

Alison Griffin - VP - IR

Tom Akin - Executive Chairman

Byron Boston - President, CEO and Co-CIO

Smriti Popenoe - EVP and Co-CIO

Steve Benedetti - EVP, CFO and COO

Analyst

Trevor Cranston - JMP Securities

Mike Widner - Keefe, Bruyette & Woods

Jason Stewart - Compass Point

Richard Eckerd - MLV & Company

Operator

Okay. Good day and welcome to the Dynex Capital Inc. Fourth Quarter 2013 Earnings Conference Call and Webcast. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Alison Griffin, Vice President, Investor Relations. Please go ahead.

Alison Griffin

Thank you, Maurine. Good morning and thank you for joining the Dynex Capital’s fourth quarter 2013 earnings conference call. The press release associated with today’s call was issued and filed with the SEC today, February 19, 2014. You may view the press release on the Company’s website at www.dynexcapital.com under Investor Relations and on the SEC’s website at www.sec.gov. With me today is Executive Chairman, Thomas Akin; President, CEO and Co-CIO, Byron Boston; EVP and Co-CIO, Smriti Popenoe; and EVP, Chief Financial Officer and Chief Operating Officer, Steve Benedetti.

Before we begin, we would like 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 in or contemplated by the forward-looking statements as a result of unforeseen external factors or risks.

For additional information on these factors or risks, we refer you to our Annual Report on Form 10-K for the period ended December 31, 2012, as filed with the SEC. The document may be found on our website under Investor Relations as well on the SEC’s website. This call is being broadcast live over the Internet with a streaming slide presentation and can be found through a webcast link on the Investor Relations page of our website under IR Highlights. The slide presentation may also be referenced by clicking on the fourth quarter 2013 earnings conference call link also on IR Highlights page of our website.

I would now like to turn the call over to Tom Akin.

Tom Akin

Thanks Alison and thank you all for attending the 2013 full year conference call and fourth quarter update. As a veteran bond investor of over 30 years there have been few periods as volatile as interest rate environment observed last year. In particular such volatility while the fed’s funds rate remains anchored near 0% I don’t think has ever been witnessed.

Ben Bernanke uttered three little words in May, possible fed tapering, and the rate route was on. Most institutions got caught off guard as four years of low rates made most investors complacent about the risk of higher rates. Earlier in May prior to Ben Bernanke’s proclamation investors’ concerns was more around how to manage in ever lower yield environment. How quick things changed. Originators had pipelines full of new or refinanced mortgage loans, investment banks were enjoying the carry trade and huge unhedged positions lay in the marketplace. The retiring baby boomers were fully committed to income investment.

Talk of normalized yields changed and rates such as 4% to 6% in 10 year yields were bantered about as if they were afraid to complete. The direction wasn’t questioned, only the magnitude of the move. It was no wonder that levered mortgage REIT saw price declines of over 30% and cratering dividend yields. The first three quarters of 2013 saw mREIT book values drop precipitously.

At Dynex we’ve always adhered to several simple basic rules of the road, limit your risk by limiting your duration, leverage and diversify your portfolio. Simply said, the best way to avoid volatility is to not buy it, to begin with. The Dynex portfolio was designed to perform in a variety of market environments in both good and bad. We’ve always held a healthy respect for the dangers of leverage no matter the volatility. We have never purchased a 15 year mortgage or a 30 year mortgage as they have not offered the proper risk return trade off of the Dynex portfolio.

There is no question that the increased volatility today will make it more expensive to hedge an mREIT portfolio. However, the glass is half full as well. Despite the negatives, solid returns still exist in the marketplace with limited downside risk and solid cash flows. The anchored financing rate for the next two years should give ample opportunity to create cash flow for our shareholders. We continue to focus our efforts there and continue to build a portfolio for the long-term.

Now I’d like to turn it over to Byron Boston to discuss the portfolio in detail.

Byron Boston

Thank you, Tom. Now let’s turn to our performance for 2013. Please -- I am starting on Slide 4 if you are following along on the web. 2013 began a transition for the global fixed income market, despite the many changes and surprises that developed, we at Dynex Capital maintained the strategy that we deploy from inception in 2008. We pride ourselves on the fact that we have not made -- we have not had to make major changes to our business model or our strategies. We have managed for the long-term by constructing a portfolio designed to perform in a variety of market environments.

