Dynex Capital, Inc. (NYSE:DX)
Q4 2015 Earnings Conference Call
February 17, 2016 09:00 AM ET
Alison Griffin - Vice President, Investor Relations
Byron Boston - CEO, President and Co-CIO
Stephen Benedetti - Executive Vice President, Chief Financial Officer, and Chief Operating Officer
Smriti Popenoe - EVP & Co-CIO
Eric Hagen - KBW
Douglas Harter - Credit Suisse
David Walrod - Ladenburg
Jay Weinstein - BELR
Good morning and welcome to the Dynex Capital Fourth Quarter and Annual Earnings Conference Call. All participants will be in listen-only mode. [Operator Instruction] 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.
Thank you, operator. Good morning everyone and thank you for joining us. The press release associated with today's call was issued and filed with the SEC this morning, February 17, 2016. You may view the press release on the Company's website at dynexcapital.com under Investor Center, as well as on the SEC's website at sec.gov.
Before we begin, we wish to remind you that this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, forecast, anticipate, estimate, project, plan, and similar expressions are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. The Company's actual results and timing of certain events could differ considerably from those projected and/or contemplated by those forward-looking statements as a result of unforeseen external factors or risks.
For additional information on these factors or risks, please refer to our Annual Report on Form 10-K for the period ending December 31, 2014, as filed with the SEC. The document may be found on our website under Investor Center, as well as on the SEC website.
This call is being broadcast live over the Internet with a streaming slide presentation which can be found through a webcast link under Investor Center on our website. The slide presentation may also be referenced by clicking on the Dynex Capital's Fourth Quarter 2015 Earnings Conference Call link on the Presentations page of the website. With me on the call today I have Byron Boston, CEO, President and Co-CIO; Smriti Popenoe, EVP, Co-CIO; and Steve Benedetti, EVP, CFO and COO.
I now have the pleasure of turning the call over to Byron.
Good morning. Thank you very much for joining us today. Our results for 2015 were mixed as we have generated a solid dividend return to our shareholders that was offset by a larger decline in our book value.
Let me point out a few key things. First to better understand 2015 it is best to put our results in the context of our strategy over the past two years. In early 2014 we became concerned about the complexity and fragility of the global financial environment. As a result we sold the majority of our lower credit quality investments and reinvested our cash in AAA securities and securities backed by government agencies.
By improving the credit quality and liquidity of our balance sheet we materially reduced the impact of an extremely volatile year in credit spreads. Credit spread widening, especially in the CMBS sector was the major reason for our decline in book value in 2015. We also positioned our portfolio to continue to generate solid net interest income as represented by our steady $0.24 dividend payment throughout 2015.
Although we are not happy with the decline in book value, we continue to stay focused on long-term results and we do believe – which we believe will be heavily driven by generating net interest income over the long term.
Second, let me say a few words about funding in the repo markets. Since the beginning of the year, we have received questions about rumored problems in the financing markets. Let me assure you that we have no problems financing our positions and the impact of being denied membership into the federal home loan bank system has been overblown. In fact the home loan bank issue does not materially impact the outlook for our business.
Third, despite the periodic declines in book value we continue to remain focused on the long-term. Since 2008 we have experienced two other major bouts of book value decline due to wider spreads. In each situation, we continued to hold our positions and to invest capital at the wider spreads. As you can see in the attached charts on Slide 4 and Slide 5, we earned an above average dividend yield over time and it helped cushion the impact of volatile spreads and it was a major driver of returns over the long-term. So if you look at our slides going back to 2003 and especially if you look in 2008 you can see that we incurred a spread widening in 2013 and in 2011. We held steady to our strategy and over time as we still believe today, the strategy proves beneficial over the long-term.
So with that I'm going to turn it over to Steve Benedetti and Smriti Popenoe, who will give you a lot more detail regarding our results.
Thanks Byron and good morning everybody. I'm on Slides 9 and 10 for those following the presentation. As Byron mentioned, results for the quarter and year were mixed. For the fourth quarter, we reported core net income of $0.25 per common share, while we incurred losses of $0.55 per share from the net decline in the fair value of our investments and hedges. Together this resulted in a comprehensive loss to common shareholders of $0.30 per share for the quarter.
Core net operating income to common shareholders increased $0.01 per share from the prior quarter as share repurchases and favorable prepayments on our investments offset a smaller investment portfolio during the quarter. Our total economic return was a minus 2.9% for the quarter, consisting of a $0.24 dividend and a decline in book value per share of $0.48.
On Slide 11, we provide a reconciliation of common shareholders equity and book value per common share for the fourth quarter. If you look at the chart on this page, the decline in book value is due to declining asset values net of hedges from a combination of higher rates reflecting our net interest rate risk position during the quarter and wider credit spreads on our securities and sympathy with the broader market rapes and sell off in risk assets.
