Good morning and welcome to the Dynex Capital Third Quarter 2012 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 Alison Griffin. Please go ahead.
Thank you, Valerie. Good morning and thank you for joining the Dynex Capital third quarter 2012 earnings conference call. The press release associated with today’s call was issued and filed with the SEC today, November 1, 2012. 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 on the call today are, Thomas Akin, Chairman and CEO; Byron Boston, President and Chief Investment Officer and Steve Benedetti, Executive Vice President, Chief Financial Officer and Chief Operating Officer.
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, forecasts, anticipate, estimate, projects, 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 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, 2011 as filed with the SEC. The document may be found on our website under Investor Relations as well as on 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 Q3 2012 earnings conference call link, also on IR highlights page of our website.
I would like to turn the call over to Tom.
Great, thank you Alison and thanks everybody for joining us this morning. We know it’s a very, very busy earnings schedule what with Hurricane Sandy sort of collapsing all of these calls into and it appears Thursday, but thank you for attending.
By now the entire investment community is aware that the extraordinarily yields of the last four years have become scarce. After several rounds of quantitative easing and the recently announced QE3 last quarter, the Fed has succeeded in its efforts to force lower mortgage bond yields and therefore the opportunity for levered RMBS return.
RMBS returns have now returned to the more historic norm driven by the Fed and not normal market action. One of the reasons Dynex chose a diversified investment portfolio approach was to provide flexibility in the investments for times just like.
Our investment strategy and our portfolio was forged from the crisis of 2008 and knowing that a volatile environment lay ahead. Dynex continues to maintain a highly diversified, high quality short duration investment asset mix.
Over the last few years, we have moved actively from our original large concentration in agency RMBS to CMBS assets as the Fed made clear their intention to lower mortgage agency yields at the expense of agency RMBS investors.
We have concentrated our portfolio activities so to where the Fed’s hand wasn’t quite as heavy. CMBS assets have continued to not only offer yields to remain attractive, but have the added value of providing more explicit prepayment protection and giving us more predictability in our cash flows as rates as moved lower. We continue to find attractive low to mid-teens returns in selective CMBS investments.
Our leverage this quarter was slightly below target, mostly due to the 7% rise in our book value at quarter end. Already we have added enough assets to move our leverage back to target. That plus the accretive value of our preferred offering should provide stronger core earnings in Q4.
During the quarter, we took gains where the spread risk to book value exceeded the future cash flow opportunity. These gains were available as yields and credit spreads dropped precipitously during the quarter and QE3 euphoria. We have already taken several additional gains this quarter that will be reflected in our fourth quarter results.
Our goal is to capitalize on the appetite for yield assets and protect our book value without dramatically changing the cash flow characteristics of the portfolio. Today, our portfolio has moved to where agency RMBS represents less than half of our invested capital. We still have room to add more CMBS assets to our mix and likely will depending on supply considerations. While we will not be immune to lower rates completely, we expect to be able to mitigate a dramatic decline in our earnings due to our diversified portfolio without changing our core investment strategy.
Our focus continues to be on high quality short duration assets. We have not needed to extent our maturities to either 15 years or 30 year mortgages, as we continue to find sufficient opportunities in our strategic investment side. With rates at historic lows and with commensurate risk, we are pleased to offer our shareholders a substantial cash return while maintaining maximum portfolio flexibility if the investment environment changes dramatically.
The Dynex math at this point is fairly simple; our 200 basis point net interest margin multiplied by our average leverage of six is 12%. Adding in our CMBS yield coupon of 3.5% gives us a 15.5% return, subtracting our expenses of roughly 2.5% is a net ROE of 13%. We may increase our leverage modestly to 6.5% and that would add an additional 100 basis points bringing our total ROE to 14%.
The good news is that rates have moved substantially lower and our book value has reached a record level. The bad news is that rates appear to be stuck at these low levels for a substantial amount of time making future returns less attractive. Whatever the future direction of rates, we feel that it is imperative that we retain a flexibility to maximize cash flow and minimize risk to shareholders.
The mortgage REIT market is cyclical and at this point in the cycle, risk has substantial forward price. I am happy to report that Dynex has not changed our core investments strategy, but maintained our lower risk profile while continuing to show attractive investor returns.
