Dynex Capital (DX) CEO Byron Boston on Q2 2014 Results - Earnings Call Transcript

Jul.30.14 | About: Dynex Capital (DX)

Dynex Capital, Inc. (NYSE:DX)

Q2 2014 Results Earnings Conference Call

July 30, 2014 11:00 AM ET

Executives

Allison Griffin - VP of Investor Relations

Byron Boston - Chief Executive Officer

Steve Benedetti - Chief Financial Officer

Smriti Popenoe - Chief Investment Officer

Analysts

Douglas Harter - Credit Suisse

Trevor Cranston - JMP Securities

Jason Stewart - Compass Point

Mike Widner - KBW

Operator

Good morning and welcome to the Dynex Capital Second Quarter 2014 Earnings Conference Call. 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 Allison Griffin, Vice President of Investor Relations. Please go ahead.

Allison Griffin

Thank you, [Gwen]. Good morning the press release associated with today's call was issued and filed with the SEC today, July 30, 2014. You may view the press release on the company's website at www.dynexcapital.com under Investor Relations and on SEC's website at www.sec.gov.

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, plans, 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 please refer you to the Annual Report on Form 10-K for the period ended December 31, 2013, as filed with the SEC. The document may be found on the company’s website under Investor Relations as well as 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 under IR Highlights. It may also be referenced by clicking on the Dynex Capital’s second quarter 2014 earnings conference call link also on the IR Highlights page of the webcast.

I would now like to turn the call over to Byron Boston, CEO.

Byron Boston

Good morning and thank you for joining us today. With me today again is Tom Akin, our Executive Chairman; Steve Benedetti, our CFO and Smriti Popenoe, our Chief Investment Officer.

We are happy with our second quarter results as we were able to take advantage of a great environment for generating solid net interest income. As we mentioned in our prior call that even though the market environment is very complex, there is a great business opportunity to earn net interest income as the yield curve remains steep rates range bound and volatility very low, nonetheless we remain on heightened alert given that risk premiums in most asset classes globally have materially declined over the past three years.

Most of what you’ll hear today will sound familiar. Our goal is to remind you that we continue to manage our portfolios in a very disciplined manner and we have not been forced to make major changes to our strategy. One year ago, we told you that we expected slower prepayment speeds, tighter spreads and rolling down the curve to be significant factors in our future performance. That is what has happened over the past 12 months.

Six years ago, we told you that we were constructing our portfolio to perform in multiple market environments and then we expect the shape of the yield curve and the level of rates to be supportive of our investment strategy. That is also what has happened to-date.

We have continued to pay an attractive quarterly dividend of $0.25 and our book value has increased 5% this year. Our larger portfolio thesis continues to hold. Hybrid ARMs have become more attractive as more investors have thought to shorten the duration of their asset portfolios. The multifamily sector continues to perform as the home ownership rate has declined and the commercial mortgage sector has proven to be an excellent anchor at the core of our investment strategy. The current global economic financial and regulatory environment is highly complex and we believe that we have an excellent strategy for producing solid net interest income without taking excessive risk.

With that, I’ll turn the call over to Steve Benedetti, our CFO.

Steve Benedetti

Thanks Byron. I'm on slide five for those that are following the presentation. My comments are going to be referencing a number of non-GAAP financial measures as disclosed in the earnings release and which are also reconciled on slide 36 and 37 in the appendix of the conference call slide deck.

As in prior quarters, we present these measures as a result of the discontinuance of cash flow hedge accounting under Generally Accepted Accounting Principles during 2013.

For the second quarter, we reported a GAAP net loss per common share of $0.15 which reflects the mark-to-market loss in our hedging instruments for the quarter. As a reminder, our GAAP results include market value adjustments from our interest rate hedges while corresponding changes in our asset guys reflected only in shareholders’ equity and book value per common share.

As a result, we present core net operating income which excludes the market value losses on our hedges and which was $0.26 per common share for the quarter compared to $0.25 per common share last quarter. This represents an 11.3% return on our average common equity for the quarter.

