Good morning. My name is Dennis and I will be your conference operator today. At this time, I would like to welcome everyone to the Dynex Capital Third Quarter 2022 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Alison Griffin, Vice President of Investor Relations. Please go ahead.

Thank you, Dennis. Good morning and thank you all for joining us today for the Dynex Capital third quarter 2022 earnings call. The press release associated with today’s call was issued and filed with the SEC this morning, October 24. You may view the press release on the homepage of the Dynex website at dynexcapital.com as well as on the SEC’s website at sec.gov. Before we begin, we wish to remind you that this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, forecast, anticipate, estimate, project, plan and similar expressions identify forward-looking statements that are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. The company’s actual results and timing of certain events could differ considerably from those projected and/or contemplated by those forward-looking statements as a result of unforeseen external factors or risks. For additional information on these factors or risks, please refer to our disclosures filed with the SEC, which may be found on the Dynex website under Investor Center as well as on the SEC’s website. This conference call is being broadcast live over the Internet with a streaming slide presentation, which can be found through a webcast link on the homepage of our website. The slide presentation may also be referenced under Quarterly Reports on the Investor Center page. Joining me on the call is Byron Boston, Chief Executive Officer and Co-Chief Investment Officer; Smriti Popenoe, President and Co-Chief Investment Officer; and Rob Colligan, Executive Vice President, Chief Financial Officer. And with that, it is my pleasure now to turn the call over to Byron.

Thank you, Alison, and good morning. And let me start the call off with a few messages, few thoughts for our shareholders and then Rob and Smriti will take over with more specifics. So to our shareholders, as I’ve mentioned in the past, this is an incredible moment in history. Across all major asset classes, prices have fallen and volatility has materially increased, especially during the last two to three weeks of the quarter. And even though all asset managers are in the same storm, I want you to know, we are not all in the same boat. The Dynex Capital boat was built to withstand a storm. We have been preparing for this type of environment for years. We have managed through markets like this before, and it is our experience and flexibility that will guide us through to the other side of this complex market cycle. Given these challenges and complexity, I want to maintain our tradition of transparency and open dialogue by simplifying my takeaways from this quarter into five key points. First, our portfolio is solid. Dynex is prepared for this market. Several years ago, we proactively moved up in credit and up in liquidity and we further increased our focus on liquidity after March of 2020. Our portfolio is government guaranteed and is backed by U.S. borrowers and U.S. real estate. Agency mortgage-backed securities are second in liquidity only to U.S. Treasuries and mortgage-backed securities have a history of being a very liquid and very efficient corner of the fixed income markets even in turbulent markets like the one we are in now. Second, our liquidity position is strong. Most of our liquidity is in cash, the most liquid asset of all, but we also have [unpledged] (ph) Agency securities that are easily financed or…

Thank you, Byron, and good morning all. The company reported a comprehensive loss of $2.20 per common share and a negative total economic return of 12.9%. The negative total economic return was driven by declines in the value of our mortgage-backed securities, and TBA positions exceeding the increasing value of our interest rate hedges as spreads widened significantly this quarter, especially in the month of September. Spreads are near historically wide levels, driven by recent economic policy and geopolitical risks. We believe our portfolio will recover significant amount of value when the flows into mortgage backed securities improve or simply as paydowns occur over time. Smriti will cover market activity including spreads in her comments. Earnings available for distribution or EAD was $0.24 this quarter. G&A expenses and EAD include a onetime cost of $2.7 million, or $0.06 of severance costs related to the CFO transition during the third quarter. At Dynex, our key strategies include the management of interest rate risk, liquidity management, and protecting shareholder value. We accomplish this through thoughtful asset selection and hedging activities. This quarter, we're highlighting the benefit of our hedging activities, as our earnings available for distribution calculation does not incorporate the positive impact of the company's interest rate risk mitigation strategies, because our primary hedging instrument is interest rate futures. If the company use interest rate swaps instead of futures, the hedge benefit of the swap would be included in both net interest spread and earnings available for distribution. Through September 30, Dynex has over $500 million of hedge gains, primarily on futures instruments. These realized hedge gains are recognized immediately for GAAP reporting, but are deferred for tax that are amortized into REIT taxable income over the hedge period of approximately 10 years. The benefit of interest rate hedge gain amortization was approximately $9 million or $0.21 for the third quarter, and is estimated to be $12 million or $0.25 per common share for the next five quarters. The total amount of gain to amortize into REIT taxable income can go up or down depending on the company's hedge position and movements in rates in subsequent quarters. Since hedge gains are a component of REIT taxable income, they will be part of the company's distribution requirements along with other ordinary gains and losses. As we move into the fourth quarter, we expect hedge gains will be supportive of the dividends in 2023 and beyond even if net interest income and earnings available for distribution decline due to rising financing costs. Please see the additional disclosures in our release. And be on the lookout for our 10-Q, which will have additional information and will be filed next week. I'll now turn the call over to Smriti for her comments on the quarter.