Finally the entire mortgage market is reeling from the passing of Mike Farrell; Mike and Annaly were without question are the leaders in this industry and his presence and whip will be surely missed. We at Dynex would like to offer our deepest condolences to Mike’s family and wish the entire Annaly team best success in the future.
And now I would like to turn the call over to Byron Boston, our President and Chief Investment Officer, and he will pickup more detail on the portfolio.
Good morning. If you have the presentation would you turn to slide six; I know that in this marketplace, prepayment risk and lower reinvestment opportunities are the top topics of our investors and as such I am going to spend a fair amount of time discussing our overall risk.
Here is what’s important; since January 2008, we have methodically constructed a balanced portfolio that is designed to perform in a variety of market environments. We have remained focused on building the short duration, high quality portfolio that minimizes prepayment risk, credit risk, liquidity risk and especially extension risk. A core principal of our strategy has been to diversify our portfolio such that we do not expose all of our capital to one type of risk. Hence in today’s market of high prepayment risk, we are very comfortable as Tom mentioned a second ago, that less than 40% of our capital is exposed to unexpected prepayments. The majority of our capital has been deployed into sectors with explicit prepayment protection or less prepayment volatility. The commercial loans that back our CMBS securities have some form of prepayment penalty or lock out that reduces the risk of loss from unexpected prepayments.
In addition over the past few years we have deployed our capital in a very opportunistic manner, the bulk of the CMBS securities have been acquired over the past three years during periods of very widespread. In fact starting in July of 2011, I think that's a very important point because that's when the Fed really came out and extended their guidance for a longer period of time and became a little more aggressive.
We began to shift the material amount of our capital from agency hybrid securities to the CMBS sector. The results of these actions over the last 15, 16 months or so has been to minimize the amount of cash that we must reinvest each month since the CMBS bonds have minimal prepayments. Let's look to slide 7 and let's take a closer look. Let's look at how we've allocated our capital. Since June 2011 as I mentioned a second ago, our capital allocation has shifted from 50% allocation in residential RMBS to less than 40% allocation today.
You can see this on the graph to the right as we show you on percentage of 38.7% allocation to agency RMBS, 61% allocation to all other assets. You could also look at it in absolute dollar terms in the pie chart to the left, the other chart to the right. Hence 60% of our capital completely allocated to areas that are not exposed to residential prepayment risk.
Furthermore the durations of these securities are more predictable and minimizes any unexpected loss of principal due to prepayments. Let's move to slide 8 and let's look at our prepayment risk in another manner. First and foremost let me emphasize that at Dynex Capital, we've not bee afraid to take premium risk and we've been very strategic in that process. Every single year since 2009 whether it’s ’09, 2010, 2011 and now in 2012, we've had this heightened market of prepayment risk fear.
So let's take a closer look at the amount of premium that is on our books today. If we look at the graph to the left, you will see that we've got $750 million in total premium. Of that amount only 19% represents or is exposed to agency RMBS. The bulk of the premium on Dynex Capital’s balance sheet another way to say this is that we paid our higher dollar prices for our CMBS securities which are absolutely protected from premature prepayments.
If you look at the graph on the right, agency RMBS premium detail let's break down this $145 million and specifically look at how we've selected securities. 100% of the securities in our portfolio have been selected slowly and in an opportunistic manner. They are all expensive by tools. We don't do TBH security at Dynex Capital. The hybrid sector is different than the 30 year sector wherein 30 years you can get specific characteristics and the hybrid sector takes us a little more time to selectively pick the assets that have more favorable characteristics from a prepayment perspective and as such our overall prepayment experience has been in our opinion very favorable for a high dollar price portfolio.
If you go to slide 9, let's take a look at some of the macro factors around prepayment. A look at the MBA refinancing index. The most important thing to note here that over the last month the index has declined 24%. Now that's the pattern that it’s been going over the last several years. Each time you have this new lower rates and new program from the government, you have a spike in terms of prepayments and then what you have after that is a trail off. So what's been happening, have there been no borrowers refinancing or is it just the same borrowers refinancing again.