Approximately $0.26 per share of the decline was from higher interest rates and approximately $0.28 per share was from wider spreads. Offsetting these items was $0.05 in benefit primarily from the repurchase of 1.5 million common shares during the quarter at a weighted average price of $6.63.
Our total economic return was minus 3.9% for the year consisting of $0.96 dividend per common share and a decline in book value per share of $1.31 on beginning book value of [$9.02].
For the year we reported core net income of $0.93 per common share. Core net income benefited from a higher average earning asset base and favorable hedge positioning. While the book value decline was due to spread widening on assets versus our hedges and to a lesser extent the increase in interest rates during the year will stop.
Smriti will provide additional details on her comments on spread and book value performance for the quarter and year. From a hedging perspective, the average notional amount of net current fixed hedges during the quarter was $566.5 million at a pay rate of 1.16% versus an average notional of $662 million at a pay rate of 1.3% last quarter. At December 31 we had $480 million of current pay fixed interest rate swaps at a rate of 1.06% with an additional notional amount of $325 million in swaps beginning in January 2016 at a weighted average net pay fixed rate of 1.94%.
Leverage at the end of the quarter was up to 6.5x shareholders equity versus 6.4x last quarter despite the drop in our borrowings. Leverage declined 0.4x from lower borrowings but increased 0.15x from share repurchases and 0.35x due to a lower equity balance from the net changes in fair value on our assets and derivatives that I previously discussed on Slide 11.
As most of you are aware, the FHFA adopted a final rule in January, which forces the termination of our captive as a member with the Federal Home Loan Bank of Indianapolis in early 2017 and requires us to repay advances in the interim upon their maturity. We have approximately $257 million in advances maturing tomorrow, which are being replaced with repo financing at competitive returns on capital with the balance maturing in October.
With that, I'll turn the call over to Smriti.
Thank you Steve. For the call today I will begin by focusing on our performance for last year and last quarter and then turn to our current positioning and outlook.
In the first quarter of last year, you heard us describe the investment environment as complex. In fact if you look at the charts on page 15 in our deck, in the four quarters of 2015 we actually had a mini bear market, a mini bull market in the same year with curve twists of all types, a bull flat during the first quarter, bear steepener in the second, bull steepener in the third and we ended the year with bear flattener.
If you are not familiar with these terms, we have included a definition on page 41. We saw interest rate at times buffeted by domestic factors and at times driven entirely by non-US closing factors. In the second half of the year, rate movements were accompanied by a broad-based repricing of risk premiums, spreads widened across the board with risky assets taking the biggest hit.
The list of exogenous events in 2015 is long but the critical one was the dramatic fall in oil prices. As Byron mentioned, we did assess this environment as complex, but one in which we had the opportunity to earn net interest income in high quality assets, specifically those that would suffer less in a spread repricing.
We approached this year with an up in credit, up in liquidity strategy, allocated capital selectively to assets and aggressively to share repurchases when the opportunity presented itself and we decided to maintain our swap hedge positions for 2016 and beyond.
With this strategy and economic backdrop, as Steve mentioned, for the full year, we generated a total economic return of minus 3.9%. Our book value performance in the fourth quarter and for the year was driven mostly by our long-duration position, spread widening in assets and spread tightening on our hedges.
Specifically our asset values were impacted by price drops on post-reset hybrid ARMS, which are floaters. This happened particularly towards year-end because the sector felt some selling pressure and a broad-based spread repricing across the CMBS sector. As you can see on page 16, we saw widening across the board in all types of assets classes, but particularly in CMBS areas in which we are invested.
So this begs the question, what is driving spreads. In our assessment spreads are wider across many asset classes due to the confluence of a number of factors. First, fundamental factors. Investors have reassessed the probability of getting paid back, specifically in the riskier securities and they have repriced those bonds. Those names that are closely associated with the fall in energy prices suffered the most.
Spreads on all risky fixed income securities have widened in a similar reassessment of risk versus reward. If you look on page 16, you can see at the very tights in June of 2014 high yield spreads sat at 397 basis points. As of 12/31/2015 they sat at 746 basis points. That is the riskiest assets repricing.
BBB CMBS at the tights were at 312 basis points. They ended 2015 at 552 basis points, over a 250 basis point repricing. Now in contrast, agency DUS bonds, agency multifamily bonds, which is the second item on the list at the tights were at 39 basis points. They widened about 50 basis points as of December 31.