This is a simple conservative strategy built on limited leverage, limited extension risk, product diversification and high credit quality. For the last 10 years our shareholders have been able to trust the management of Dynex to manage their capital. As our operators we treat the capital as our own. Our results reflect these efforts, in 2013 we paid out dividends of a $1.12 per share on core earnings of a $1.17 per share, which equates to a core ROE of 12.2%.

Additionally, our Board approved a $50 million share repurchase program which we utilized throughout 2013 to support our stock price and as we saw value on repurchasing shares versus reinvesting capital. We have 42.1 million of remaining authorization to repurchase shares as we see today. Our shareholders can also take comfort in the fact that senior management of Dynex further invested in the Company by taking incentive compensation of stock for the year 2013.

As many of you are aware we made some significant additions to our personnel and title changes within the senior management ranks. One of our most important strategic goals in 2013 was to enhance our human capital and our secession plan for senior management. We achieved both; first we hired Smriti Popenoe as EVP and Co-Chief Investment Officer as of January 2014.

Smriti has had a long-term relationship with Dynex. She assisted us in developing our core strategic plans in 2010 and again in early 2013. Prior to Dynex, Smriti has had multiple senior roles in the financial services industry from fixed income portfolio manager, SVP and Senior Investment Officer for Wachovia Bank’s balance sheet, Chief Risk Officer at PHH Mortgage. Most importantly she was my partner in starting at De Novo Mortgage REIT in 2004 was REITed public via an IPO in March of that year and successfully managed through the most recent impair market in fixed income.

We believe we are in an environment where experience and seasoning counts. We have added talent and we have added experience to our senior management ranks. Second, Tom Akin has become Executive Chairman and I have resumed the title of CEO and Co-Chief Investment Officer. This is an important step for our shareholders as we have effectively implemented a secession plan that ensures that we will lose no continuity in vision and management of our Company.

And then finally, we have also strengthened our Board of Directors by adding two professionals with long-term careers and experience in managing fixed income assets and commercial lending. I am now going to turn it over to Steve to discuss our financial performance in detail.

Steve Benedetti

Thanks Byron. Most of you on the call understand that we have discontinued GAAP hedge accounting for our derivative instruments. As such we now present non-GAAP measures in an effort to present our financial results for easier comparison historically and with others who continue to utilize hedge accounting or might also present some measure of core earnings. GAAP net income was $0.35 for the quarter versus a loss of $0.13 per share last quarter, core net operating income per share was $0.29 compared to $0.27 in the third quarter.

On Slide 5 we present the non-GAAP financial metrics core net operating income per share and adjusted net interest spread each for the last five quarters. As a reminder, core net operating income equals GAAP net income excluding gains and losses from hedging activities and asset sales and as such is intended to present net interest income in our investment portfolio less the current period cost of hedging interest rate risk and less operating costs.

We’re in $0.29 on a core net operating income basis exceeding our dividend of $0.27. For the year we earned $1.17 in core net operating income versus a dividend of $1.12 per share. Core net operating income for the fourth quarter included a positive $0.03 contribution from reduced compensation expense. Adjusted net interest spread increased by 12 basis points as we adjusted our hedges to reflect our macro view and as such our effective borrowing cost declined by 22 basis points for the quarter.

As far as asset yields are concerned, we saw slower prepayments on our agency RMBS which we had been anticipating since May given the selloff in rates. As such over the second, third and fourth quarters we had adjusted prepayment speeds leading to moderate reductions in premium amortization over those periods. Our RMBS weighted average yields for the last two plus quarters have already incorporated the lower prepay space that we saw this quarter in our corresponding expectations.

In spite of the selloff occurring in the quarter in rates, book value increased during the quarter by $0.10 per share from $8.59 to $8.69. Spread tightening on our assets and gains on derivative positions more than offset the rise in interest rates for the quarter helping to increase book value.