Maybe if you look at some of the lower coupons in the speed, let’s say 30 or 3.5; it looks as if the same borrowers are refined over and over again. Here at Dynex Capital, our RMBS CPRs have been relatively, it's been a relatively tight range of 17 to 25 CPR, with an average of approximately 22% for the last 16 months. It's been a relatively consistent and stable. Our assumptions that are built in our yield models or up nearly 27 to 28 CPR and let me make it real clear that as speeds slow down from here, we would be expecting increase in our net spread of anywhere from 50 to 100 basis points. We are very well positioned for the current environment.
Lets talk about the next type of risk that most people have been concerned with which is really the overall reinvestment risk in the portfolio, and this we will get it in a couple of ways. First, how much money do we need to invest on a monthly basis? The fact of the matter is our monthly runoff from our portfolio is not that great. We're estimating between 40 million to 70 million in portfolio runoff per month. This results in probably no more than 4 million to 7 million in capital that we need to redeploy.
Second, because we do not depend on one sector for our investment needs, we have more options for seeking and finding value. The expected ROEs continue to hover in the 10% to 13% range. Given our selective process for choosing assets, we're confident in our ability to find decent relative value within the current environment. For example, we maintain a slow discipline process of investing during the third quarter which resulted in a lower average leverage for the portfolio.
However, we're very happy with the assets we were ultimately able to put on the books despite the Fed’s activity. Now if you look at this slide on slide 10, let me point out something that’s very, very important. You can see that the Agency RMBS range of ROEs go some 6% to 13%. The Agency CMBS ROEs from 8 to 13%. In the agency sector, we have some very conservative prepayment assumptions built into those ROE projections. If we have any slowdown in prepayment and again let me just make it clear our average speed has been about 22 CPR we are projecting 27 to 28 for the portfolio. We would expect the higher end of those ROEs to move from anywhere around 13% to potentially as high as 15 to 16%.
Let’s go to slide 11 and let’s talk about a couple of other risks and we will do it relatively quickly and then we can move to questions and answer period. Let me reemphasize short duration and high credit quality portfolio. If you look at the graph on slide 11 to the left, we are just reemphasizing a bulk of our portfolio continues to be centered in the what AAA type of ratings either it’s in agency or AAA security.
We have increased over the last year or so some of our A rated paper, but again it continues to represent a small percentage of the portfolio as a whole. If you look to the right and if you follow Dynex Capital, you have seen this graph before. We continue to focus on assets with either expected maturity or resets inside of 10 years. What that really means is we have minimized the extension risk in our portfolio. One of the top trades in the marketplace and one that concerns us here at Dynex Capital is to go out buy 30 year securities and under hedged them. 30 year 3 and 3.5 are very, very long duration instruments. As such with to date we have avoided expanding or extending on our durations to the 15 year or 30 year sector.
One year from now, two years from now, three years from now our portfolio our portfolio will continue to roll down the curve in a very, very efficient manner. So let met reemphasize the Dynex Capital we have worked to minimize prepayment risk, our overall credit risk, liquidity risk and a specialty extension risk in the portfolio.
With that Tom, I am turning back over to you.
Great, Byron and thank you. Next slide is basically the total rate return of Dynex which stands at 94% since we started the portfolio in 2008. The final slide are the key takeaways, I would like everyone to think about in this very interesting time, we obviously said at to certain degree and flexion point in the mortgage REIT industry where I think a lot of things are going on.
We continue to believe that our diversified investment strategy helps our shareholders to minimize risk and maximize ROE. Our business model provides options, to take advantage of selective opportunities and deliver the returns. We have the ability to add more CMBS assets, non-agency assets. We have the ability to had light amount of additional leverage if we see appropriate. We have not fully pushed out our business model of the point where we have no flexibility left in what we do.
Our prepayment risk is mitigated by the majority of our allocation to CMBS. We have explicitly got into the CMBS sector because of the natural maturities of these bonds which are mostly 5 to 10 years in maturity. And we focus in the 5 to 7 year area. We anticipate modest monthly reinvestment as Byron had pointed out.
We are not reinvesting $500 million, $700 million a months which makes our business that much more difficult to manage. It is a rather manageable number. And finally where secondary for our current part of portfolio we believe reports our current dividend policy. Finally as owner and operators we have always been focused on the shareholder and focused on the long-term value of our shareholders.