Thank you, Rob, and welcome, everyone. As a longtime sailor, I can certainly appreciate Byron's analogy of a boat navigating a storm. I've done that in real life with my family aboard our sailboat. And during my 25 plus years of experience in the fixed income markets, I've often felt that sailing offers important lessons to me as an investor. I'll structure my comments today on our path through the storm, how we're navigating it, our short-term views and strategy, and then I'll turn to our long-term outlook. The storm we are in represents a transition from an era of low inflation, low interest rates, financialization, leverage, globalization, peace and a global pandemic. On the other side of the storm is an environment where the amount and mix of all of these factors will be different and there will be new factors to contend with. We believe the storm and its effects will present excellent long-term investment opportunities. But we have to navigate through the storm first. We prepared for this environment with the highest level of liquidity in over five years and the highest allocation to the most liquid instruments backed by U.S. real estate, Agency-guaranteed residential mortgage-backed securities. Our TBA position has given us flexibility and maneuverability to adjust risk. The financing markets are functioning in an orderly manner, our counterparties have access to liquidity, haircuts are stable; and from our perspective, there currently do not appear to be any signs of financing dislocation. We can trade our highly liquid futures hedges 24/6. Our balance sheet is mark-to-market daily, so there is no mystery about the value of our positions at the end of each day. We had anticipated that as global central banks withdrew liquidity and raised interest rates to combat inflation, the price of government bonds…

Thanks, Smriti. Let me remind you again, this is a historical moment that is evolving as we transition to a new global economic market and geopolitical environment. I want to also remind you that we have built Dynex Capital to withstand the surprise market gyrations that we're encountering during this transitional period. We're committed to providing long-term attractive returns to our investors and our focus on these long-term returns has not wavered in this environment. Take note of our track record as displayed on Slide 15. Dynex has proven to be a better cash generating alternative to many other debt and financial alternatives through all cycles over the past 15 years. This is not our first storm and this will not be our last. And just as in the past, we're prepared to remain patient and disciplined until the sun comes out. Finally, we're in the boat with you. Both management and the Board are comfortable owning both Dynex Capital common and preferred stock as we ride out this current transitional period in history. The stormy environment will evolve. This transitional period will end and we will have the flexibility to adjust our posture to a more offensive stance to take advantage of these truly attractive return opportunities. So with that operator, we can open the call up for questions.

[Operator Instructions] And your first question is from the line of Doug Harter with Credit Suisse.

As you guys look and balance kind of the short-term and the intermediate to long-term, can you go through how you kind of arrived at that 7x leverage that you talked about and that you are at currently?

Hey, Doug, I didn't quite hear that. Say it over again.

Sure. Kind of as you guys look to balance kind of the short-term versus the attractive intermediate to long-term, can you just talk about how you kind of arrived at the current leverage level?