During the quarter, we declared a dividend of $0.25 per common share, in line with core earnings and which represents a current yield of 11.8% based on last night’s closing stock price. Adjusted net interest income, another non-GAAP measure was $20.1 million flat to the first quarter. Adjusted net interest income benefited from an increase in the adjusted net interest spread of four basis points to 192 basis points which helped to offset the smaller interest earning asset portfolio.

Our leverage declined by 0.2 turns to 5.7 time shareholders’ equity, as a result of the deleveraging of our investment capital coupled with an increase in shareholders’ equity of $13 million during the quarter. With respect to prepayments, we saw a modest increase this quarter in our agency RMBS but this increase had only a nominal impact on our reported results and our longer term prepayment expectations remain unchanged.

On slide six, we present key trends, key financial metric trends for the company. Net interest spread has increased four consecutive quarters as we have shifted our asset mix more towards CMBS investments and we have benefited from declining borrowing cost from the repositioning of hedges in the fourth quarter of 2013 and also as repo costs have declined.

We continue to maintain the majority of our interest rate exposure on the zero to four year part of the curve. For the quarter, book value per common share increased $0.25 or 3% and for the year book value has increased $0.43 or 5% as investment wise have benefited over the last several quarters from the lower volatility tighter spread environment. The increases in value are spread across the entire portfolio with the biggest increases from a dollar point of view on our hybrid ARMs and our non-agency CMBS.

I’ll now turn the call over to Smriti who will talk about our investment portfolio outlook and strategy.

Smriti Popenoe

Thanks Steve. I am on page eight for those following along on the investor presentation. I am going to start to with a quick update on the markets that we are active in and as you know we think about those in terms of fundamentals, technicals and psychology.

The multifamily sector where we have most of our capital invested continues to evolve. The current fundamentals property prices, vacancies, rent, growth and prospects for these fundamentals in this market remains strong. We’re seeing certain markets peak in terms of property price appreciation. This is mostly where there has been some overbuilding but we still believe demographics will support rent growth and vacancy trends in this sector.

In the non-agency CMBS sector, we continue to see competition and loosening of underwriting standards particularly on the collateral front where this is showing up in the form of higher LTDs and deals that we’re looking at. We’re also seeing an increase in the number of mezzanine loans against properties. As you know we invest in the AAA part of the capital structure here and underwriting is not at a troubling level yet, but we do see this type of activity as a sign of cash chasing yield.

The fundamentals on the residential sector are starting to show some weakness with 30 year rates declining from 4.4% to 4.1% roughly over the quarter, we did see a seasonal pick up in prepayment speeds but the big story in residential has really been the slowdown in activity on the home sales front existing home sales, new home sales and pending home sales have all come out with weak numbers recently. The other point to note is that the year-over-year increase in home prices as measured by that is finally starting to slow. These factors could cause the next supply of MBS to be lower than most people expect.

On the funding side, we continue to have access and availability to liquidity at attractive levels. This is being primarily driven by excess balance sheet capacity and a lack of high quality collateral. And finally, the nature and timing of GSE reform is still uncertain with no private standalone solutions yet and in place to replace the GSEs.

From a technical standpoint over this quarter, things really weren't much different versus last quarter. Continued government involvement, abundance of cash and search for yield resulted in lower risk premiums across the globe, which meant tighter spreads. We also saw this in the long and up that treasury. China purchasing a record amount of treasury bonds over the quarter.

We believe the key technical factor over the next quarter is the Fed’s exit, particularly for MBS and that's apply this month which was reported actually this morning is meaningfully positive and has begun to impact spreads. In fact in the month of July, we've seen a modest amount of spread widening in both RMBS and CMBS. 13 and 15 year RMBS are about 10 basis points wider, CMBS about 5 to 10 basis points wider across the capital spec. The good news is spreads on short hybrid ARMs have been fairly stable. Keep in mind though, even though we're talking about some spread widening, we're still near the tightest spread level since 2011 in most sectors.