So there has been a widening. The widening has hit the riskier assets more than the not risky assets. Secondly, there are technical and structural factors driving the widening. Last year corporations issued the largest amount of bonds on record. Investment grade issuance totaled 1.3 trillion dollars with an average maturity of five years or longer. Net issuance was actually 626 billion, the highest amount on record.
That is a significant of duration and paper to absorb. We discussed last quarter how some of this issuance was affecting swap spreads. In the fourth quarter, investors had to contend with this corporate supply as well as CMBS supply. Pipelines were full and many deals had to be priced in the short window between the market turmoil in the third quarter and year-end pressures.
Furthermore, the market-making function of Wall Street has been severely crippled by the [Indiscernible] and other new regulations, effectively removing the buffer of temporary demand provided by Wall Street in the face of this type of supply.
Finally, you have psychological factors. Risk aversion and volatility kept many investors on the sideline, leaving the main factor driving spreads as the seller. When sellers drive pricing in the absence of buyers, spreads will widen, and this happens whether or not the assets are high quality or not high quality and it usually impacts lower quality assets more severely.
You can see that again on page 16. So should spreads be wider? Yes, they should be on some assets. There is legitimately greater risk of principal not being repaid back. Have some assets being unfairly penalized due to risk aversion or selling pressures? Yes. Now these conditions continue to be in place as we begin 2016, and it should give you an idea as to what was driving book value last quarter, and we will talk more about spreads later in the call.
Now I'm going to turn to our outlook and our current position. So we can flip back to page 13. As you know we approach our investment decisions in a top down fashion. So I will start with the macroeconomic environment. We continue to believe that the environment is complex and more interconnected globally than in prior times. This is going to bring more volatility and opportunity.
We also believe central banks will continue to drive asset prices and financial conditions globally. Many developed market central banks are in [Indiscernible]. They are ready to move to negative interest rates. The Fed and the Bank of England are in wait and see mode. Emerging market central banks, including the PBOC are managing slowdowns, contracting credit, possible losses in their banking system, as well as currency fluctuations relative to the dollar.
The actions of emerging market central banks, particularly the PBOC, as it relates to currency management will have implications for US treasury yields. Specifically their actions could act as a limit on how low treasury yields can go, as well as a catalyst to push yields higher than would be suggested by fundamentals. The other factors on this page remain driving forces for global yields and they form the basis and thesis of our core positioning.
Turning to the investment environment, we discussed earlier the reasons for wider spreads, some assets have actually widened now to the widest in several years post crisis. Low global yields are a reality for us, particularly as we factor the potential for negative interest rates. Surprises are likely we said this last year. We are in an environment where volatility is the most high probability outcome. We must act accordingly.
And then you have the Fed. The Fed has acted to increase interest rates. The psychology at the Fed is to continue to increase interest rates in the absence of a major impediment. The market has obviously taken a completely different view of this, pricing very little or no hiking in 2016 and 2017, and thus far financial conditions have put a roadblock on the hiking path of the Fed, and it appears that maybe they won't move in March.
We see the US economy as having recovered from the worst effects of the crisis, but it is still vulnerable and fragile to shop. Now because of this and because of the probability of surprises, it is going to be very difficult to predict outcomes with a high degree of confidence beyond a very short term horizon.
So what we have just described is a complex environment, economies and a global system that is somewhat fragile vulnerable to shocks. How are we positioned to deal with this environment? Let me talk about that. I'm going to refer to pages 19 and 20.
An overarching basis in our investment philosophy is to invest in securities where there is very little risk to getting our principal back. 83% of our securities are agency guaranteed, 93.5% are AAA rated. We believe this is an appropriate posture for this environment. We have also biased ourselves towards assets that are prepayment protected, combined with those that return cash flow to give us the flexibility to reinvest.
46% of our assets are in the agency guaranteed RMBS sector in the form of hybrid adjustable rate securities. Some of these assets are floaters as you can see on the reset chart on the right hand side. They reset somewhere between the next 12 months to the next eight years. These assets provide stable cash flows Compared to 30-year fixed rates they are relatively less sensitive to fluctuations in mortgage rates, they are relatively liquid, eminently financeable and while they are subject to temporary spread shocks because of supply demand imbalances over the long run they have proven to be a good store of value because of their short duration nature.
They give us the flexibility to earn income while we rotate into less liquid sectors or credit sensitive sectors when the opportunity presents itself. 52% of our assets are in commercial real estate. About 25% of that, half of it, are in Fannie Mae guaranteed multifamily bonds known as DUS bonds. They typically have a final maturity of 10 to 12 years and a prepayment lockout of 9.5 to 11.5 years on which if we receive an early payoff, we actually receive compensation. These bonds are positively convex, meaning their prices actually go up when rates go down and prepayments are positive cash flow event. This helps us diversify the risk on unfavorable prepayments in our Agency RMBS position. The remaining half of our commercial real-estate assets are split between Freddie Mac guaranteed AAA multifamily backed interest only strips and non-agency CMBS interest only structure.