Yes. Hi, Doug. Good morning. Yes. So it's a function of two things, right? The level of spreads where they are today relative to where we think they could go. That's the first thing. We're being very respectful of the technicals in the mortgage market. And the probability here, I think we’ve -- as I said on the call, the catalysts for things to go tighter are fewer than the catalysts for things to go wider in the near-term. So that 7x leverage reflects the ability of the portfolio to really withstand substantial further widening in spreads. And we believe that's the appropriate position as we navigate the next few months. So the things that we take into account, where are spreads today, where could spreads go in the near-term, how much liquidity and capital do we want to have to be positioned with that? How much leverage do we want going into that? And then finally, you know, as I mentioned, sometimes in the storm is when you can actually get most of your opportunities. We want to make sure that we're positioned in a way that we're not hampering our ability to take that offensive posture when the opportunity does come.

And when that opportunity comes, I guess, where do you think -- where would you feel comfortable taking leverage kind of when you think that some of those catalysts are starting to play out?

Yes, look, that's like the $90,000 question which people have been asking us since July, right? And we have actually faced a lot of pressure from our investors and others saying, when are you going to take leverage up? How much are you going to take leverage up? And I think the right answer to that is, it depends. It depends on what the market is doing at that time. And what I can tell our investors, and I can tell you, and you've seen us do this now time and again is, when the opportunity presents itself, we will take advantage of it. It's going to be in the context of the broader macro environment. And if we believe the risk return trade-off is positive, that leverage will go up, right? So it's always going to be made in the context of that decision. And what I can tell you right now, we said in the deck, we think we have somewhere between 2 and 4 turns of incremental dry powder. That's what we hope to deploy but we'll do it slowly and we'll do it prudently.

Yes, let me add one other thing -- I mean one other thing on this, Doug. You've heard Smriti tell you how broad our book value swung during the quarter. And so, we're sitting here and the world starts to change, the environment changes, and we're looking at a book value that’s potentially going to be materially higher than where we sit. That's going to have a material impact on where leverage happens to be. We'll take that into account in terms of how we're managing the portfolio. So we're not sitting here thinking in terms of a static moment in time, you can't. You can see how much volatility there that's in the marketplace now. But really take note about that excellent book value because we were up book value solidly at the end of August, right? And so it's pretty fascinating to see this with a book value up that high, your leverage goes down immediately, the 1, 2 turns potentially. So very important that we're thinking in terms of top-down approach, where -- if spreads are headed 20 basis points to 30 basis points tighter, leverage is headed down. We're not going to wait till they get there to make the appropriate adjustments and investments as we think about it. So just to add that little piece in there to give you some more clarity.

Your next questions from the line of Bose George with KBW. Please go ahead.

Hey, everyone. Good morning. Actually just sticking to the theme of leverage, obviously with spreads wider here, your mark-to-market leverage has increased. Back of the envelope is that the mark-to-market leverage is like around 9.5 now. And you noted that there is the risk that spreads widen further. With that backdrop, like how willing are you or where -- what's kind of the range are you willing to let your mark-to-market leverage kind of run up to? And is there -- because I guess the concern is there's some level at which you might want to delever and that clearly sort of removes some of the upside when spreads tighten. So just kind of how you're thinking about that? Thanks.

Yes. So, Bose, we did talk about the adjustments that we made in the portfolio. As of the end of last week, our leverage is actually down from quarter end. Leverage to total capital that we disclosed was 7.2 times during my comments. So we have taken the opportunity to actually not take the write up on the entire portfolio for -- to further spread widening. And I think that's what we believe is the right approach here coming into what we still see is going to be a rough ride here through year end. And, again, in terms of like how high would you let it, how -- it is that type of decision at this point is a -- is almost like a day-to-day moment-to-moment decision. If we believe the market environment requires further deleveraging, we're going to do that, right? But as of now, we're operating with enough liquidity and capital, more than enough liquidity and capital to withstand basically a spread widening out to the peak of 2008 and beyond. So the liquidity position will be able to withstand that. Whether or not we actually choose to allow it to do that is a function of where we actually see the market environment evolving. Now, in the intermediate term, we are saying the environment is going to improve for all the reasons I outlined in the call, right? You've got raw returns that are really outstanding. You've got supply that's coming down. And ultimately, unfortunately the people who are selling bonds in this market are selling what we own. And when all this is over, they're going to want them all back. So at that point, it's going to be nice to have that. So it's a delicate line walking to say you want to -- you don't want to be in the position of giving up a lot of that upside when it eventually comes, but you got to get there. You got to make it there intact. And we're very, very cognizant of the risks involved with that. And so we haven't allowed our leverage to float up. We've made that adjustment and that's part of how we're navigating this. And Byron, I think you want to add.