And with that operator, I would like to open it up for questions.
(Operator Instructions) The first question comes from Zach Tanenbaum of MLV.
Zack Tanenbaum - MLG
Just starting off on book value with the 7% increase, I think it was $0.65 per share; can you give us what the biggest contributors were in terms of the different buckets of your portfolio, of that increase?
Steve Benedetti, our CFO would probably explain that.
Most of the increase in the quarter would have come in our CMBS portfolio in the A rated paper that is the Freddie K Multifamily Program that we invest in. And secondarily, we would have had some spread tightening and increase in book value from the agency RMBS book. That was the bulk of the changes from quarter-to-quarter.
Zack Tanenbaum - MLG
And then just sticking on CMBS, Tom you mentioned some supply considerations as going forward you may want to allocate more capital to CMBS, can you talk about just a little more color on what you mean by that? Obviously, I think the new issue markets picked up but how do you think about supply going forward relative to your reinvestment capabilities?
Well, I think the reason that the CMBS market is not a good fit for everyone is that it is not a particularly large market and the opportunities to basically put it to work a $10 billion, $20 billion, $30 billion; $40 billion portfolio is rather limited. We are looking at specific smaller tranche issues that offer what we feel to be attractive returns but that's why we've remained small because we have to stay the size of our marketplace. Byron you want to add anything to that?
Let me just chime in on this one Zack. One of the points I was trying to make a second ago is we don't have a large reinvestment need per month. Here's what happened last year. So I'm going to use this as an example between June of last year and the end of last year, we invested practically every marginal dollar in the CMBS sector. We didn't grow much in terms of our overall capital and it wasn’t that hard to do. Now, the environment is changed a bit now because we have more competition for CMBS but we still again don't have enormous redeployment needs and so its relatively easy for us to continue to deploy our capital in the marketplace and then on the book value question that you asked a second ago, we are different than, a lot of other people have talked about their book value increasing because of the Fed’s QE3.
We've assembled the CMBS portfolio at really widespread when a lot of the marketplace ran to the sidelines. And what I mean by that is we expected to get this type of book value increase whether the Fed did QE3 or not because these are money good securities and we expect them ultimately to tight. Now we've got a Christmas present, they tightened a lot faster and a lot sooner than we anticipated but we do want to call that distinguishing factor in Dynex’s portfolio versus everyone else’s who is relying upon the Fed’s activity to increase their book value.
The next question comes from Trevor Cranston of JMP Securities.
Trevor Cranston - JMP Securities
So my question is on your comments that you guys have the ability to increase leverage a little bit if you need to. You also issued some preferreds recently. So I was wondering if you can maybe talk about how you would weigh, maybe doing another preferred issuance to the extent that it's accretive versus increasing leverage and how you guys think about that trade off?
Well, I don't think, I think the preferred issue that at an 8.5% given the opportunities that we have, we are just still in low teens type stuff, it is very attractive and I think it's very accretive to our shareholders and we really didn’t get a full effect of that because we just have done the preferred during the quarter. Would we issue more preferred, I suppose we would.
I do think as long as it remains an attractive investment environment that we would be willing to do that but we don’t see any reason to grow dramatically until there is a lot more clarity in terms of what's going on down the road. I think the thing to remember for investors right now is that every year there are substantial opportunities during the year to make investments and you have a tendency to look at the current environment and say it's going to be like this forever.
I mean look around the world. There are going to be plenty of opportunities for volatility and as this volatility translates down into the markets that we invest in, it's going to be like 2010 where you saw great opportunity. There was a great opportunity earlier this year. Look at January was a great opportunity with most of those CMBS IOs we bought had 20 handles in their ROEs and a lot about book value increase was because we bought them when there was a little bit of a shakeout in the market. So I think we got to be careful about annualizing the lowest level of interest returns for the foreseeable futures as you look forward.
So with that being said, are we done growing, would we not look at any other additional opportunities to raise capital? Absolutely not, but we have always maintained the sort of the owner-operator ethic and that is we are not going to be looking capital until we have risk return opportunities that far outweigh the cost of that capital.
