Good day and welcome to the Dynex Capital Fourth Quarter and Full Year 2022 Earnings Call. Today’s call is being recorded. [Operator Instructions] And I would now like to turn the conference over to Alison Griffin, Vice President of Investor Relations. Please go ahead.

Good morning and thank you for joining us today for the Dynex Capital fourth quarter and full year 2022 earnings conference call. The press release associated with today’s call was issued and filed with the SEC this morning, January 30. 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 maybe 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. Good morning and thank you for joining us today. We started this decade at Dynex, believing that surprises would be highly probable and 3 years into it, the surprises continue to come. I have been active in the financial markets since 1981, with a four-decade long career that began with a deep curiosity for economics. As a trader and banker on Wall Street, I learned disciplined processes for risk management. And my experience since then has laid a tremendous foundation for navigating this current period. I can say with all my years of having been on this planet that we are at a big moment in history. Last year, we saw more volatility than I had witnessed since my early years on Wall Street. Bond markets had the worst year of returns since 1926. Our performance for the year reflected some of this turmoil. Our total economic return for the year was negative 9.45%. We are a big proponent of preserving book value and we never like being in a position of losing capital. So on a standalone basis, this is a disappointing result. Nonetheless, Dynex outperformed major fixed income indices and our peer group and we continue to deliver industry leading returns. In the context of a worst performance in almost 100 years for the bond market, we made disciplined and deliberate choices in managing our risk. And as you can see on Pages 4 and 5, we remain the top performer over for 3-year and 5-year period. Against a historically difficult backdrop and markets, I take enormous comfort in this relative result. As a fellow shareholder, I focus on how we are building long-term value. Please turn to Page 9. You can see we started the decade at $18.01 in book value and we have…

Thank you, Byron and good morning to everyone joining the call today. For the quarter, the company reported book value of $14.73 per share and comprehensive income of $1.17 per share. The book value performance plus the dividend delivered an economic return of 6.2% for the quarter. The portfolio benefited from spread tightening which occurred in the fourth quarter and drove increases in the value of our mortgage-backed securities and TBA positions. Our thesis of book value recovery based on spread tightening still holds true. We believe that our portfolio should recover a significant amount of value when investor demand for mortgage-backed securities improve or simply as pay-downs occur over time. Smriti will cover more granular details as well as our views on recent market activity and our outlook for the future in her comments. Earnings available for distribution was $0.03 for the quarter. As discussed last quarter, this does not include the benefit of our hedging activities. If the company utilize swap instruments instead of futures, EAD would be dramatically different. Our decision to use futures is based on the depth and liquidity of the futures market as well as lower capital requirements compared to a comparable swap instrument. That provides equivalent rate protection. While it’s rare for extended periods of interest rate inversion to exist, it’s not a completely new market environment. With rate inversions, income needs to be generated from the management of interest rate risk, primarily from appropriate hedging strategies. In the fourth quarter, Dynex realized $205 million of hedge gains bringing our year end hedge gain to $691 million. This is a material number that has insulated the company from rising rates and has protected book value from a dramatic rise in short-term rates as the Fed continues to use rate policy in an attempt…

Thank you, Rob and good morning everyone. Rob has covered a great deal of detail on our financial performance in 2022. My comments today will be focused on our current macroeconomic thinking, our risk, portfolio posture, opportunities and outlook for 2023. There are three key elements underlying our macroeconomic thesis. First and this one has been a consistent theme since 2015. The global environment is increasingly complex, with rising global debt, increasing human conflict, rapid technology changes and shifting demographics. This leads us to favor more liquid strategies. Second, global central banks have embarked on a monetary tightening cycle against this complex backdrop. How long the tightening cycle lasts, how effective it is? The intended and unintended consequences are yet unclear. This leads us to prepare for multiple scenarios and unforeseen events. Third, quantitative tightening, which is seen currently as running in the background, can have a significant impact on the price of risk going forward. We believe the draining of liquidity has the potential to be a major driver of the repricing of risk in this decade. We think this can occur even if the Fed is cutting rates as the balance sheet continues shrinking. This leads us to hold assets that can be easily valued and traded at those valuations, saving dry powder for when valuations on all assets, especially less liquid assets reflect fundamental value with less distortion from central bank balance sheets. In our view, these factors have shifted the yardstick by which to measure what is a fair return for the risk environment. It is easy to be beguiled by a return that seems higher than we have seen in the last 8, 10, even 15 years. We are taking the approach that the last 15 years of market history must be viewed by considering…