Yes, let me add something to this, from the last two questions, Bose and Doug. As this -- when we say we went up in credit and up in liquidity, we increased liquidity on the balance sheet such that from 50 basis points on the 10 year. This ride, we have set here and we have had plenty of liquidity not to worry about making adjustments to the portfolio, because leverage is moving around or because margin calls are come in. We’d have been very easily actually managing our balance sheet. Now, Smriti, you will have probably saying it isn’t easy because they feel the stress that the investment team, as all investment teams do in the world with this type of market volatility. But in terms of the way I'm listening to your line of question around leverage, leverage will pressure those companies that don't have enough liquidity, because they will scramble as leverage is moving to meet their liquidity. And if you look at their internal operation, they'll be scrambling. We don't have that issue, because we went up in credit and up in liquidity. You can see all the decisions we made over the years to have enough liquidity to deal with a surprising environment. And the real key is that, as leverage moves around, we may make very tactical decisions, but it won't have anything to do with meeting liquidity. It will have something to do with the risk posture we are taking. Your best example is March of 2020. They operated in exactly the same way. We had a ton of liquidity. We didn't worry about any type of margin calls. We adjusted the portfolio two or three times within that major storm. And by the end of the year, everything was fine. So if you need a benchmark, go back and look at how we made decisions in 2020. Look how we made them in 2019 before 2020 and look how we made them in 2020. Back to you.

Okay. Great. That's helpful. Thanks, guys. And then actually just one on the funding markets. Any changes you are seeing there, volatility haircuts, anything to comment on?

The answer to that is no. The Agency RMBS repo market has been very, very stable. We have had zero haircut issues. The market is functioning in a very orderly manner. So no issues there.

Your next question is from the line of Trevor Cranston with JMP Securities. Please go ahead.

Hey, thanks. A question on the change in sensitivities you guys are showing as of October versus where you are at, at the end of the quarter. Can you go into some detail on what the changes you have made to hedge portfolio and the asset composition that have kind of led to that material change particularly in the rate exposures?

Right. Yes. So a big portion of that, it's a combination of two things. It's a combination of hedges that we put on. And second, a reduction in the credit spread sensitivity. So some reduction in the level of assets, some increase in the level of hedges. And Trevor, what we are doing is, making these adjustments sort of in real time, and what we've commit to do on this call is, as we make those adjustments and we complete making those adjustments, we will actually give more detail around exactly what those moves were over time. So suffice to say, what we are really trying to demonstrate in those two slides is, number one, as it relates to interest rate sensitivity, that's substantially down versus quarter end. And then as it relates to sensitivity to credit spread, that's down some, right, but on a percentage basis less than the interest rate sensitivity in the book.

And then the question was on the coupon composition of the portfolio. Given how much rates have moved, obviously, the coupons show in the portfolio as of September 30th anyways, are all trading at meaningful discounts. On the margin as you guys are deploying capital, can you talk about, like if you guys are looking at deploying into current coupons? Or if you're still kind of focused on more discount securities?