Slide 6 contains a comparison of our hedge position at December 31st versus September 30th. We terminated approximately 852 million in current pay fixed interest rate swaps during the quarter and another 50 million of forward starting swaps. We also terminated Eurodollar contracts that were forward starting primary in 2014 through 2016, there we also terminated some longer dated contracts. These terminations are consistent with our view on short-term rates and improved our net interest spreads as previously noted.

With respect to the Eurodollar contracts as we noted on our last call these contracts are based on three month LIBOR or forward starting and allow us to synthetically replicate swap curves and/or hedge specific points on the swap curve where we may have duration risk. As these contracts are forward starting, we include in core earnings only the cost of those contracts that are effective. Like swaps, fluctuations and value of these contracts would be included to GAAP earnings and book value.

I will now turn the call back over to Byron.

Byron Boston

Thank you, Steve. We are now going to discuss our outlook and strategy. I will start with some comments on the macro outlook and Smriti will take you through our portfolio position and strategy

Since 2008 we have stated that we expected short-term interest rates to remain lower and for a longer period than most people expected. We also had told that the yield curve would remain steep for many years. We continue to hold to these opinions. We believe that economic uncertainty, regulatory uncertainty, and global market uncertainty have created a very complex environment for economic growth to be able to accelerate to the level seen in prior post-war recoveries.

We see a fragile global economic picture that might withstand minor increases in U.S. interest rates but will not withstand a major correction back toward rate normalization. Let’s consider a few of the key macroeconomic and policy factors that had worked throughout the global financial system. There are many structural and democratic shifts that play in the U.S. economy today making it more difficult to forecast economic data. Some examples are the impact of retiring baby boom generation, and U.S. immigration policy on the labor market.

Global inflation rates, global inflation levels are potentially problematic and could become a surprise factor. We also see significant changes coming in the form of government policy. The uncertainty of the nature and form of policy action, we believe requires particular attention. Against this backdrop we have seen spreads tighten resulting in lower returns, there continues to be far too much cash chasing assets. As Smriti will discuss shortly we made selective investments in the fourth quarter, mostly in the CNBS sector because we still feel, the trend supporting multifamily housing are in place.

I would now like to introduce Smriti Popenoe, our new EVP and Co-Chief Investment Officer, and welcome to her first earnings conference call with Dynex.

Smriti Popenoe

Thanks Byron. I’m delighted and excited to be here again working with you, Tom, and the Dynex team. Let me start on Slide 9, by briefly discussing the investment environment and the implications for our strategy. And when I say investment environment I’m focusing on spread levels and opportunities to deploy capital. The current investment environment remains supportive of our core investment pieces, a diversified portfolio of commercial MBS and short duration hybrid ARMs.

At Dynex, as you may be familiar we like to analyze the market from the perspective of fundamentals, technicals and psychology. The best way I can characterize the overall environment right now is that it is mixed. On the one hand, we see supportive, demographic and economic trends in the multifamily sector, combined with home price recovery, slowing prepayments, and lower default in the RMBS market. On the other hand, we have watched risk premiums across asset classes decline causing us to be more disciplined and selective in our investment.

As the government begins its pullout of the mortgage market, after the Federal Reserve ceases its large scale asset purchase program, for the first time since the 1970s we will not have a government entity be the dominating purchaser of MBS in the secondary markets. Also keep in mind that securitization and credit pricing in the prime agency eligible and prime jumbo markets are yet to function in a standalone manner. These factors give us pause when we think through capital deployment opportunities available today.

As far as market technicals are concerned, here again, we see a mixed picture. On the positive side as investors expected rates to rise, hybrid ARM securities have become more attractive. As rates continue to rise fewer MBS will be produced and despite reductions in the fed’s purchases of MBS by most estimates they will still absorb a majority of fixed rate MBS through the spring and early summer. On the negative side we do not see a sizable investor base willing to take down fixed rate MBS at these levels.

Dealers also clearly showed their reduced levels of risk appetite last year and we expect all of this will have a major impact on spreads in the absence of sizable demand for MBS outside of the fed. In terms of market psychology, we have seen it all over the place but mostly it is bearish in tone and moves less or more bearish with the data. This also gives us pause as the data have been coming in mixed as well, giving a pretty unclear picture of the true state of the economy. So, turning to Slide 10, what does this all mean for Dynex. First-off, it’s great for our current portfolio. Hybrid ARM spreads have tightened and credit fundamentals continue to support our multifamily investments.