Thank you, Smriti. Let me conclude with some final thoughts. We are in an evolving environment and at a unique transitional period in history. It is important now more than ever to be able to rely on a team with a clear strategy and deep experience and navigating complex environments. We are patient, disciplined, focused on execution, and on driving long-term shareholder returns. We are investing our money alongside you. So our goals are aligned and we take the responsibility as managers and stewards of your savings very seriously. We believe that Dynex Capital represents a compelling investment opportunity. Our stock trades at a discount to book. We pay an attractive and consistent monthly dividend that we believe is sustainable. And we have ample dry powder to take advantage of attractive investment opportunities as they develop. For our existing shareholders and stakeholders, I thank you for your trust and joining us on this journey. For those of you who are not yet our shareholders, I hope we have made a compelling case for you to join us. With that, let’s open the call up for questions.

Thank you. [Operator Instructions] We will take our first question from Eric Hagen with BTIG.

Hey, thanks. Good morning. I got a few questions. In the higher coupon pools, can you say what the loan age is and the prepayment profile more generally, maybe just how you plan on toggling between the TBAs and the pools and the higher coupons? And then the second question is do you see any risk or potential that mortgage rates could come down into the 5s, call it the mid-5s and what kind of read-through do you see with respect to supply and demand for MBS and other kind of scenario? Thanks.

Hi, Eric. Good morning and thank you for your questions. So in the higher coupon pools there are new [wallet] (ph) pools, mostly I would say, not excessively high pay-up. So again, we are trying to limit the exposure to high pay-up pools to be able to cut down on that the pay-up exposure, right. So the idea there is again, you are playing the hedged return game, right, between TBAs and pools. And so over time we are kind of thoughtful about where we purchase our convexity. Sometimes that convexity is better off in pool form. Sometimes when the securities are trading at a big discount, we like the flexibility of TBA and then eventually being able to swap out. So that’s kind of been our mindset with the higher coupons. And our pool position at this point is mostly in the 4.5% very, very small position in the 5s. With regard to your second question, do we think that mortgage rates could drop? And I think the answer to that is yes, I think we actually included a slide in our investor presentation this time, it might be in the appendix that has some of our views on the mortgage market dynamics. It’s on Page 12 actually, but yes, I mean, we believe that just even if interest rates in the broad markets don’t change, there is the possibility of primary, secondary spreads coming in because of competition, the need for mortgage originators to continue producing, profitable returns for their shareholders, that is a strong impetus for mortgage rates to decline regardless of whether treasury yields decline. So could you get that to below 5%, I would say is a stretch, definitely below 6% is a possibility. And then how that affects demand and supply? I think that was your last question. Am I right?

Yes, exactly.

Yes. So, look, right now, I think there is levels of cash-out refinancing that are starting to get limited a little bit by the GSE policy. But the bottom line on any kind of decline in mortgage rate from here on out is an increase in supply without necessarily a corresponding increase in demand. So that is a technical factor that we are very focused on.

Hey, Smriti, you want to – let’s make one other comment here about these higher coupon 6s and others that have been originated. What I found fascinating was an article in the Wall Street Journal about Rocket Mortgage and their sales pitch at this point. A lot of loans have been made on around debt consolidation. And it is – as they make these higher coupon mortgages, many originators are assuring to the borrowers that they will be able to refinance these mortgages within 2 years or so. So there is – it’s very interesting to see you want to understand what’s happening between the borrower and the lender to get a real understanding of value. These higher coupon mortgages are being originated and especially the really highlight the 6s, the 6 handles, where they are being assured – the borrowers are being assured, they will get the opportunity to refinance within a couple of years. So it’s an interesting dynamic that you want to really understand that is happening at the front end of the mortgage market.

Yes, absolutely. Thank you guys very much.

Thanks, Eric.

We will take our next question from Doug Harter with Credit Suisse.

Thanks. Can you just talk a little bit more about the decision to raise capital through the ATM and kind of how you view the tradeoff of near-term dilution versus future returns from that capital?