Our book value has been stable since quarter end. So what does this all mean for Dynex turning to page nine? Last quarter, we communicated our view and our view was this is not the environment in which to make big best one way or the other. We think that's the haunt, we're continuing our disciplined investment approach to seek and find value to add on the margin, we think we can do both on the investing side and the funding side. Our focus is to generate earnings by keeping the investments in our current portfolio, but being very conscious and mindful about the risk in the environment being ready to take action if necessary and appropriate. We are managing our liquidity and our leverage with that in mind. I will say we do have the capital and liquidity to withstand the spike in volatility and we would that actually view that as an opportunity to invest we are also focused on creating value and diversifying our financing portfolio.

Turning to page 10 to describe our interest rate risk position. Our interest rate risk position saw a very little change over the quarter and just to remind, you this page shows you both the exchanges in our fair value of our assets, net of hedges for parallel and non-parallel interest rate shocks. And as I have made the point in previous calls the market rarely moves in parallel fashion and this is really where you get to see the difference between the impacts on fair value for parallel and non-parallel interest rate shock. So not much change in our interest rates sensitivity over the quarter.

Page 11 just goes through our portfolio allocation. Again here not much change between last quarter versus this quarter. Page 12, we have our CMBS portfolio of credit quality. Again majority of that capital is invested in AAA assets. Page 13 not much change in our RMBS portfolio either. And then just turning to page 14, a few comments on our financing portfolio. As I mentioned earlier we are actively managing our financing portfolio to generate value and reduce risk. We did continue to see a decline in financing cost this quarter, our average repo cost for the quarter went down from 61 basis points to 57 basis points. And really this is being driven by demand for high quality collateral.

As you also know we have a committed facility to finance our CMBS portfolio. We use this primarily to fund CMBS IOs. And the funding cost on that facility also declined over the quarter contributing positively to net interest margin.

And finally a couple of market developments, we've been keeping a close eye on from a financing perspective which we expect to impact funding cost in the near future. The first is the money market fund rose that the SEC came out with this week. We believe this is a net positive for agency repo as it shifts capital from non-government funds to government funds, increasing the amount of funding available for high quality agency collateral.

The second is the supplemental leverage ratio. This is something that's been around for a few months now. We've actually seen interestingly this benefit our non-agency repo financing cost,. The demand for non-agency repo financing from financing counterparties who are subject to this supplemental ratio has been very robust, we expect that to continue.

And finally, the reverse repo facility at the Fed; we continue to monitor the activity and the levels in this experiment that the Fed is conducting. We believe this will be a major part of Fed policy in draining liquidity from the system.

In terms of just what we expect our future funding cost to be. Right now the GCF futures market is pricing in about a 2 basis points to 3 basis points, increase in repo cost over next quarter. So we may see slight pressure on margins later this quarter and into the fourth quarter.

Before I turn it over to Byron, I would like to leave you with the following thoughts. The first is we're focused on generating earnings by keeping our investments in the current portfolio. We're very mindful and conscious about the risk in the current environment. We're managing our liquidity and our leverage with that in mind. We're comfortable with our ability to withstand the spike in volatility and we view that as an opportunity to invest. And we're focused on creating value and diversifying our financing portfolio.

With that I'll turn it over to Byron.

Byron Boston

Thanks Smrit. Let's move to slide 16 and let me remind you that an above average dividend compounded over several years is a significant source of long-term returns. We've included here a chart showing total returns of various thoughts and indexes of over 10 year horizon.

One of the interesting facts about the past 10 years is that we have seen multiple market cycles during which the dividends have gone up and dividends have gone down. Book values have gone up and book values have gone down. For example over the past decade the Federal Reserve Bank tightened credit and raised interest rates over 400 basis points between 2004 and 2007.

The U.S. housing market collapsed and the global financial system nearly failed. The mortgage REIT strategies with the liquid balance sheets and disciplined risk management have proven to be the winners. When we run this chart over a longer horizon, the numbers are even more compelling as compounding dividends offset a variety of negative market disruptions.

We believe that maintaining a liquid balance sheet having a portfolio that can perform in multiple market environments and disciplined risk management are powerful strategies for generating attractive long-term returns. As we have always said you can continue to trust that we will manage our capital for the long-term and we will remain very disciplined as we navigate the current complex global environment.

Operator, we’re now ready to answer questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question will come from Douglas Harter of Credit Suisse. Please go ahead.