And I know, that's a great question. And one of the things that the principles that you've probably seen us now follow for a few years is, you want to generally try to have instruments that are, I'm going to say, hedgeable and that you know the duration or you're trying to estimate the duration that’s as well as possible. The amazing thing about the coupons that we have owned and continue to own is, that right now with everything trading below $95 price, most of those coupons are fully extended. And so the duration of those is not hard to estimate. And that's a really nice position to have in this volatile interest rate environment. So I'm very comfortable positioning us in that manner until we get through this transitional period. Now, as we go through the transition, we're evaluating all kinds of things, right? So yes, current coupons, we are evaluating that. There's risk and reward associated in the current coupon as well as the lower coupon. So the trade-off is always going to be what's the incremental return that I'm getting for the risk that I'm taking? And yes, current coupons offer more return. But there's a different type of risk that's involved. And there'll be a time and a place to put that risk on the balance sheet. We haven't we haven't felt like that's appropriate yet. But that is exactly the type of offensive thought process that we're going through at the moment.

Your next question is from the line of Jason Stewart with Jones Trading.

I wanted to ask about the cost to operate in sort of defensive, lower leverage environment. And how you guys are thinking about that?

When you say the cost to operate, Jason, I mean, just the overall cost of running the business?

Correct.

Our cost levels are basically the same in terms of just -- it hasn't increased in cost, we're having this type of market volatility where the cost [that’s gone was] on our time. Our focus level is that a materially higher level in terms of our personal time and how much time we're focused on the markets, you go from kind of normal work days to a 24/7 type of environment, but in terms of just the cost of running the business. We have a long-term perspective. And we're putting the right amount of money into our business to ensure that we are in great shape one, two, three, five and 10 years, short-term, medium and long-term. So we're making some major changes in terms of our technology platform and other different areas that will really a year from now, two years from now proved extremely beneficial, furthermore back to us believing that surprises are highly probable and the world has become more complex. We started to make these types of technology changes to put us in better shape to manage through this type of market environment, the exact market environment. And so this environment doesn't have any impact in terms of overall cost of doing business. Our focus on the long-term is still exactly the same. We're investing in people, process and technology to build a sustainable organization over the long-term. We believe that the world needs a solid asset management team like Dynex Capital, especially a cash generating vehicle such as this. So I hope that gives you some insight.

It's great. That is perfect. I wanted to ask you two other quick questions. One, any expected changes that you guys think come out of FHFA, given this environment?

Great question. Yes, I mean, I think this is the environment in which they open up the credit box, right, to potentially change the affordability picture for as mortgage rates are up here at 7%. We're looking at the loan size issue. Obviously, that is something that will come up here towards year end. Those are two big factors. Nothing in the news so far that we can see where there's been movement towards opening up that credit box. We're looking at the November elections. That's going to be something that we're focused on as potential signaling of how this might evolve over the next two years. So, right now, I think nothing is on the radar as far as we can see in terms of any major changes here.

I have one other thing. This is just a Byron comment, which is, you asked it out in public, so I'm going to make the comment. As a country, the Agency security is a phenomenal asset for the United States. I would like our government and our FHFA to make Freddie Mac and Fannie Mae temporary stabilizing agencies for this market. They don't have to grow the portfolio like they did before. But it is ludicrous to have these organizations sitting there, when they can actually be a stabilizing agent, and ensuring that these markets trade smoothly. The mortgage market has traded anything but smoothly over the last few months. They could play a minor role, they could have played a minor role in March of 2020 and things would have been a lot easier. So you could talk to government regulators, bring that issue up. I worked at Freddie Mac. I know a role they can play. They don't need to play the big portfolio role they played before. But they can play a stabilizing agent in terms of how the Agency mortgage market trades. And I would hope that one day, our regulators, FHFA or whoever else, will understand that.

Last one for me. How are you guys looking at buybacks on common or preferred versus investment opportunities? I mean, they both present pretty good opportunities in my view right now.

Long term returns at 19% to 25%, Jason. Marginal returns are -- buybacks makes sense when your investment opportunities relative to your cost of capital are inverted. That's not the case right now. And so, again, this is an investment environment in which we're going to want to hold and deploy capital.