Sure. So really, I appreciate the question, Doug. I think one of the things that we think about the main thing we think about is the spread between the return on investment versus our all-in cost of capital. That is the main driver of capital issuance at all times here at Dynex. We think about what can we invest the capital in and when we adjust the all-in cost of capital for dilution in the near-term, are we able to earn that back over time? How quickly can we earn that back? And one of the key points about this particular environment and when we talk about it as being a sustained return environment that is favorable is that we feel like the investment opportunity a) is sustainable and b) it’s the return on investment is higher than our all-in cost of capital. So it is a very accretive investment environment. And when we see periods like this, it makes a ton of sense for us to go get the dry powder, so that we have in our pocket to be able to put the money to work at the right time.

I guess when you are doing…

Go ahead.

Sorry, if I could just get one clarification…

Yes, go ahead.

Before you add. Yes, just I guess when you are thinking about that – is that kind of assuming kind of static spreads? And in that cost of capital and I guess, if you were to think about the $0.28 of dilution, I guess at what points in the quarter were those shares issued? And would there have been some appreciation on the assets that you bought that would offset that dilution?

Right. I mean, look, book value is up since quarter end, right. So we have already gotten appreciation on anything that was issued last quarter. And I’ll remind you guys, when we talk to you for our third quarter results, we were reporting book value in the 12.95 to 13-ish area, right. But we have had a massive increase in book value since the lows of the fourth quarter. And the existing shares at the time have benefited in all of that. So, yes, we do feel like there is, we are investing capital at levels that are accretive to our shareholders relative to the all-in cost, including what we paid to issue the capital in the fourth quarter.

Hey, Doug. Just one other thing too, when you think about what happened in the fourth quarter, there were times in the fourth quarter when new investment opportunities had a return of north of 20%. So I understand that there is a temporary dilution factor, but the opportunities were there that we could put investments on the pile of investments that will deliver returns for years to come and that’s why it made sense for us to add capital during the fourth quarter.

You should also note we are long-term investors. We are building our company for the long-term. So, there are some definitive statements. We have no desire to be as large as the largest companies in this industry, zero. We are going to continue to go, build up our technology and processes, our capital base over time. With – it will add resilience. It will add liquidity for our shareholders. And then when we think about costs, costs are costs, where is my technology costs, where is the issuance costs, can we generate a return above our costs. And so, I will direct you to some of the charts that we have shown you. I love the one, especially on Slide 9, because that’s the way we think about it. And if you look at the far bar, fourth quarter ‘22, you will see it says $19.51. Look at where we are today. That number is probably closer to $20. And over time, we will think about that, it’s like a buoy in the water with a rising tide. So, costs are costs. We are building our company for the long-term. We have no desire to be as large as some of the largest balance sheets have been. Our nimbleness is extremely important to us and it’s been extremely valuable especially this decade so far.

And I guess just one follow-up on that. I mean to the extent that, like Rob said, you saw returns in the 20% range at points during the quarter. How do you weigh kind of temporarily letting leverage increase to take advantage of that versus raising new capital and then kind of if spreads tighten, just kind of letting leverage naturally come down. Just kind of that thought process versus….

Yes. I mean I think a big one there is thinking through the risks and the risks of allowing leverage to continue to ride up, okay. And in this particular macroeconomic environment where you do have the possibility of surprises, such as what happened in September and October, you want to be very, very thoughtful about allowing your leverage to rise into those kinds of events versus taking some action to address increases in leverage. So, there is a big difference, actually. When you have surprises like the ones you had in September and October, it wasn’t readily apparent, which direction things were going to go. And in those types of environments, we have chosen to not expose our shareholders to going out of business risk. We have chosen not to do that. So, there will be times when we take up leverage or allow leverage to write up in that situation. That was not one of those times. So, we think very long and hard about the risk reward of making those types of trade-offs. When there is existential risk involved, we are not going there. In other times when there is a reasonable chance that we are going to recover capital from allowing leverage to write up, it’s a different trade-off. But last quarter was not that type of an environment in our opinion.

Okay.

And I think decision was made from a long-term perspective.

And we will take our next question from Trevor Cranston with JMP Securities.

Hey. Thanks. You guys mentioned this sort of near-term outlook for spreads, you expect them to be kind of range bound and to remain correlated with other risk assets? Can you maybe talk a little bit about your outlook for interest rates this year, including kind of how you guys are thinking about volatility trending over the course of the year? Thanks.