Douglas Harter - Credit Suisse

Thanks. Byron or Smriti, can you talk about how much capital you feel like you need to reinvest each quarter from pay downs and whether that’s changed in recent quarters?

Smriti Popenoe

Hi Doug, this is Smriti. So, basically, let me explain to you what our strategy has been for reinvesting. When we saw yields at the levels that they were at in the first quarter and spreads at the levels they were at in the first quarter, we felt like it was okay to reinvest a 100% of our run off in that quarter. We thought that risk return opportunities were good and it made sense for us to do that.

In the second quarter, we’ve actually taken that number down to about 75% I would say, because we felt like that risk return really wasn’t compelling enough to put all the capital back in. And I think we’re looking at the environment right now and it really depends on what spreads do here. So, we don’t feel compelled at this point to have to put a 100% of our capital back in, if that’s…

Byron Boston

Yes. And Doug, with our increasing equity allocation to the CMBS sector, that has reduced a need. So the overall amount of dollars that are coming back just have not been an excessive amount. One of the big stories in the marketplace over the last month or so has been a slight increase in prepayment speeds more than some people anticipated. That was not an issue here Dynex. And so as long as we’ve got the CMBS product, again it’s been a great anchor for this portfolio having a focus on commercials.

Douglas Harter - Credit Suisse

And I guess just to follow-up on your comments there, Smriti. With the backup and spreads we’ve seen so far quarter to-date, is that enough for you to want to put some of that excess capital you hold back to look at or would you look for more volatility or more widening before you got more constructive?

Smriti Popenoe

Yes. We’re still very close to the absolute tight, Dough. And I think the real key here for the first time you've actually seen some meaningful next supply coming to the market in the month of June and the month of July. It's been a net positive of 5 billion to 7 billion. The Fed's probably going to announce another reduction in their purchase program today. We think there is room for some of this for mortgages to widen some more. So not yet there in terms of where we think there is meaningful risk award to put capital to look at.

Douglas Harter - Credit Suisse

Great. Thank you, guys.

Operator

And the next question will come from Trevor Cranston of JMP Securities. Please go ahead.

Trevor Cranston - JMP Securities

Hi, thanks. You guys mentioned several times throughout the presentation that risk premiums have continued to decline and spreads remain at close to the absolute tight levels. Is there any point at which you guys would think about adding some hedges either in the CMBS space or the agency space to protect yourself against spread widening or is you approach to kind of be just little more cautious on what you purchase and maintain your liquidity so you could take advantage in that way?

Smriti Popenoe

So Trevor, the answer to that is yes, yes to both. So, there is two ways you can manage spread risk, one is delevering and not participating in the market at some point and then the other is actually hedging. We look at this all the time and it’s part of our risk return trade-off. So absolutely we look at it as a way to protect ourselves.

Byron Boston

And Trevor, let me just; I am glad you asked this question because I want to clarify something; I want to make sure everybody understands this. When we say we are disciplined investors, it doesn’t mean that we are not investing, doesn’t mean that we are now looking for great opportunities. And so the answer is yes, as a disciplined investor, we are always thinking about when to add that additional hedge.

And let me just explain some other behaviors as they go on here at Dynex. We spend an enormous amount of time running future scenarios and future risk shocks; we develop strategies that we can potentially deploy if we either sense that the profitability of that scenario is increasing or if we find ourselves in that type of situation. So that’s what’s meant in terms of disciplined risk management. You have to first recognize that if you want to compare us to 2011, right? Let’s compare to 2011; that was a great year; there was an enormous amount of risk in the system, S&P downgraded the U.S. and enormous amount of investors moved to the side lines. Dynex Capital aggressively put capital into the marketplace. Why, because spreads were at all time wide at that point. So a disciplined investor wants to put more capital in the market with spreads are really wide and when they recognize that we are to get to closer to the tighter levels, we want to be a little slower, a little more disciplined, a little more careful and be prepared to understand what type of hedges we may need to put on, if we sense that again spreads may wide or rates may do some type, or curve may adjust in some other fact of fashion. So, I appreciate your question. I want to make sure you and everyone else understand what's meant by disciplined investor?