Our Freddie Mac interest only strips are agency guaranteed, they're backed by Freddie Mac, issued by Freddie Mac as part of their K-Series program. These IO's return us cash every single month and give us the flexibility to reinvest or retain that cash. Our non-agency securities are backed by AAA rated bonds. This provides us diversification and additional return enhancement to the agency guaranteed securities. And our thesis in the non-agency market has been to own a diversified set of cash flows across many vintages and issuers.
For both agency CMBS and non-agency CMBS IO's we are well insulated from high severity defaults, either because the agency guarantees it or because we're on the AAA part of the capital stack. So, if a loan defaults at maturity, usually that's when a lot of loans default, we'd usually earned all of our cash investment back in the IO. If it defaults before maturity, either that loan is guaranteed by Freddie Mac, and we'll receive the payment for that reason or because it's in the AAA part of the capital structure, the loss is absorbed by the equity or the B tranche or the BB tranche and so on of the stack.
So, this type of protection makes us comfortable taking this type of risk. So, you can think about our asset position as really being mostly agency guarantee with a high degree of protection against high loss severity events in the non-agency sector. What we're trying to do is preserve optionality to invest while having some prepayment protection. By focusing on assets that have guaranteed principle repayment or structural protection, we reduce spread risk, and you can see that in the way spreads have moved on high quality assets versus low quality assets on page 16.
Now, let's turn to capital deployment for the quarter. This is on page 20. A couple of things to note here, first that the balance sheet was smaller quarter-over-quarter. Leverage, slightly up mostly due to a decline in book value. We made a few select investments in the CMBS IO sector as spreads widen last quarter.
I'll now discuss the liability side of our balance sheet. Turn to page 21, please. As you know, we finance our asset position using reversely purchase agreements. These borrowings are over collateralized with a margin and daily mark-to-market requirement that ensures adequate protection for the lender. This means will require to maintain this predetermined margin as the percentage of the fair value of the asset on a daily basis with our counter party.
Needless to say, we're highly focused on our liquidity position and our ability and capacity to handle any issue that could negatively impact our borrowings. As a user of derivatives, we're also required to post cash margin against all of our [indiscernible] the transaction. In fact, since we begin our security strategy in 2008, I can safely say that we've never failed to meet a margin call or post any kind of required margin on derivatives.
Our liquidity and contingency planning include stress scenarios that would adversely affect our margin requirements. So, we're managing this very aggressively in a focused manner. We continue to manage our counter parties with a same high degree of focus. Our strategy incorporates several factors. Whether the counter party is domestic or international, what are the regulatory constraints facing the counter party, our overall relationship with the counter party across products. The counter party source of funds. What's their commitment to the Repo business? What are their commitment levels for term financing?
Are they willing and able and providing us with financing for non-agency assets. All of these are factors that we consider when managing our counter parties. And with this in mind, we have over 30 established counter parties against which we have active of about 19 of them. Part of our portfolio construction is also with a view to the financing landscape. There is a lot of talk about regulation. Money market reform regulation will create additional demand for Repo on agency securities.
And 83% of our book is agency guaranteed. Balance sheet constraints on domestic banks are pushing them towards financing more attractive non-agency assets. We've worked to source the committed facilities that finance, what we consider to be our risky assets. It's typically count with IO's with Wells Fargo.
While we believe the regulatory landscape is changing on the financing side, by no means do we give the changes as posing an existential threat to our business model. Cash is still out there that needs to find a relatively safe return offered by short-terms borrowings like repo. Demand for borrowing is still there, from entities like ourselves and many more. The pipes between these pools of demand and supply are being built. Centralized clearing, potential for money funds to join the FICC direct repo. All of these developments are indication that a connection can and will be made.
Even if we have a situation of mandatory minimum haircuts, we will be looking at a scenario where pricing would need to be adjusted and with that perhaps an adjustment of return expectations. But we do not give the developments in the funding market as wholly detrimental to the levered business model. As Byron and Steve mentioned, the home loan bank issue on the financing side is pretty much a non-event. We've not had any issue reallocating the financing across our current set of counter parties. We have never considered this as an important development other than a diversifying our counter parties to include a GSE type of entity. And as Byron mentioned, our business will go on with or without a membership in the system.
I'm going to briefly touch on our interest rate risk positioning. On the next page. We've chosen to maintain a long duration position through most of last year and in to this year and into this year it has helped us offset a good portion of the continued amount of spread widening, that we've seen in 2016. And given the volatile nature of the environment that we're in, you can expect us to manage this position pretty dynamically this year.