Wow, Trevor, you asked me if I have a crystal ball. It is, I would say like, I have been in these markets for a long time. And I think the environment that we are in is, it is among the most difficult environments that I have sat in, in the last 30 years to be able to look forward and say, with any degree of confidence, that x, y or z is going to happen with respect to interest rates, okay. We do have a name for it here. We are calling this flat distribution with fat tail for a reason, which is that it is really, really hard to come to a conclusion about inflation, the level of inflation, the level of growth, the exogenous events that could happen. It’s really difficult to say things are going to go in one direction or another. So, we have actually got a very neutral predisposition to interest rates. You can see that in our risk position, up or down, curve shocks were pretty flat, because this is in an environment where you can – we think you can actually put your shareholders’ capital at risk for those types of moves, because you are not as certain about that. So, that we – leads us to that kind of a risk position. So, we are in that – our view on interest rates right now is, you cannot predict, you cannot predict. I would say the other thing that that informs us and I mentioned this in my comment is, the last 15 years we have had a massive distortion from quantitative easing, whether people necessarily recognize it or not, it’s been a massive factor in the price of risk. And you are now entering an environment where that is actually being taken away globally by all central banks. And so the price of risk has to change. It’s going to happen slowly over time, potentially, shocks like September or October, those are going to be more normal as the liquidity gets taken out of the system. So, you don’t want to lean too far in one direction or another in terms of interest rates. And so all of these things lead us to say, better have a more neutral kind of position with respect to that. Now, the markets have done an incredible thing here by being very confident that interest rates are going to come down. And we will see what the Fed has to say about it later this week. But we are not ready to go in that same – in the same direction per se.

Thanks Smriti. Just can you talk about how wrong the market has been? That’s an important point that is overlook and most people don’t see the forward curve and see where the market was predicting rates just a year ago, 1.5 years, the market has been wrong throughout time, it had been extremely wrong recently. Can you just discuss that a little bit?

Yes, sure. I mean like the – if you look at the forwards on December, in December of 2021, I mean the market would have told you that interest rates will be up at like 50 basis points or 75 basis points at the most, right. So and look, even the Fed didn’t really believe that inflation was something, really they had, if you guys remember they had FAIT, remember that thing, flexible average inflation targeting. That was basically saying we are going to average inflation out over time and so we can stay more dovish. All of that has gotten thrown out the door. So, the ability to predict here is very, very hard. And look, in general, predictions are hard. We try not to predict here much. And so that’s kind of what informs our opinion.

Yes, but [indiscernible]. And throughout time, there are better probability distributions than we have today for investing money. This is and it’s very important, we will stand firm on this at Dynex Capital. This is an evolving environment. And you have one of your best ways to understand and look back at the forward curve, and look at how wrong the market has been this decade. And then consider the surprises that have happened. We came into this decade, we believe surprises were highly probable. Not only have we had surprises, but almost all have come from overseas. You have first, you had the pandemic, then we had the government response to the pandemic, then you had inflation, we had another government response, and we had a war and then we had the craziness that came out of Britain in September. So, when you start to talk about a prediction, and anyone wants to forecast, any economists, I want to ask you what precedence you are going to do, what is Russia going to do. And then that can go down a huge list of other questions for you that will challenge your forecast. And then finally, one of the best statements that Jay Powell made this year is when he said you can’t trust any forecast today. That’s our opinion at Dynex.

Okay.

Some of you – some people would believe us, and some will disagree.

Okay. I appreciate that. That’s a good perspective. Thank you.

Thanks Trevor.

[Operator Instructions] We will take our next question from Bose George with KBW.

Yes. Good morning. Actually wanted to ask just about this current levered ROE, I mean you guys noted this is above the dividend, but just any more color on kind of a range of where current ROEs are would be great?

Right. Yes, I think the – what I would say, so I quoted just 7x leverage, because that’s the leverage to common that we have on right now. I would say that – so we are assuming the spreads of about 125 to 130, 135, there about. Those are in the 13 to 15 ROE, depending on the coupon that you pick out. And this is for like 4.5 to 5. That would be where they are at the moment.

Okay. Great. Thanks. And then actually, you have noted that you didn’t sell assets during the quarter or nothing meaningful in terms of recovering book value. But just on the TBAs side, with the TBA positions that were closed, I mean were there sort of losses there to think about?