Someone asked me in the last quarter, hey are you guys are really, really cautious? Cautious isn't a word, discipline is the better word to describe what we do at Dynex.

Trevor Cranston - JMP Securities

Got it. I appreciate those comments. Thanks a lot.

Operator

(Operator Instructions). The next question will come from Jason Stewart of Compass Point. Please go ahead.

Jason Stewart - Compass Point

Hi, good morning. Thanks. Could you talk about the growth in the CMBS IO portfolio, it looks like maybe give us some color on the pace of growth during the quarter. And where your thoughts on that stand today with spreads were there?

Smriti Popenoe

Sure. So versus the first quarter, our growth was actually slower. I can dig through the numbers in a few minutes here and maybe get back to you offline. We saw spreads tighten this quarter, basically all through the quarter, even though a lot of deals got done in the month of June. Probably, I would say a good 15 basis points to 20 basis points over the quarter in CMBS IO portfolio.

They got to the levels Jason, if I could describe to you sort of our behavior last quarter versus this quarter. Last quarter, we were comfortable and I'm just using an example here, putting in for $10 million of a deal and call it 155 to 165 over swaps. And we put in for $10 million, we’d get $2 million or $3 million. That kind of continued over this quarter as spreads tightened in. And as spreads tightened in earlier in the quarter, we felt like we the risk return was still good. But towards the end of quarter, we actually started dropping from deals. So people would ask us if we were interested in remaining in the deal at tighter spreads and we actually exercised some discipline there.

So what you should see basically as these tighter spread levels we are being a lot more choosy about which deals we want to invest in and quite frankly we've turned down deals at some of these tighter levels.

Jason Stewart - Compass Point

Would you -- I mean it looks like both Fannie and Freddie's multifamily volume accelerated throughout the quarter as the scorecard was finalized, would you expect spreads to widen as their volume picks up throughout the year or do you feel like the supply demand equation is fairly balanced?

Smriti Popenoe

The Fannie-Freddie deals are interesting because the P&I bonds for these deals actually got included especially the Freddie bonds got included in the mortgage index so you've seen a lot of outperformance of those deals relative to non-agency deals this year because they are now in the index.

So they are actually an interesting opportunity I think but I think also that they tightened in a little too much relative to everything else. I would expect those again given the amount of cash in the system I am hard pressed to see spreads widening too much from here. I think investors are finally starting to see that some of these levels are reaching nose bleed levels and we need to start to back off a little bit. And as I mentioned in my previous comments any type of widening like this we view as an opportunity to jump in.

Jason Stewart - Compass Point

Okay, that's helpful. Thank you. And then let me just pull back for a second it seems I think in the first quarter you touched on potential opportunities that may be more medium or long-term as Freddie and Fannie exit the residential mortgage system. Any thoughts on -- any further thoughts on how that's progressing in the Dynex strategy or thought process?

Byron Boston

Yes, Jason, this is Byron. It’s uncertain how that ultimately will in terms of the actual legislation on our reform of housing finance reform will take place. However, here is what we do know for a fact is that when the treasury, I am sorry when the Federal Reserve Bank sees these purchasing monthly mortgages or large scale asset purchases and we still have a wind down of the Freddie and Fannie portfolio, as in my 30 year career to be the first time that a government agency not dominated the trading of mortgage agency mortgage back securities so that means those assets as they have created over the next year or two, three, four, five we’ll have to be how’s on someone else’s balance sheet and in our opinion it means that those assets will have to be priced at where private capital get earned a sufficient return to take that risk.

So we view that long-term is one of the most simplistic business opportunities on the horizon. And so we do look forward to being able to take advantage of that as the world evolves in front of us. We are trying to predict legislation around this. There is very difficult for me to have more insight on that than we actually do. If we have a wish list it would be that the FHFA would put more pressure on Fannie and Freddie to dispose of the risk that’s on their balance sheet both interest rate risk and credit risk. I believe the capital markets are ready to be able to take more of that risk on in the private space. So, from our perspective we look at future in a positive sense. We don’t get and one of the reasons we put those long-term charts in our presentation that we’re not getting gloomy just because there is conversation around maybe the Fed will reduce some of the liquidity that they've been providing to the system. We still believe that in the future, there are some great business opportunities both on the residential side at the book and on the commercial side of the book.