Your next question is from the line of Eric Hagan with BTIG. Please go ahead.

Hey, thanks. Good morning. Just a couple more on relative value within the coupon stack and how you guys think about managing liquidity, just in light of the paydown differential for securities across the stack and how you mix that with TBAs and pools? And then on the funding side, is there any value in borrowing with longer term repo right now? Can you comment on the liquidity that you see for repo along the yield curve? Thanks.

Yes, I'll answer your second question first, Eric. We -- I think the idea that you can borrow across term, right, is something that we've used very flexibly and well here at Dynex and it continues to be sort of a mainstay of how we get through quarter ends and so on and so forth. So, there is a term premium that is currently being charged in the markets to go through year end. It is actually not as big as term premiums that we've seen in the past for the year end turn, but there is a premium and I think that's a big piece. The other thing that you're seeing is substantial amounts of uncertainty in the repo market with respect to when the Fed will make their 75 basis point hike move or that 50 basis point hike move or 75? So there's a lot of just price discovery that's going on for November and December and beyond with respect to the magnitude of rate hikes. So -- but none of that has prevented us from A, being able to term out our financing; or B, just the availability of financing. So we are able to term things out. Financing is available. We've not seen any issues with respect to haircuts or anything like that. We are seeing a term structure to those interest rates as you would expect. But again not a problem with respect to actually how we operate. So your first question regarding relative value and pools and all that stuff, so here's really how we're thinking about it. The first principle is just the principle of risk management. When you have coupons that are fully extended and the prepayment risk is more or less baked into the price, they're much easier to hedge.…

That's good color. I appreciate that. With respect to the comments around the dividend and such, are we hearing that your dividend will most likely be characterized as a return of capital for both 2022 and 2023? And any guidance I suppose on that? Thank you.

Yes, thanks, Eric. No, we are not saying that at all, because the hedge gains in particular, that would all be ordinary income, and we will look at the distribution calculation. So yes, we are not saying that at all. And we are going to provide -- continue to provide color on our hedge gains and the impact on that -- to the portfolio, to financing and to taxable results, so everyone can understand where we are. We can be transparent. People in your seat can model out where we are and kind of understand the direction that we are going in.

Your next question is from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Hi, guys. Are you continuing to issue any shares into the fourth quarter here?

Did you say are we…?

Issuing shares?

With that price thus far. But in this type of chaotic market, Chris -- I appreciate you’re asking this question. This type of chaos says, you hunker down on all aspects of the balance sheet and you wait out the storm. That's the purpose. We pulled this analogy, the boat up for very strong reason. Smriti is a sailor. Tom Aken, who was CEO before this, is a sailor. We are serious. In a storm, you hunker down the boat, put down anchor, and you are waiting storm out. This is on both sides of the balance sheet here. And so, no, the short answer is, I couldn't answer that to say, no. As of right now, we are in a storm. If the storm took an interesting twist mid-September, that's one of the other key point here, is that you leap into a zone, where we are patient on all aspects of the balance sheet. So if you want to make sure everyone understands this point about what we are saying, we have talked about whole ton of other stuff coupons or vol. The bottom-line is, mid-September with the chaotic British situation, along with the last inflation number, created complete chaos in market trading across the globe, treasuries, mortgages, corporate, whatever you want to mention. And in a situation like that, a smart boat hunkers down and waits the storm out. That's what we're doing in Dynex. If you want to take away any message from here, you say they are waiting the storm out, they have a boat that's built for storm and we got the ability to wait the storm out because we built the boat with plenty of liquidity starting multiple years ago.

And at this time, there are no further questions. I will now turn the call back to Byron for any closing remarks.

Thank you, all. I really appreciate you being here. Thank you for the questions. Stay tuned. We'll be transparent. We're hunkered down and we really appreciate all of you who are shareholders in the company. Thank you very much and we'll look forward to chatting with you at our next call.

This concludes the Dynex Capital third quarter 2022 earnings conference call. Thank you for your participation. You may now disconnect.