Second, the mixed environment means we have to be much more cautious when investing capital at these levels. As such, we are operating with lower levels of leverage and higher levels of cash and capital. We have been very selectively making investments in the CMBS market in specific cash flows that we believe continue to offer value. In terms of our strategy going forward, we expect to maintain our current investments which offer good stable cash flow and the opportunity to hold down the yield curve. We expect to maintain a positive duration at the front-end of the yield curve and to continue our discipline on assessing risk adjusted returns and deploy capital opportunistically. This would include repositioning the asset and hedge portfolio as necessary.

Turning to Slide 11, we show the modeled impact of various interest rate scenarios on the market value of our assets net of hedges. This looks like a complicated page, but I’ll take you through the different tables. You can see we’ve included non-parallel shifts in interest rates because really it’s where that the yield curve moves in a parallel fashion, typically the yield curve flattens or steepens.

So, if you take a look at the tables, I am going to ask you to note the pattern in the market value changes. When we shift rates up in a parallel fashion, up 50 basis points for example on the top right hand side of the page, the market value of our asset net of hedges is projected to decline by 0.9%. However, turning to the second table on the bottom of the page, when we shift interest rates in a steepening fashion as in the second scenario on that table market value only declines by 0.45%, about half of the parallel shift.

Similarly when we shift interest rates in a flattening scenario as in the second to last scenario, scenario six, market value declines by only 0.51% about half of the parallel shift. The key takeaway here is that the interest rate risk in the portfolio is focused on the front-end of the yield curve and the position benefits from lower rates in the front-end of the yield curve.

As Byron mentioned, our view is that the economic uncertainty, regulatory uncertainty and global market uncertainty have created a very complex environment for economic growth. We don’t see it accelerating to a level seen in post-prior war recoveries. We actually see a fragile economic picture that could withstand small increases in U.S. interest rates but not a major correction back towards rate normalization. We are comfortable with this position at this point given this view on the macro-environment, but we are very vigilant on any data or trends that might want to counter to this view and we stand ready to adjust this position if needed.

Now let’s turn briefly to how our capital is invested on Slide 12, this is a slide that many of you have seen before, again not much different. Our equity is mostly in the CMBS sector, 91% by asset value is in AAA assets, most of it has a maturity or reset profile of 10 years or less. On Slide 13, just briefly reviewing our financing picture, liquidity is strong. We continue to have access and availability of financing. The move away from hedge accounting has really allowed us to manage our repo book more effectively. We have been moving our contractual maturities up now at a 114 days from 91 days last September. We did see attractive rates to lock-in term financing for 90 day periods and we did take advantage of that and we continue to seek such opportunities.

On the financing side, we are also very focused on the impact of regulation on our 31 counterparties and we are working actively to manage these relationships. The next few slides are pretty self explanatory. We put down again the reason for our investment thesis in the CMBS and RMBS sectors. I am going to just highlight a few points on a couple of the slides. Slide 15, I want to show you that 76% of our CMBS assets are AAA rated. On the top right hand side, the majority of our investments are in post-2008 vintages which have stronger underwriting and collateral characteristics. We have actually experienced LTV upside, having made these investments that values have rebounded.

On the bottom left hand side, you can see our focus is on the multifamily sector. We really believe there is a strong demographic story here that continues to play out. And on the bottom right, this is a well diversified position across agency, non-agency, IO and non-IO securities.

Turning to Slide 17, these two charts may look complicated but what we are really trying to say here is to show you the difference between pre and post-2008 credit support. What this shows is that the rating agencies are actually now showing more discipline by requiring more subordination as the risk in the deals increases. At Dynex, we are vigilant about this because we have actually seen a lot of cash chasing investments in the CMBS sector particularly in the multifamily area. And we have seen terms and loan conditions and underwriting standards slip a little bit. We like to track this to make sure that we get comfortable with the credit subordination even if our investments are at the AAA level.

On the RMBS front, as you all know we have been extremely focused on the hybrid ARM market. As we discussed earlier, the investment environment here is truly mixed, on one hand slowing prepayments and negative net supply are positive factors, but they’re offset by the potential negatives of new supply and the impact of the fed’s exit from the RMBS market.