Jason Stewart - Compass Point

Thanks. Appreciate you taking the questions.

Operator

And our next question will come from Mike Widner of KBW. Please go ahead.

Mike Widner - KBW

Yes. Good morning guys.

Byron Boston

Good morning, Mike.

Mike Widner - KBW

So I think your answered a lot of questions. Let me just one other characterization you made I think was that you're not necessarily cautious about the market, asset opportunities but you're more diligent in your process. But I mean I certainly here in your tone and this was true last quarter and I'm just still hearing it today is that your [lessoned foods] I think about investment opportunities and you were when say spreads were at much wider levels. I mean is that accurate and I guess is there, are there places where you're still more enthused to, I know there isn’t as you look forward to the market evolving places where you think there might be greater opportunities that may not be there today, but certainly look more promising?

Byron Boston

So Mike I want to be real specific, I mean time what I said a second ago. Because 2011 was a year when a lot of people were cautious, spreads were really wide and we were really excited and we tried to back the truck up and put capital to the marketplace. So that was a risk environment and this is a risk environment today.

So that's why I want to point out in terms of how we're very disciplined in this process. Obviously when spreads are really, really wide, you'd love to really expand your balance sheet and when spreads are really, really tight. This is a more to reference as you like to reduce the balance sheet or slowdown the process. One of the complicating factor is really all these issues that are at play globally and it could change our north at any point in time. Nonetheless and as we have explained you say that the global environment is complex but there is also a great business opportunity. With this type low vol environment heavily being influenced by the central banks globally it is a great opportunity to generate net interest income and we don’t want to miss that opportunity. What we don’t want to do is make a foolish decision about the type of risk we take or taking too much risk at these type tight global risk premiums. Does that give you a better impression of it.

Mike Widner - KBW

Well I mean I think it does except you use the term backup the truck, I mean what I am hearing from you is yes we love the net spread environment but it’s certainly not a backup the truck kind of moment.

Smriti Popenoe

Exactly.

Byron Boston

Yes that’s exactly correct, I mean I would love 2011, it was a point spreads were IOs were over 500 basis points and little Dynex Capital in Richmond, Virginia was cleaning up CMBS deals because most other investors at once at the side line. I would love for every other investor to run at the side lines and allow us to do that again (inaudible) scenario right. But here we are in 2014 spreads are at the opposite end of the spectrum and yes antennas are higher, we can see lenders, with this amount of cash in the system. It’s borrowers market right now. If you look at how loans are being made and so lenders are loosening credit standards. We want to keep our eyes on what lenders are doing to ensure that we are not the investor to uphold the back with a bad deal. So we look, we love to take a closer look at deals that are coming to the marketplace. Yes, I see some deals that we have passed on when it looks, it’s a little shaky in terms of the instructions that are being brought to the market. So when spreads are this tight our antennas are higher, we are more alert to looking for any type of anomalies that could create some problems over a longer terms basis.

Mike Widner - KBW

Yes. I mean I guess another way of sort of thinking about it, if we go back to 2006 or early ‘07, it seemed at least to me at the time or guys at the time that investors were willing to overlook a lot of risk or at least chronically underestimated risk and asset prices were relatively high as a result. And as you said 2009, 2011 is the opposite, everyone was running scared and everyone was sort of overestimating the risk or at least pricing implied that. I mean today, it feels to me a lot more like ‘07 than ‘09. And I guess ‘06 to ‘09. And spread opportunities where I suppose -- spread opportunities were always good for a leverage lender to be honest with you but it’s just a matter of how you feel about the risk profile and your view of risk relative to the market.

And I still get the sense that you guys feel like the market is in many ways and in many places underestimating the risks relative to how you see them. And so you used all your words to describe that, but you don't want to go so far as sort of saying that it feels more like ‘06 than ‘09. But I guess is that right?