So, let's talk about Dynex strategy going forward, what can you expect from us, what should shareholders look for in 2016. In terms of earnings, we believe the opportunity still exist on net interest income and produce what we'd consider to be an above average dividend yield at this environment. You can expect us to focus on our risk position, to manage our risk position that reflect the dynamic environment. What this probably means is more swap activity in adjustments intra quarter that will make earnings probably a little less predictable.
You can expect us to very carefully and deliberately redeploy capital at the opportunity it presents itself. The investment environment finally presents real opportunity to take on risk at long-term attractive risk reward levels. But this is going to require a lot of analysis as well as clear pictures of financing options before we jump in and fully execute. Now, our decision to take on this risk, obviously will be opportunistic and will be reallocating capital using our risk adjusted framework and part of this capital allocation decision we expect is always will include the decision to repurchase shares.
We currently have about 9 million remaining under our current authorization and will obviously consider reauthorization should we deem the opportunity to be compelling. You can expect us to continue to manage our financing using the approach that I just described to you, while we explore avenues for alternative financing to the traditional repo market.
In terms of book value, our book value is still centered as to movements in spreads. Spread widening has taken a fair amount of its toll on value, particularly for higher rated security. There are a few factors that we believe are supportive of spreads in this environment. First, sellers are stopping because spreads have repriced, that's causing primary market pricing to actually adjust. The supply of corporates and non-agency CMBS appears to be slowing in the second quarter. And this will help potentially stabilize existing positions.
Second, cash is still in the system. Real money buyers still have cash to be put to work across the globe. In the U.S. yield and spreads offer an attractive risk return profile in what is possibly one of the few appreciating or should I say not depreciating currencies in the world. Okay. Third. High quality assets in general, when there is a [slight] [ph] quality, tend to benefit. But you really have to see overall market volatility decline for people to be confident to put money to work.
Now, this doesn’t mean spreads can't widen or won't widen, we just think that some other catalyst for further widening particularly in higher rated securities have dampened down a little bit. We do have the added benefit in our portfolios of seasoning and assets spread world on. As our longer duration asset season come down the curve, we benefit from tighter spreads and if the curve is still steep, which it still is, there will be pricing off of a lower yield point on the curve, so we do have some built in book value upside there. On the hedge side, any kind of normalization and swap spreads will be upside although we believe the catalyst for that is not yet present.
To summarize, we think the opportunity continues to exist at earn and above average dividend yield. The current environment is uncertain, it’s going to cause period-to-period volatility in our result, but we don’t believe that it affects our ability to be a diversified mortgage REIT and deliver and above average dividend yield.
Higher dividend yields will help us cushion any potential volatility and book value. I’d also remind you we constructed our portfolio to naturally de-lever overtime which gives us the flexibility to invest. The investment environment is now more balanced with respect to risk and return then in prior years and we believe offers real opportunity to make long term accretive investments. But uncertainty around economic growth interest rates, regulatory changes will make us very, very careful before we invest or reallocate capital. At the end of the day we believe our strategy can produce solid income and we think we can drive long term results in spite of periodic volatility in book value.
And with that I’ll turn it back over to Byron.
Thank you Smriti. As you can see we want to give you a lot of details we can understand, like exactly how we’re approaching the market today. And with our last, sounding too repetitive I want to repeat the fact about complex and fair to global markets. Now, in the last we look to the future with great anticipation. One of the largest challenges will be impacted regulation. However, due to regulations will have both the positive and a negative impact. Most importantly, we believe market returns will adjust to the new regulatory environment, we continue believe in the long term opportunities that are developing in a variety of securitized product sectors, especially in CMBS, I think it’s a great long term core product for our portfolio. As prices adjust book value may fluctuate, but opportunities will be created.
Please look at slide 25, just a comparable total return across multiple asset classes, as you can see 2015 was not a great year for returns across the global landscape. Nonetheless, as we continue to stay focused on disciplined risk management we believe the future dividend payments will help cushion short term fluctuations in book value and as you can see on the reiterate I’ll show you chart again on slide 26 and slide 27, long term chart in on constantly looking at reminding myself to stay focused on long term returns. And you can see that from either 2003 to 2008 these returns are driven heavily by above average dividend yields and as such we look towards the future with great anticipation.
With that we’ll open floor, we’ll open the call up to questions.
Thank you. [Operator Instructions] And our first question will come from Eric Hagen from KBW. Please go ahead.
Thanks, good morning guys. Can you describe some of the hedges you have in place protect from spread wide, credit spread widening as opposed to just pure interest duration? I appreciate the book value roll forward which is genesis of the question. Thanks.