I mean, yes, you get one thing we did disclose right at the end of last – I mean during our conference call in our earnings presentation for the third quarter was a change in our risk position. So, if you go back to the third quarter earnings deck, we provided information, not only in terms of our interest rate risk, but also our spread risk exposure, which declined during the early weeks of October. So, that was in our numbers for the full quarter.

Okay. Thank you. And just from a P&L standpoint, is that – are those changes, is that floating through that derivatives line, along with the TBA drop income?

It should be in there, yes.

Okay. Great. Thanks very much.

Thanks Bose.

Our next question comes from Christopher Nolan with Ladenburg Thalmann.

Hey, guys, quick question. Follow-up on Bose’s question on leverage, does that 7x include TBA or was that simply just that…?

Yes. It includes TBAs, Chris.

Okay. And I guess my follow-up question would be, given the increased reliance on hedging for income, should we look at EPS, distributable EPS to be somewhat more divorced from the overall performance of the company?

We have talked a lot about EAD being a limited metric in general. And I would say, focus on total economic return. Rob can take you guys through once again, just like the A plus B plus C plus D on the hedge gains. And maybe you should do that. Now, Rob, in terms of just how to how to think through EAD plus, what is more directionally correct.

Hey Chris. Go ahead Rob.

Sure. So, yes, thanks for the question. One of the things that we added this quarter, just to highlight rate moves and how we look at the portfolio. We added a chart on Page 8 of the earnings deck. So, you would see, as you would expect, repo expenses are up. Both our interest income and our hedge gains have also ramped up this year. So, that’s how we are feeling that we are insulated from a lot of the rate moves and how we are using our hedge book to supply either a buffer against rising rates or even just simply income. I think it’s an interesting market factor that right now, if you have a future on because the rate curve is inverted. We actually get paid to put a hedge on whether that is a future or a swap. There haven’t been that many times in my career that that has happened. But it’s an interesting market dynamic that will actually add to that hedge benefit in 2023. We will see how long it lasts. But the market dynamics are a little bit different now. So, we are adjusting to that and doing a good thing for earnings and book value.

And Chris, I am going to just finally just chime in on one other piece as a long-term investor in Dynex Capital. And a very, very – we are very responsible for our shareholders. I am looking at this graph that we have shown you on Slide 9. So, when we talk about performance, what’s the worst in that? I am simplifying it for you. On Slide 9, I am going to be looking at that $19.51. And I am going to be looking at it as I continue to add a monthly dividend to that number. And we are looking to regain our book value over time. And I am going to be looking at that number to go up. That’s what I am looking to do. And that’s the way I am going to be thinking about our performance here at Dynex Capital. And the other piece in this would be to really understand, and Smriti made this comment in her statement. We didn’t take permanent hits to capital in 2020 or 2022. So, when you look at that bar, and please make – you do the same graph for every company that you might consider to analyze or invest in, and then look and compare to us again. Over time, this says, we are concerned with our shareholders savings. We want to deliver a solid cash income. And then we want to make that final bar continue to move up over time. So, when we say performance and how do we think about our performance, we simplify it in that graph. You can come up with all kinds of funky GAAP terms. But at the end of the day, our shareholders are expecting an above average dividend cash, cash income, which we are looking to continue to pay on a monthly basis. And we are looking to maintain the book value over time.

Okay. Thanks guys.

And that does conclude the question-and-answer session. I would like to turn the call back over to Byron Boston for any additional or closing remarks.

Thank you so much for joining us. I want to emphasize to you that we are long-term investors, skilled risk managers, disciplined capital allocators. Today, we have allocated our capital to the agency mortgage backed security sector. I will emphasize, we are not an agency only REIT. We are not doing the new hot thing. We are investing for the long-term. When we think about our costs, Doug, I appreciate you are asking that question. We are thinking about our costs over time and can we generate a higher return. And then I will emphasize to you. Get familiar with that slide, Slide 9, we like that. It shows our accumulated dividends along with where we are and our track record in terms of our book value. And when you are a little confused about who is managing your money in this decade, very important to ask yourself that, create that graph for every company that you consider and then compare it. We appreciate you joining us this quarter. And we look forward to chatting with you again at the end of the first quarter sometime in April. Thank you very much.

Thank you. And that does conclude today’s presentation. Thank you for your participation and you may now disconnect.