Trevor Cranston - JMP Securities
Okay, that makes sense and just a change for just for a second, you obviously had a nice book value gain in the quarter, can you talk a little bit about the trends you have seen in asset prices since quarter end?
I don’t know Trevor, if I can say it there has really been any type of major trend the big factor is obviously the Fed has entered the marketplace. You had a real risk on period as investors have scrambled to a variety of different sectors whether it happened to be corporate credit, mortgage credit, to find a home. So I don’t know that there has been since quarter end a major move in prices to really speak up. I think the volatility you can see in treasury rates hasn’t been that great and I think the same situation in terms of spreads, things have moved around back and forth, but nothing really in my opinion that I would say is a watershed event to talk about.
The next question comes from Mike Widner of Stifel Nicolaus.
Mike Widner - Stifel Nicolaus
Just wondering if you could elaborate first on where you see incremental spreads today and where you think as you look into redeployed that capital what you are favoring, do you continue to see a shifting equity allocation mix?
You know Mike; we continue to what we are doing really in fact is we talk about having a lower level of average earnings assets throughout the third quarter. We moved that to overfill $4 billion by the end of the quarter. At this point, we are redeploying our capital for any type of run-off that we might get, this is not that great. And as such, we continue to favor the CMBS sector.
The bulk of our product in CMBS portfolio has been put on at much; much wider spreads such that right now, we are buying at tighter spread, we’ve actually traded some securities also, we have actually sold some but we have been a positive add position in the CMBS portfolio. But we are adding so much because we don't need at this tighter spread but we continue to add. We continue to believe that the securities are still money good. We do have a heighten bit of credit concerns and obviously because that the market is more you (inaudible) about of the multifamily sectors and some of other CMBS sectors, so we are more on guard than let's say three years ago, but we continue to like the lower prepayment risk of the CMBS sector.
Mike Widner - Stifel Nicolaus
So and may I guess, I think a little bit more about the agency sector and how are you viewing that today? You highlighted some of the risks and challenges but its not only the prepays but also the risk of curved steepening which we’ve seen most of the past and pretty much every year for the past four years as we head into the spring, economic enthusiasm in the marketplace picks up and green shoots and all that stuff and we see the 10 year move anywhere from 50 to 100 basis points higher.
And with dollar prices on MBS and the QE3 where we had moving all that stuff up there is, again you kind of have the dual risk of maybe the Fed pushes rates lower, so prepays pick up; but on the other hand maybe the curve steepens and you get a substantial price sell off at MBS and with the prices being where they are that's a significant book value risk.
So I guess a two part question how do you think about that, particularly with regard to what's the right amount of leverage and then how do you think about that with regard to how do you hedge your specific portfolio relative to those kinds of risks?
I think for us, that’s a huge issue; and which is why we’ve stock with the hybrid arm sector. I do think we are in for a curve steep at some point, whenever it happens we are not going to, it’s not going to be an announcement that the market is turning and you're going to get a steeper curve. I do think there are limitations to it with the Fed in the current stance that they are in, but I mean within a week you could have a turnaround in terms of just market psychology.
Furthermore, the amount of liquidity that's now being pumped globally into the system we’ll have an impact without an exogenous shock taking place and that too will favor a steeper curve at some point. And the Fed has been very clear they are going to hold short rates lower even after inflation or the economy is picking up, so they are in effect saying that we are going to allow the curve to steep in some, at some point in time.
So we are thinking heavily about a steeper curve at Dynex Capital. We are always looking at, you know, we do have a duration gap, we do maintain a duration gap, but we use these shorter duration assets really to help protect against with what we are most concerned with is the extension risk. You see people talk about they have got the duration gap at low levels, but the fact of the matter is they are hedging a portfolio to two shorter duration and the question becomes what do you think the duration of a 30 year three or 33.5 happens to be. I think they are very long on over the life of those instruments.
At Dynex, we've got securities; again the agency portfolio is relatively short, average month to role of 55 months. We've got a nice chunk of currently resetting hybrid arms to help again in an up rate environment. Our CMBS portfolio does roll down the curve nicely. Those are probably the longer duration instruments with durations out in the five to seven year part of the curve.