In this type of business model, your best way, you’re really de-risking method for credit spread would be to reduce your balance sheet. And we’ve done it in the past, its best if you look back at the 2008 time period. So, we take spread risk in this business model, we’re not hedging our spread risk, we do carry a long duration position to help offset the impact of wider spreads, historical correlation which shows the spread widening in down rate environment and potentially we’ve tied in enough great environment. just be more specific as we look out into the future, 2016 and 2017 will be very interesting years for CMBS. More at the top of the capital sack with agency backed product and AAA product, we affirm and believe this is money good over the long term as these spreads continue to wide, it creates great return opportunities and as we look through 2016 we have the new regulations coming on board where you may see some prices readjust. But, as long as continue to invest at the wider spreads remain in the business we have shown in the past that throughout the time that this business model would turn out to be a extremely profitable overtime. So we don't hedge spread risk, spread risk is the risk that we take, our biggest concern would be that if we had product that really was not money good, but the CMBS product today especially with some of the positive and the negative the regulations one of the positives of the regulatory environment is that goes to try to reduce the potential for having an out of control credit environment. So, we still believe in the CMBS sector spread may fluctuate we want to take advantage of wider spreads.
Okay that's helpful. I always appreciate your macro commentary, so I guess going back to the idea of negative interest rates. How do you think the stock and I guess equally important that the mortgage REIT sector, how do you think that survives or just copes with a negative interest rate environment I don't think it's unreasonable to think that U.S. rates can chase European and Japanese yields pretty far down the curve? Thanks Byron.
Here what's changed if you look back over, you’ve to look since 2008 that's where we have been building in the current portfolio. There is a couple of real psychological shifts that in my opinion has happened at the Federal Reserve. First one was when they really shifted from the lower; really had a desire for raised rates so I would say right now the Federal Reserve Bank, the government of Federal Reserve would like to raise interest rates if they could. But, they may not be able to and the thought process would be the zero lower bound as if once they got to rate at zero they couldn't go lower but as we see now over the last couple of years first Europe did this and now Japan has done this.
Let me just say that in the U.S. we took some more drastic steps to help in this process. The issue with negative rates in my opinion was that fiscal policy can truly make a difference so the question comes how can we get to fiscal policy changes that will elevate the need for negative interest rates. And fiscal policy in the U.S. can truly make a global difference well if you look at the current election you would say – and its years away. But, if you think about scenario where in fact U.S. would have to go to global rates it probably in a situation where all kind of drastic measures will suddenly appear and be willing to be considered.
So, I continue to believe that if you have a negative rate environment, our financing cost will not go negative, our financing cost will decline and now absolutely potentially be a positive one of the biggest concern would be prepayment risks and that's why we stick with the CMBS sector. We have had an opinion with some concern about the global environments for really some type actually fiscal 2008, we never really changed that opinion. I always say that structure global finance doesn't really make sense, it's unsustainable it has to change there has to be corrections and we have had one in 2008 here in the U.S., we had another trying to deal with U.S., the European debt crisis and now we are right in the middle of the European, I mean of a emerging market adjustment what will be the ultimate impact of those there is still a question mark around that. I do believe before we get to negative interest rates in the U.S. would be a drastic step I think other steps maybe taken in Washington that may elevate Federal role. And I would also think that when you really look at the current level of employment and how close we are to having a decent level of economic activity again I still believe those will provide some cushions to ultimately getting to a negative interest rate environment.
And I think also from a positioning perspective Eric, it's also a very compelling reason to maintain a long duration position.
And then, let me emphasize again CMBS, I don’t think I completed that part. The CMBS product is prepayment protected. So, one of the key benefits in 2015 was we really had a positive prepayment experience, our CMBS position offsets any negative in our ARM and hybrid ARM portfolio and we had a positive experience in two ways. One, when our CMBS product repays we are compensated. The second reason is that in our ARM portfolio we selected specified tools and its portfolio and it’s outperformed, we can compare our average prepayments to be in our ARM portfolio versus others in the industry. So again, lower rates one of the largest risk is prepayment risk and it can perform really significant if you were to say take the tenure down 50 basis points, we will be in good shape with the amount of capital that we have allocated to the CMBS sector.
That’s really helpful as always guys, thanks for the commentary.
[Operator Instructions] Our next question will come from Douglas Harter of Credit Suisse. Please go ahead.
Thanks. As you guys mentioned you could still see some volatility in spreads in this environment and how you look to balance book value volatility versus kind of generating net interest income?
Here is what we have done in the past, so I want to use 2011 as an example because in that year if you look at our quarter-to-quarter you will see some declines in book values. As spread continue to widen out we continue to invest money, we stock with the sector and overtime it prove to be a very, very, very valuable investment. Likewise, I have a lot of comfort in the CMBS product especially at the top of the capital spec, especially this agency, this agency CMBS product.
