Good day, and welcome to the Dynex Capital Incorporated Second Quarter Earnings Conference Call and Webcast. 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 that this event is being recorded. I would now like to turn the conference over to Alison Griffin, Vice President of Investor Relations. Please go ahead.

Thank you. 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 August 6, 2015. You may view the press release on the company's Web site at dynexcapital.com under Investor's Center, as well as on the SEC's Web site 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 the Annual Report on Form 10-K for the period ending December 31, 2014, as filed with the SEC. The document may be found under the Company's Web site under Investor Center, as well as on the SEC Web site. The call is being broadcast live over the Internet with a streaming slide presentation, and can be found through a webcast link under Investor Center on our Web site. The slide presentation may also be referenced by clicking on the Dynex Capital's second quarter 2015 earnings conference call link on the presentation page of the Web site. 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.

Thank you, Alison, and good morning. Our second quarter results for 2015 reflects the complexity of a global financial, economic, and geopolitical environment. Movements in the major financial markets have all been challenging for the past one-and-a-half to two years. Global currencies, commodities, interest rates, and stock markets have all continued to deliver surprises as corporations, investors, regulators, and politicians work hard to understand a rapidly changing landscape. As a result, I want to take a few moments to review our second quarter earnings, our strategy, and the risks that we take to ensure that our investors understand our approach to the business. In my 30-year career of managing fixed income assets, and my 11-year career managing a mortgage REIT, I have found it necessary from time to time to stop and review the business model, the risks that we take on a daily basis and our long-term approach to the business. Hence, my goal is that you leave our call today with the a better understanding of Dynex, our long-term approach to the business, and why we continue to feel comfortable honing -- owning or holding Dynex stock in our personal portfolios. I will start by asking myself a series of questions with the goal of giving a high level picture of the business. After that, I will finish, and turn it over to Smriti and Steve, who will give you more details regarding the overall results from the quarter. So first question, what happened during the second quarter of 2015? Simply put, we generated core net income of $0.21. Our book value was 853, which is down 4.8%. We paid a dividend of $0.24. Our stock yields currently 13%. What were the drivers of our results in the second quarter? Our earnings were impacted by faster pre-payments fees.…

Thanks Byron. For those of you that are following the presentation, I'll be covering parts of Slid 6, 7, and 8 with my comments. As Byron noted, this was a challenging quarter given the volatility in rates and spreads, which is reflected in our results. We reported a comprehensive loss of $0.21 per common share for the quarter, and net income of $0.52 per common share. Breaking comprehensive loss into its component parts; we earned core net operating income of $0.21, and had losses on our investments net of their related hedges of $0.42. Core net income to common shareholders of $0.21 was $0.02 lower than the first quarter. Despite a larger earning asset base during the quarter, core net income was lower primarily due to three reasons. First, premium amortization was higher from faster prepayments on agency RMBS. As Byron noted, this was partially offset by prepayment compensation received on our CMBS and CMBS IO portfolios during the quarter, which reflects the benefit of our diversification model. Second, we had higher hedge costs during the quarter as we added pay-fixed swaps in connection with managing our duration position, given changes to the portfolio. And lastly, we had modestly higher operating expenses this quarter versus the first quarter. Partially offsetting these amounts was an increase in earnings for the quarter from our partnership investment in re-performing loans. Adjusted net interest comp decreased from the first quarter primarily due to the previously mentioned higher premium amortization on our portfolio, coupled with the higher hedging costs. For a similar reason, adjusted net interest spread was lower by 10 basis points, but that also includes the addition of assets during the quarter of lower net asset -- net interest spreads. Overall, our investment portfolio was flat quarter-to-quarter, but up slightly on an average…

Thanks Steve. I'm going to discuss macroeconomic factors first, and then drill down to our risk position, and our activity through the quarter referring to Slides 12 through 19. We see an evolution of the complex environment that we've been describing over the last 18 months. This quarter, against the backdrop of quantitative easing in Europe and Japan, we saw the existence of the Euro zone threatened by a potential Greek exit. We also saw extreme volatility in Chinese equities. Chinese authorities and central bank took a number of unorthodox and dramatic actions to stem the tide of investor losses. Yet, over the quarter, U.S. treasury yields rose, more in the long end of the curve than the short end. Two-year rates only arose 9 basis points, and then contract 5 and 10-year rates rose 28 and 41 basis points respectively. Early in the quarter, U.S. markets were driven by moves in German bonds, and later in the quarter, market participants believe that little would stand in the way of the Fed raising interest rates. However, the pace and the timing of Fed hikes remain an open question. Because in spite of the strong desire to move off what's perceived as emergency status of zero interest rates this year, the Fed still remains data dependant. And the data thus far still leaves a fair amount of uncertainty in the picture. Turning to Slide 13, where does this leave Dynex? We've assessed this environment as one where the outcomes are really quite divergent. And the scenarios with the higher probabilities are likely unforeseen, unknown surprises. But we also have to plan for a scenario where nothing gets in the way of the Fed raising interest rates as they so desire. We've described this environment as one being -- one in which…