Smriti Popenoe

So, I would say yes, yes Mike. I think the biggest difference between ‘06 and ‘09 is that I think investors in ‘06 were underestimating the risk and they got a lot of it massively wrong. The difference is you now have coordinated global central banking actions. They are basically acting to squeeze volatility out of the system, which means that you have to question, yes, things are tight; things look expensive but these global banks have basically made it, so that the amount of volatility in the system is now substantially lower and could potentially be low for a long time. That's what gives us pause. So I would love to sit here and say gee, guys, this really looks overpriced and we should be short the market. But I have -- I cannot do anything but respect the power of central banks. And that’s really what we think about and returns are still attractive on a relative basis. I mean that's you can’t ignore that either. There are pockets of value here that we’re able to find either on the resi side and on the CMBS side where you say okay, I am all right taking this risk return.

Byron Boston

And Mike, I am glad you brought this up because we put the 10 year chart in our presentation. So we're willing to talk about the last 10 years. So let's identify Dynex Capital or Smriti and I in that time period versus now, what makes a difference. You could see the risk. You could see the risk and what was happening. And in let’s call between the ‘02 through ‘07 time period and reason I go back ‘02 is because I am on record as identified that subprime sector would go for a major correction as early as ‘02, ‘03. And unfortunately had I expressed an onion at that time in the form of let's say shorting those sectors would have been very painful for several years. If you read the book to big short you will see somebody in obviously short at the sector; very early on it was very painful at certain points in time.

So there is an abnormality here which Smriti pointed which is essential bank activity. That is an extreme abnormality; make it very difficult to predict the future. So again let's compare back. If you go back to Dynex Capital ‘06, ‘07, Dynex was selling asset. If you now compare to -- and when it’s easier to predict where the markets were headed at that point in time. We can't predict the future but we can run scenarios and so the probability distribution on multiple scenarios, the multiple options here in terms of how the markets may evolve over the next several years and as such that’s why we’re approaching and we used the word such as discipline. So we agree with this that the risk is heightened that these type of risk premiums. But our behavior reflects our knowledge of the past and our experience in the past and trying to ensure that if this type of low volume environment is going to go on for the next two years we want to be able to take advantage of it and generate solid net interest income for our shareholders.

We however don’t want to take excessive risk in this type of environment. And as such you can see that our balance sheet is lower today than a year ago, but we’re still pretty aggressive about looking for pockets of opportunity to take advantage of the environment.

Mike Widner - KBW

I mean that certainly makes sense to me I appreciate the color. And I guess my last thought on it is no one has been in this environment before with the central banks basically.

Byron Boston

No, never.

Mike Widner - KBW

Trying to crush wall but we don’t have to look very far back, sometime spring of last year when all of a sudden we were not in the very low volume environment despite, so I mean obviously I think you would agree most people would agree it’s a dangerous game when the Fed is manipulating everything. And so yes, I mean it looks like val will be low for a long time but we might wake up on Monday and all of a sudden val is back that’s the risk.

Byron Boston

Yes, that’s correct. And we expect, so we expect spikes in volatility and as such as built up the liquidity on the balance sheet and we’re still paying a solid $0.25 dividend and that’s where our mind is focused and we pay a solid dividend. We built up liquidity over the last year so we believe we’re looking to expand spikes in volatility. And then in the back of our mind we understand that with these type of abnormalities with the interconnectedness of the global financial system, we must be prepared for the unforeseen event and the uncertainty bit to evolve in front of us and then we must be very discipline amount of decisions in that process. And we want to make sure that our shareholders understand and feel very comfortable, look back over the history of the past financial class through and understand one really, really experience skilled risk managers and we are taking our time and we're being very diligent about how we make decisions in this environment.

Mike Widner - KBW

As always appreciate the comments guys.

Smriti Popenoe

Thanks Mike.

Operator

(Operator Instructions). And at this time I'm showing no questions in the queue. I would like to conclude the question-and-answer session and turn the conference over to Byron Boston for any closing remarks.

Byron Boston

Once again, we want to thank you very much for joining us today. And we look forward to you joining us for our third quarter conference call in about three months or so. Thank you again.

Operator

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.

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