Couple of points to note on our portfolio on Slide 19; first, the maturity a month to reset profile, again fairly well distributed. On Slide 20, we show RMBS gross and net issuance and the key point to note on the left hand side chart there is the amount of negative net issuance in the 5/1 hybrid ARM sector and modest net issuance in the other sector is really contributing to the positive technical in hybrid ARMs. On the right hand chart, you can just see the prepayments on our hybrid ARM portfolio dramatically dropping off in the fourth quarter of last year.

Turning to Slide 21, I just like to summarize the key points. First off, the macro environment of lower short-term rates and a steeper yield curve continues to provide us an attractive opportunity to earn carry. Second, the uncertainty around economic growth, regulatory changes, market reaction and global market imbalances require discipline and vigilance. We’re behaving very much in line with that. Risk adjusted returns are lower as we’ve seen these risk premiums decline and they are lower than the extraordinary opportunities of several years ago as well as since mid-2013.

At this point, we are maintaining a positive duration gap focused on the short-end of the yield curve. We’re maintaining lower leverage and opportunistically increasing our exposure to CMBS versus RMBS. And over the long-term, we do see opportunities for investments in both residential and commercial assets and in markets that are currently dominated by the fed and GSEs.

I’ll now turn it back over to Byron.

Byron Boston

Thank you, Smriti. If you go to Slide 22 and you just take a look at the upper right hand box consistent with our long-term view let’s put the last year into context. We show our historical performance using a number metrics total return, dividends, and our core return on equity. We’ve been able to generate a double-digit return or more importunately we’ve been working to do so with stability over a long-term horizon. As you can note, dividends have remained relatively steady between $1 and $1.15. Our return on equity has been solid double-digits and more importantly if you look over to the left, our long-term returns really important to us that you take note of the fact that our shareholders have been able to trust this Dynex team to a variety of market environments over the last 10 years.

As you can see our five year return, solid 73%, four years, 43%, over the last three years 25%. And let me summarize our message for today, we’ve added to the experience and talent of our management team. We’re maintaining the long-term focus of our Company and as I just stated a second ago and I’ll repeat again, for over 10 years our shareholders have been able to trust this team, prudently manage the risk exposures of the Company through a variety of market environments including the 2008 debacle.

We are aware that our portfolio is unique in the sense that we’ve got the short duration hybrid ARMs married with a solid CMBS portfolio of which a majority of that portfolio carries an agency guarantee. We believe that we’re the highest yielding CMBS portfolio and one of the most stable agency portfolios as a whole. We’re nimble, focused and very disciplined in our approach and most importantly we’re optimistic about the our ability to manage our portfolio through this new transition environment and to capitalize on the investment opportunities that we believe will be available in the future.

With that, operator, I’d like to open the call up for question and answers.

Question-and-Answer Session

Operator

Okay, we will now begin the question-and-answer session. (Operator Instructions) The first question comes from Trevor Cranston from JMP Securities. Thank you.

Trevor Cranston - JMP Securities

Hi. Thanks and congratulations on a nice quarter. I guess my first question is related to your interest rate exposures that you show on Slide 11. You made some changes to the hedge book this quarter and you show even after that a fairly small exposure to kind of the curve flattening scenario with the short-end going higher in particular. I was just wondering if you could comment on, if this kind of reflects your optimized portfolio currently or if you would be willing to take a little bit more exposure to that flattening scenario and potentially lift some more of your shorter term hedges and just how we should think about that?

Byron Boston

I think Trevor, we’ve given you the -- and the real important thing is as we do and from a top down perspective. The reason we wanted to go into our macro, it will ultimately lead you down to how this portfolio is constructed. We feel most comfortable to have now duration exposure in the short-end of the yield curve. And as such we aggressively manage our risk exposure in the long-end of the curve. So, overtime as -- if factors present themselves globally, because we’re in that type of environment, where we have to make adjustments and changes, we’ll make those adjustments and changes as appropriate.