And then, we always look at a question we ask ourselves what would it cost us to fully I mean just really batten down the hatches and just would near swerve to heads down this portfolio and for us its not a large sum of money and its really a function of the how we've constructed the portfolio with bonds; we've married short duration bonds with bonds that have very little negative convexity and we think we have a core position that we are in good shape if rates rise, if the curves steepens out.
Mike Widner - Stifel Nicolaus
So and specifically with regard to leverage, I understand that you guys are focused on some assets that are different than what would all the more pure agency REITs are all in and the RMBS hybrids for the agency sectors are focused on. But you know your leverage is at the same time a bit higher than them, so specifically on the leverage, where are you guys comfortable on, do you worry about sort of the difficulty of trying to hedge against two very different scenarios. Again, a scenario of increased prepays of the Fed successful in pushing rates lower versus the scenario where the curve steepens on you and prices fall, even amidst the Fed holding rates are zero and continuing to buy MBS, it's certainly possible that we see and MBS sell off despite that?
Well, Mike, I think the only way you mitigate risk this business is to try and not take them to begin with. What you are describing are obviously the business risk in this, in the mortgage REIT model, okay; anytime you run a levered portfolio, you are going to have a multiplicity of risk because of that and particularly in the mortgage world. One of the reasons we believe that you don’t run a levered portfolio with a significant amount of extension risk is simply the fact that it can and has gotten away from you if you go back and look historically. So I think in terms of worrying about the curve steepener, yeah, we’ve got some vulnerability to that but we minimize by not owning 15 or 30 year securities.
In terms of the spread risk, in having, different assets in your portfolio, we try to minimize that by really focusing on the highest quality assets that we can find. We have a little bit more leverage than lets say some of the other hybrids who utilize a sort of a junk bond portfolio where they basically marry agency securities with a very low grade, low dollar price. If you look at dollar price of a lot of their securities, they run in 60s, in the 70s. So clearly they don’t need to lever that because they are making a different sort of depth there and they couldn't lever that.
We have always chosen a high-quality portfolio that we can lever; almost all of our securities can be levered, because they are of the high-quality nature. So what we would like to describe it as really a short duration, high-quality portfolio that gives you a good solid current return and but does not offer the significant volatility that goes along with it. So I don’t know if that makes sense but it really comparing apples and oranges when you compare us to the other hybrids.
Mike Widner - Stifel Nicolaus
Yeah well I certainly appreciate that and appreciate the comments and the color.
The next question comes from Ken Lewis of Bank of America/Merrill Lynch.
Ken Lewis - Bank of America/Merrill Lynch
I am afraid I am not going to let that question from Michael go completely. I would like to may be address the leverage little bit more specifically from the standpoint of what your targeted range is within each of the just as we go to slide 10 you have got the four pockets how do you think about leverage within each of those the target leverage within each of those four pockets?
Let me see if I have got, I don’t think I have got one slide, we do have a slide that is public Ken that we can we can definitely send to you what we actually breakdown how much capital we are kind of holding against all of these positions. So let me just drive right of the top. Even within the agency RMBS sector we are diversified. We don’t view all agency security the same, we actually think about them in terms of who am I, which borrower am I buying. So we’ve got a large chunk, our highest leverage is held against our shortest duration instruments.
So we’ve got a nice chunk of agency hybrids which are currently resetting, they are resetting either every six months or they reset every 12 months and we have a highest leverage there. And then that’s in the range of anywhere around 9 to 10 times, a little more money market type instrument. Then on the agency CMBS paper, it is called the Fannie Mae dust paper, which are just pass through. Fannie Mae secondly pass through is backed by multi-family loans that portfolio you are looking at leverage between seven and eight times.
The longer duration hybrids which we call longer duration which is shorter versus everything else in the marketplace, generally the seven and ten ones again there we got target and that persists some more between seven and eight times, and then you move into the CMBS universe the non-agency CMBS Universe in the CMBS IO Universe and you are talking about leverage between three to five times.
And let me just point out one thing here, that we did complete our facility this quarter where we were able to finance about $200 million of our CMBS IOs for two years and that facility has leverage stock of about three times. So we are not, we don't target one leverage number for all of our assets, we got a diversity of assets, we got a diversity of the amount of capital we hold to get to see each one of those positions differ. I hope that gives you some color, happy to send you this other of slide page that we’ve got in some of our presentations as public, so I am happy to send it end of the call.