We lean on CMBS but let’s say another opportunity evolve hybrid ARM security we are probably going to be slower in terms of trying to reallocate the lower credit product until we get more comfortable with that adjustment process that kind of ripple through high yield wide now as investment grade credit wide now then you saw the CMBS lower credit product wide now and if there is any issues with financing that will probably be in the lower credit products as opposed to the higher credit product. So we are going to lean and say that the higher in that the capital spec if you take agency CMBS out in widen it in steps with non-agency CMBS I think it's a great investment especially if the 30 or 50 year fixed product remain within a tight band of credit spread.
So that's why I look at the future with great anticipation because there is a ton of scenario it may evolve here but I am absolutely believer in this business model generating the above average dividend yield. And what do I mean by above average dividend yield that means GE [indiscernible] dividend or increasing dividend over time that’s not realistic for this business model for anyone in this industry. The business, the dividend levels should fluctuate but when I say above average dividend yield, I am comparing it to the average on the S&P or the average on the Russell 2000 and our business model is made to generate that hyper cat flow to our shareholders.
So yes, CMBS spreads may fluctuate I think there is some debate as to exactly how this will happen, I think 2016 and 2017 will be the most interesting year than you have this huge drop off in 2018 in the amount of loans that are coming up through refinancing. So I think, it may be a great opportunity to accumulate a solid balance sheet or a really attractive assets with good credit quality and good prepayment protection over the next year or two.
I guess along those lines Byron, if we were to go through a period unlike 2011 where spreads don't snap back where they continue to widen for an extended period of time before the ultimate quality, the assets gets reflected I guess what is the risk that you kind of get stopped out in some of those positions given that you’re a levered invest –
IP agency product that's exactly why we sold that product at the end of 2014, but if you recall we had a large position in BBB and single A rated CMBS product. We sold the entire position because we said spreads were too tight, the global financial environment is too complex and therefore it's too risky to have those assets on short term financing, it's better –
The one other thing on that goes out is that you are right that that spreads could widen, but you don't ever want to get stopped out of these positions because you are managing your liquidity and your capital for those contingency. So, as you are adding a riskier assets onto your balance sheet your liquidity and contingency planning has to incorporate a scenario that those spreads could go wider right. One of the things that why we have been able to do what we have been able to do, maintain leverage at our current level have the asset position is that liquidity and capital management one thing we have always said is hey, spreads widening is actually a good thing for us. It's not great for current position but it's great for marginal investments right. So you want to be able to manage the liquidity in capital position to have the liquidity and capital available to invest when that happens and to be able to manage that cycle appropriately and what timing is everything in this business so you don't want to be too early to the game, you don't want to be too late to the game and obviously how we assess the environment is going to be a big factor and when we invest.
And if you look back over time Dough you will see that – to the 98 crisis or the 94 crisis or early 1990s when you did have a real estate collapse, the agency product can truly perform differently than the non-agency products especially in terms of financing being available for those products versus other product sectors. So, I don't disagree with you that's what we that's what our risk management we talk about this risk management and our best example of that would be the move that we made to get to sell all of our single A rated and BBB rated product and move up to more toward agency based portfolio.
Great, thank you.
Our next question will come from David Walrod of Ladenburg. Please go ahead.
Good morning everyone.
I just wanted to talk about the share buyback a little bit, you said you’ve $9 million remaining on the current authorization.
Talk a lot about your investment opportunities that are available now can you I guess kind of way out how you think about putting money to work to those opportunities versus buyback of stock at these levels?
Let me just say David we bought back a fair amount of shares last year at a time when spreads were much tighter on a relative basis to our stock. At this point there has been a major adjustment in credit spreads. And so, returns are more attractive and when I think about the long term opportunity that may evolved here for investing our capital and fixed income markets, I take a little bit of a different view than maybe I took five or six months ago because I do think there are going to be some really attractive opportunities on the fixed income side we have been disciplined about it to say, let’s just look at really where the return opportunity comes in but from a long term operational perspective of company such as ours, the opportunity sets have changed versus six months ago when our stock was cheap and spreads were really, really tight.
Okay that's helpful thank you.
Our next question will come from Jay Weinstein from BELR please go ahead.
Can you hear me?
Yes, good morning.
Okay, good morning. I will kind of suggest you change the word complex which you have used to something along the lines of even less predictable than it normally is environment, but that's a different issue.
That's actually that is the result of it is that when you say even less predictable it means surprises or very likely and Jay I had a lot of conversations in 2014, when I first start to using that word complex. I was challenged on that issue I don't no one is really challenging me on it at this point with that a ton of surprises through the year 2014 and 2015 and I think the bottom line is it's really less predictable.