Right now we feel very comfortable with this position and so -- and I mentioned this on the last call and I want to say this again, and I think it is really important, I know many of you in the analyst community, you want to predict book value. You want to predict earnings. In the last call I said, the ability of you to predict book value, and even earnings in some situations, of all the mortgage REITs, they’ll probably will decrease and it’s not because of any problem with you guys, it’s really the function of the market environment. This is very unique and we said it with three words, we say economic uncertainty, regulatory uncertainty and global market uncertainty and combined together to create a very complex environment.

We’re not going to just sit on our hands in this environment, it dictates that we need to act very prudent as risk managers, and that’s what we’ll do, we’ll make adjustments in this business appropriately, but we try to give you as much information to see how we’re positioned today and exactly why we’re positioned this way.

Trevor Cranston - JMP Securities

Got it, that’s helpful. And on the asset yield side, I mean Steve discussed I think in enough detail kind of what was going on with the agency book and slower prepay speeds. It looked like the other component of the -- it’s kind of slight drop in the asset yield was on the non-agency CMBS bucket. Can you comment on what was driving that drop and kind of how we should think about that number going forward and also where you’re seeing yields on the new investments in the CMBS space you’re putting on the books?

Steve Benedetti

Okay, this is Steve, Trevor. I’ll take the, what happened and I’ll let Smriti talk about the forward looking yields. I mean in terms of what happened in the fourth quarter, we have some old legacy bonds that have been a partner for the Company for quite a while as you’d probably remember and overtime those bonds have opened up in terms of the ability to prepay and they have been modestly prepaying down the -- that would have been a whacked risk as well as reducing the overall yield for the non-agency CMBS.

Smriti Popenoe

Trevor, it’s Smriti, I’ll try to answer your question on the CMBS yields. So, generally I am going to quote you ROEs.

Trevor Cranston - JMP Securities

Okay.

Smriti Popenoe

In terms of levering these somewhere between two or three times and on the margin they’re probably between 10 and 11 ROE at this point in AAA rated bonds, probably 11 to 13.5 are credit sensitive bonds, so low single-digits.

Trevor Cranston - JMP Securities

Got it, okay, that helps. And then I guess last thing, Byron commented on the fact that we like to try and predict book value. Can you guys give us any color on what you’ve seen, what changes in spreads since quarter end?

Byron Boston

It’s still a very -- Smriti said it best, there’s a lot of cash chasing assets, spreads are firm. If you really summarize the last year, last summer looks like a blip, spreads kind of -- we had a technical move out and they’ve come back. And so spreads have come back in, book values, we don’t give exact numbers out, but book value is obviously improving and moving in a positive direction.

And again I’ll repeat something I did say before is, these moves of 1% to 5% in book value this is kind of part but of course it’s the way the business goes and we’re not jumping up and down when it moves up 3% nor we sit and loosen our shirt if it goes down 50%. We’re trying to manage the Company again over the long-term. But the fundamentals, Trevor, are supported, given the way we structure the portfolio, book value at this point in time.

Trevor Cranston - JMP Securities

Okay, fair enough, thanks a lot.

Operator

Our next question comes from Mike Widner of KBW.

Mike Widner - Keefe, Bruyette & Woods

Hey good morning guys. I guess let me first just follow-up on Trevor’s question there going back to Page 11 of the deck. Just a little bit of clarification, that percent changed in net asset value there, is that before or after the effective leverage?

Byron Boston

It’s before.

Mike Widner - Keefe, Bruyette & Woods

Okay. So to get to a real book value change we’d still need to multiply that by leverage effectively.

Byron Boston

Yes, that’s correct Mike.

Mike Widner - Keefe, Bruyette & Woods

Okay. And also I guess my other question is, I’m struggling with -- and you guys you are not unique in this, but I mean there’s certainly more use of Eurodollar futures today than there was say a year or two years ago. And as we all try in vain to mark things to market during the quarter, it’s important to actually understand what those contracts are. And so from that standpoint I guess I’m just struggling to understand or to make sure I understand what’s actually being reflected in the tables and maybe if I start with Slide 6 I guess the thing for the Eurodollars really for how you disclosed this in general that it’s not clear to me as Eurodollar futures as I understand them generally one quarter contract there is three month contract.