Ken Lewis - Bank of America/Merrill Lynch
Sure, I am just trying to have and think about what your leverage kind of revolves to as you allocate capital onto the different segments understanding that there RMBS is probably the more leveled piece of that in CMBS it is a little less just depending upon whether it’s the agency or not. We can talk offline but thank you that is very helpful.
My other question is as you look at alternative investments in the marketplace; are there areas of interest that you are exploring and there has been a lot of discussion around MSR assets and some form. Tom I know you are quite active in this area just broadly. Are there other asset classes that you maybe able to identify and bring in to the investment portfolio that are less if you will ginned up by QE3.
Well, absolutely and I believe it’s our fiduciary responsibility to look at every eligible asset and to see if it offers to our shareholders a risk return that makes sense. In that light we are looking at everything and anything that makes sense. I think MSRs are a perfect asset for a mortgage REIT, but I think it has to be very well developed. I think you have to really understand what you’re doing and we are discussing it but we don't have anything to talk about right now.
Ken let me point out one other thing. If you look at our portfolio its interesting, our opportunities are a much broader than what our portfolio happens to reflect. We have tried over the last three or four years to purchase non-agency residential, but again we are focused on a high credit quality portfolio. We just couldn’t get in. There are deals where there were some higher quality of bonds and we try to get in on the deals. Let's say we bid $25 million. We would only get $2 million.
So we've got a broader set of mind as we evaluate different securities. What you see are our choices for what we think are the best risk return tradeoffs. But we are thinking pretty broadly at Dynex Capital in terms of trying to find the right opportunities for our shareholders, but we are pretty much sticking with the same risk profile, low short duration high credit quality portfolio.
The next question comes from John Evangelista of Retail.
John Evangelista - Retail
Just want to make a really quick brief question, is there any exposure risk of any sort in the near future some time for the fourth quarter or for the beginning of the 2013 year of any of the things that occur as a result of hurricane Sandy in your portfolio. If there's any exposure risk of any sort as they quantify and etcetera, etcetera.
There's not a lot to really say in terms of our portfolio’s exposure there. There's not. We do have some multi family bonds that are backed by some loans in New York or generally more company-op type buildings. Our CMBS portfolio specialist is [Tai Kum Ja]. He has taken a preliminary look so far. Obviously we have to take even a deeper look, but we are not seeing anything that overly concerns us at this point.
The next question comes from Jay Weinstein of Highline Wealth.
Jay Weinstein - Highline Wealth
Tom let me ask you a real broad kind of question referring to the clarity of your original remarks. You guys have done very well adding value through the big inflection points in the market over the last seven years building up to the 2008 (inaudible) and taking advantage of that opportunity to start the RMBS portfolio, agency portfolio and then kind of taking advantage of things.
Given that you kind of think we are at a next inflection point. How do you think about that? Would you ever actually shrink assets because you don't think there's value in the marketplace and you can play games off the table and there maybe a reduced leverage, how are you kind of viewing that really big question like how big this inflexion point is compared to some of the others.
Well, I think it’s funny because, you know I've listened to a fair number of these other conference calls and there is inevitably the thought that maybe you should just shrink the company because you don’t have any opportunities. As you know, I’ve been involved in this market for 25 years and the last four years as I pointed out originally have been extraordinary.
I mean I’ve never seen a period of time that lasts this long where you had rates in the high-teens, the levered rates basically with the government on both sides of our asset and balance sheet. That was extraordinary and I think when people look back at that, they're a little spoiled by what they’ve have recently seen. This business though still has a double-digit return to it and if you went back and look, over the last 25 years, I would say on average, the return is probably been more like 8%.
So I still see our stock is currently yielding right at, right near 12% and we see opportunities to be able to hold that steady. To me, that's still a phenomenal return as long as you don’t get into a situation where you are chasing risk in order to present a return that is maybe a little bit too far out there.