Yes, the previous call is actually, ask a lot of really good questions that pre-ended a lot of mine. So, a couple of questions. One. You sure seem to trade at a bigger book discount than most of the competitors that I sort of mark you against. And I know that it's never an apples to apples comparison because portfolios are different and leverage is different, etcetera. But that seems to be relatively persistent. Comments or thoughts on why?
I don’t, Jay, I don’t know that we have seen that type of differential over time.
I mean, just really talking about the last couple of years I would say.
I don’t know, I mean, that may be something we'll have to take offline and look.
Because when we look that, we haven’t seen that type of differential. I know a certain time period because, I've just [indiscernible].
Some one person may try to move a large positioning, see some adjustment in it. But I don’t know that we have seen that. I would love to get with you offline to take a look at that with you, we'll show you what we look at.
It's about 25% as of you know five minutes ago. So, I thought that was a bit higher than most of the rest of the industry. But again I'll have to double check in. Given that you did take a lot of risk off the table in 2014, are you sort of surprised still by how difficult it's been to maintain book value since then, I mean, if you would with a much higher quality, average portfolio that you kind of ran with after that?
Here's the decision that we could have made. At the end of 2014, we had sold assets and we were down to about 3.1. Yes. We're down to about 3.1 billion in assets. So, the main way you protect against spreads, if you're taking spread, we just have to liquidate the assets. So, at that point, we could have chosen to just sit there with a much lower portfolio with the proceeds in cash, we would have earned less money. And as I look at 2015, I scratched my head multiple times looking at it, we would have had a small amount of CMBS, we would have had a larger percentage of hybrid ARMS, we still would have taken the markdown on the short hybrid ARMS, which we don’t think is a long-term issue.
And then which is more of a technical issue. And then the CMBS, we would still have on the balance sheet is would have been high quality, we were still taking some lagging on it, I'm not sure that we would have ended up in the exact thing. We had lower earnings to offset a smaller move in book value, but it probably ended up in the same place, some were between zero and negative-2% loans we had. Those asset plans is on the balance sheet. I think what asset class would probably perform better, probably the [30 or 15] [ph] fix from just a spread basis.
We've been in a relatively narrow range, heavily supported, obviously from the fed balance sheet. And we've chosen instead of that product, you invest in the CMBS agency which did obviously lead to a larger book value move. Where we surprised by the move? The big surprise is really into evidence, is what happened in the swaps market or swaps, spreads, type and became in the correlations and the relationships changed in 2015. So, that was a surprise. And so, we have said we anticipate surprise and what we don’t want to do is take too much risk that would obviously take us out of the ballgame.
I'm sorry. I think the last caller definitely has the right question about now when you do have a variety of choices and when capitals always limited and just kind of how do you view reinvestment and investment kind of going forward. That will be I think one of the many problems that you'll be facing, because you doing [indiscernible]. As you say you actually have a range of attractive choices but a limited amount of money that you all obviously have to work with.
That too. And it was interesting. We have not been reinvesting money recently, because I don’t think there is any hurry right now. I'm going to have these choices. I'm going to have these just like in 2011. So, we kept investing, spread became widen, kept investing. We're actually all the way to the wide and so we bought the lines. Because we continued to stay involved in the market place. At this point, I think we have time to think about what's the optimal point or selective in terms of what we put to work. And again because we got that big CMBS portfolio, yes, we're getting cash every month, but it's not like owning 30 or 15 year fix, or you're getting probably a ton of cash, and just forced up to pull out a lot of money back in the market place.
We've, already and selective. Long winter way -- we're being very disciplined and it's elective in the process. I do think the CMBS opportunities got to be 2016 and '17. After that on a long-term basis, you may find that the product drops off.
[Indiscernible], it's been very difficult again to kind of track credit spreads for sort of types of things in your portfolio. Is there a decent way other than bothering you all the time on how to actually just keep track of where they've gone, for instance year-to-date, I assume they widen, but again I don’t know the last couple of weeks. Probably been a little bullish. I just don’t know how to track it.
That one may be another one, Jay, for us to follow-up with you.
Just trying to think of the CMBS product in the hybrid ARM product. We are in a little bit of an off the run sector. So, let's put our heads together on it.
Okay. It's not that good. Well, anyway, I appreciate it as always. I'll probably catch up very soon.
[Operator Instructions] Ladies and gentlemen, this will conclude our question and answer session. I would like to turn the conference back over to Mr. Boston for any closing remarks.
As I said before, we look toward the future with great anticipation. And with that, we thank you so much for joining our conference call. We look forward to speaking with you next quarter. Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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