And so when I look at a number here like 1904, you have under the 2017 and later Eurodollar futures and what does that -- I just don’t know what that actually means? Or similarly in the press release you do it on a effective each year. But again I don’t really know quite what that means. Is it -- are we counting things four times if they’re active all four quarter or does it mean they’re active the full year or I don’t know I mean any elaboration you can give would help me understand sort of what I need to mark-to-market if I’m going to mark these things?

Steve Benedetti

Sure Mike this is Steve. What they are, and what we’re trying to do is see people like to understand these things in terms of close to swaps equivalent as they can, right? So these are the and what we’re disclosing in the press release and in this table is the weighted average notional balance outstanding for a particular year. So you’re absolutely right. These are 90 day contracts. And so if for example we had 100 million for each of the next four months, or next four quarters, let’s say just 2014, the average outstanding would be 100 million. If we wouldn’t show 400 million in this table we would just show 100 million. Does that make sense?

Mike Widner - Keefe, Bruyette & Woods

Yes. I think that make sense. And then so if I’m looking down at the 2017 year if I’m looking at your press release where you have just over a 1 billion.

Steve Benedetti

Right.

Mike Widner - Keefe, Bruyette & Woods

For -- so I can basically model, if I wanted to model that, I could look at the June 2014 I am sorry 2017 contracts and just assume a 1 billion of those where I can spread it across the four quarters, but like you said.

Steve Benedetti

Yes, that’s right.

Mike Widner - Keefe, Bruyette & Woods

Okay. Al right I think I get that. That makes it a little easier. And like you said the swaps are different so I mean the -- as I look at again if I’m going at a press release and look at that swap, that list of swaps, I mean for the most part it’s 790 million effective in 2015. I guess as I would look at that I mean I would sort of start from the bottom and it looks like you got about 38, 39 million of what are effectively 10 year and then just sort of work backwards from there. And it doesn’t look like you’ve got tremendous amount of forward starting swaps. And so again I’m trying to sort of draw that you try to put these two together on the same page in the same table but they’re not the same things obviously.

Steve Benedetti

Yes. So you’re right Mike that’s exactly the way to think about it. We have -- most of these are going to be current pays and they’re going to be burning off over the 10 year period there is one small forward starter in that. But I think if you just look at sort of when these things are effective, you can save 39 million as effectively a 10 year swap and you can market to that because we’re marking these things every quarter so they’re defectively marked so 2023 is effectively today marked like a 9 year swap. So change in that will allow you to compute the change in the book value versus the swap curve?

Mike Widner - Keefe, Bruyette & Woods

Perfect now I’ll have to do is actually mark them. But I appreciate that I’ll get out and let anybody else ask any questions. But I definitely appreciate the clarity.

Steve Benedetti

Thanks Mike.

Operator

Our next question comes from Jason Stewart from Compass Point.

Jason Stewart - Compass Point

Hi. Thank you for taking the questions. Let me start with just a comment that you have in your release and you’ve given us some great color, but your statement that you favor the CMBS sector over the hybrid ARM sector just stood out to me given the performance of hybrid ARMs. And maybe you could elaborate on what factors in the CMBS sector and whether or not it’s credit sensitive versus agency? Anymore color there would be helpful.

Smriti Popenoe

Hi Jason it’s Smriti. So again we own a lot of hybrid ARMs and so we’ve seen those positions tightened in and actually see the marginal returns on a fully hedged basis for hybrids somewhere in the 7% to 8% area. And we’re assuming about 8 times leverage. So we see them as actually being more expensive on a fully hedged basis. On the CMBS side, we’ve been pretty selective in terms of what we’re buying. We like the CMBS I/O cash flows that’s something that we disclosed in our release we’ve been making selective investments there that’s on the senior side of -- so those are AAA bonds.

We’re also investors in the multifamily sector and that’s been actually both on the credit sensitive side as well as -- actually that’s been only on the credit sensitive side, and the I/O side there as well. But these returns on the CMBS we see as being in the low single-digits to up to 13% on some of the credit sensitive tranches. And that’s where the returns are today, I mean hybrid ARMs have tightened in a fair amount and the CMBS just look cheap relative to the hybrids.