If we had to go let’s say and do an extremely risky portfolio, then absolutely, we had to get out of our box and out of our core investment strategy, we would have to seriously say, it's too much risk for the return then that’s where we have a really (inaudible) response, the durability of the do you share responsibility to make that call and get back to our shareholders but we are clearly not even close to that point right now and that's really the meat of the matter here is to report back to our shareholders and say there is still returns out there in the double-digit area that we see that we can offer without risking too much capital and I am very happy to be able to report that.
Jay Weinstein - Highline Wealth
Okay, then last question about the tax laws carry forward I mean you could, you potentially take some gains and kind of use that up a lot faster than you kind of have over the last bunch of years, is that something that you are considering or thinking about?
Well our tax laws carry forward is now limited, it’s about $13.4 million a year and Steve correct if I am off.
I couldn’t remember what the limit was?
No that’s right Tom, 13.4 is right.
Yeah, so one of the reasons that we are constantly adjusting our portfolio and you will see gains this quarter, you saw gains last quarter and our goal is to make sure that we maximize the tax efficiency of this structure. Sort of the good news about our book value going up is that we were able to take goes gains translated into real sort of book value for our shareholders without any taxable hit. I look at Dynex is basically offering true returns, there is the taxable return and then there is the deferred return. So we work very closely with the board to make sure that we maximize that deferred return and I am happy to say that the way it looks right now, we should be able to use pretty much all of that tax laws carry forward for 2012 and we would definitely make plans to be able to use it in 2013 as well.
Jay Weinstein - Highline Wealth
Okay, Bryon anything further from you on the investment side, I said you guys being, you made it pretty clear understatement what you thought was going on and Tom in particular I thought your comments on the trade-off between book value growth and future returns I think a lot of investors in this industry don’t kind of understand and that has book values grow from capital appreciation that kind of future returns have to decline anything further?
I don't think so, I mean we debate these issues and I constantly bring up for the team here, we have a very collaborative approach. So we spend a fair amount of time debating looking at that nice book value appreciation that we got, let me do clarify this. Earlier I mentioned that, our book value increased in my opinion, where you would have read that as a shareholder, whether we had QE3 or not and that's because we believe we put on money good assets from credit spreads and we took the credit risk at really wide spreads and we felt we are going to ultimately get that. But we did get a Christmas gift, we got it sooner than we would have expected.
So we have debated internally in terms of what should we do, the answer isn’t clear, I think Tom leadership has been great in terms of helping us to understand that trade-off and keep that at the four front of our minds, trade-off of between basically return versus book value. It’s not an absolute clear picture but you should feel comfortable that we are debating those issues and looking for opportunities to provide as much value as possible to our shareholders.
Jay Weinstein - Highline Wealth
It’s a different question for three minutes last week, the stock was about 10% below book value that didn't stay there very long, would you ever repurchased stock if its (inaudible) to get discount again because it was something like mortgage [REITs] like to do?
Yeah, the thing about that is our average of return this last quarter, we have drawn near 14% and for the year it’s been ranging between 14% and 15%. When you buyback stock let's say the 10% discount, you will get a one 10% yield one hit and that's it. I think and that also I think indicates that you have too much capital. We are a small company, we are $600 million. We don't have too much capital. We do have not only a 14% opportunity today but we think a 14% opportunity tomorrow and the day after. So it would be like saying why would I want to take one 10% percent investment at that one point in time and then forego all the future of cash flows from it. I think that’s short-term minded and I don't think as you see the stock was down there for about 15 minutes and it came back.
Jay Weinstein - Highline Wealth
Yeah, it wasn’t doable.
I think as long as we execute our business model and I think show our shareholders that the kind of return they can get with the risk they are taking, I think that it will manifest itself the way it should. I can't predict what the market’s going to do. I can only really deliver an investment strategy and a return that I think makes sense for everyone. I still own a ton of this stock. So I do what's right for me and hopefully its right for everybody else as well.
Jay Weinstein - Highline Wealth
Last question, are you Giants fan?
You have to be, you have to be.
This concludes our question-and-answer session. I would like to turn the conference back over to the management for any closing remarks.
Great. I know that everyone has a busy day today. There's a lot going on. I appreciate your time. We've taken up the better part of an hour. I know there's a couple of calls starting at 8:00. I look forward to the next call and I hope we made very clear where we stand at this point in the marketplace. Thanks so much.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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