Byron Boston

And Jason again this is what -- the keyword there is relative between the two. It does and hope you didn’t read that and what we hate the hybrid ARMs, and we love the CMBS sector. These are decisions that we make on a daily basis in terms of relative value between the two, the overall structure of the portfolio where we got this short duration married with this credit exposure on the commercial side, it’s just a philosophy that we really like and we still like it today.

And so this decision between these different asset sectors, our asset class will vary day-to-day, and on a month-to -month basis, there is some debate that I can make an argument let’s say you are in an environment as to where really should the CMBS returns be? Should they even be even lower than where they are now, because they still really potentially some of the demographic trends especially on multifamily are still very supportive. So I really want to make sure that you understand it’s really relative between the two as opposed to any statement about anyone and above any other.

Jason Stewart - Compass Point

No, that make sense and we certainly, we can tell by the table you didn’t make any sales. And I guess my follow-up to that was given the move year-to-date in hybrids could we expect you to make some more sales in that sector, has it gotten to that level of relative value where it makes sense to actually sell?

Smriti Popenoe

We’re not ruling out the possibility of repositioning the asset portfolio. We don’t think it’s quite there yet, but that’s something that we watch on a daily basis.

Jason Stewart - Compass Point

Okay. And then just from a very broad perspective, obviously there is some changes at the FHFA and perhaps the approach to the multifamily programs, any thoughts that you have on how that will impact the spread environment for K certificates or Fannie DUS?

Byron Boston

Yes, I mean there is a lot and boy that’s a big one Jason. And there is a lot happening in Washington and a lot of debate around, fear the positive. It seems as if across Washington now there is an understanding that the multifamily business is at the agencies work. And there is not a huge desire to just completely rip them apart. Everyone is now acknowledging that they came through the ’08 period in very, very good shape and today they are functioning in good shape, that a lot of the desires of the politicians of having private capital in front of the government exists in both multifamily programs.

And there are people arguing and debating on both sides of this, some would like to see Fannie DUS type program we have counterparty risk with the originator standing in front of other government versus the Freddie K program where you are actually creating tradable securities and selling them to the marketplace.

Personally I have said in multiple feeds are now being financed system over the last 30 years. I prefer the government creating tradable securities, so one of the greatest creations in the U.S. has been the TBA 30 year mortgage market that has allowed securitization and the growth of our housing system. I would love to see the agencies focus on laying off the credit risk in tradable securities in a similar type of fashion, that doesn’t take major congressional changes, it’s a simple effect, I know they’re laying up the credit off now and they are headed in the right direction, I would like to see them do it more.

But I still think it’s up for debate, that’s why we say regulatory uncertainty, that’s one of the largest areas that’s still up for debate, with a new Director of FHFA we’re not exactly sure which way the specific details of multifamily program will take, but we’re happy with the fact that most people recognize now they have been very successful.

Jason Stewart - Compass Point

Okay. Thanks for the color I’ll jump out.

Operator

(Operator Instructions) Our next question comes from Richard Eckerd at MLV & Company.

Richard Eckerd - MLV & Company

Hi. Thanks for taking my call. Just a quick question on the operating expenses, they were markedly lower in the period. Was there any fact there, any reversal of previous accruals or anything like that that might explain the drop quarter-over-quarter?

Steve Benedetti

Hi Rich, Steve here, the incentive compensation expense for the fourth quarter would have been reduced for the amount of bonuses that were elected by management to be taken into stock and that was a little over 1.4 million or $0.03 a share and that expense was essentially reversed out that quarter which is why you saw the big drop.

Richard Eckerd - MLV & Company

Fair enough. And one another question Steve while I have you on the phone is, can you give us an idea of in basis points and it doesn’t have to be precise of what your premium amortization expense in the last quarter was on the agency portfolio?

Steve Benedetti

I can give you the number it was right around 8 million.

Richard Eckerd - MLV & Company

Okay. That’s good, I can calculate that. Fair enough, thanks a lot.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Byron Boston for any closing remarks.

Byron Boston

Thank you very much. We really appreciate you joining us today on our conference call. We're very excited about our new management team additions to our Board and the fact that we're stronger management team today. Our shareholders have been able to trust us with their capital for years. As you can see we have shown our commitment to Dynex by investing our own personal wealth in our Company. And with that, we thank you again for joining our call.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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