Thank you, Smriti. Can you go to Slide 21, and again, I want to put up a longer-term chart. I want to make a couple of points here. First off, if you recall back, it's not here on this slide, but the earlier slide I used earlier in the presentation. I went back to 2003, 2004, '05, '06 period. One of the other reasons I chose that time period with those stocks the environment was somewhat similar in terms of overall psychology in the market. There was some cloud over the mortgage REIT sector because the Fed might be active in the space. Mortgage REIT analysts had all started to move -- get happy about operating business models, credit and the whole loans, and servicing in these types of strategies. And so that's one of the main reasons I chose to go back to 2003, because I wanted to capture that period, and to just remind you. And if you didn't know, to inform you that this type of period has happened before, and look at the returns that can be generated over time. I've used here, on Slide 21, just to bring it back to specifically Dynex. We went back to 2008, because that's when we started to build the current version of this portfolio. We've tried to give you as much information today as possible to help you understand our strategy, and how we see the future. As in the past, we have been willing to buy back our stock, and we will be continue to be willing to do so if the relative return looks attractive. Again, in this last chart you got Dynex versus the S&P 500 and the Russell 2000, because that mix is included in the Russell 2000 index. Because we have a long-term investment strategy we do not allow short-term results to sway our overall decision-making. We are balancing our risk with the goal of generating an appropriate dividend over time because we believe dividends over time will be a powerful generator or driver of returns. As always, I will close by comments by reminding you that we continue to own our own stock. We will continue to be compensated with the material portion of our personal earnings in stock. And we will continue to operate as owner operators as we look to the future. With that, operator, we will open the call for questions.

We will now being the question-and-answer session. [Operator Instructions] The first question comes from Douglas Harter of Credit Suisse. Please go ahead.

This is actually Sam Choe filling in for Doug Harter. I just had a question, I guess, regarding on your positioning of the investment portfolio. This quarter, we've seen the mortgage REIT here is kind of take a more defensive positioning and you guys stated you were more offensive. So I was wondering if that offensive positioning was -- how are you going to continue throughout the year?

Let's look at this real close with the offensive and defensive words. We started last year identify the environment as being complex. We then made a decision, last fall, to sell our lower rated credit positions, because we feel lower rated credit positions our repo are riskier position. We then made a decision to improve the liquidity of our balance sheet, and the overall credit quality by going up in credit and up in liquidity. So in fact, we made some major decisions. We don't like to necessarily use the word, defensive; we like to use the word, discipline. So when we put on those lower credit rating securities, spreads were really, really wide, returns are really, really high. When we sold them they were really, really tight, and returns had reduced materially, and as such was warranted to move up in credit quality, such that, we reduced our balance sheet going into the end of last year. This year, we've added agency securities, and we added Triple-A securities. Our positioning reflects our opinion that the global financial environment is complex. And so, again, one of the key things we're trying to emphasize to us is that when you talk about defensive or de-risking strategies, you must be very careful in terms of understanding exactly what you're doing, because in many situations you will just take on another set of risks. If it wasn't so complex, you could either make a bearish call on interest rates, or you can make a bearish call on the overall environment, and just reduce your balance sheet, and move into cash. Both of those positions have a different set of risk than we have today. What each person is doing, and what we're choosing to do is identify a certain set of risks that we're willing to take. So we've got, again, a high credit quality balance sheet, more liquidity, and so -- I don't know if the correct words to use is offense or defense. It's neither. It's discipline.

Got it. I guess another question I had was, what's your thoughts on the GSE risk transfer deals and maybe, I mean, how are you thinking about those?

I'll take that Byron. I think the main issue on those has been using leverage with credit-sensitive assets, and the level at which those bonds are currently trading. So we've looked at these in so many ways since issuance. And we have not yet found first loss or second loss risk-adjusted return to be long-term attractive for our -- the way we look at the world. Now, that's not to say they're never going to get there. These assets are on our radar screen. When they get to the right level we think we'll step in. Look, tranches where you have first or second loss that are trading at 3%-4% yields, you're really getting your return from leverage. And spread widening, even of 5000 basis points, it's just -- they're material losses to equity when that happens, and we just haven't gotten comfortable with that.

Let me throw in a couple of other points on that. Along the lines of my comments a second ago, and I appreciate that question. Because I think that's a very important one. What we did last fall, and I'm very -- this is a very important issue to me. We're putting leverage on the lower credit sensitive assets, we believe to give a high risk strategy, want to be used as we used it in 2011, when spreads were extremely wide. Now, our general opinion on residential credit risk is it's an excellent asset. These are money good assets, because the regulators are hammering residential originators so hard that this product that's being originated in 2015 are very attractive assets. To the degree that unfortunately spreads and asset values -- spreads are so tight, asset values are so high, and there's so many people chasing those deals, that we would have to use leverage for those lower credit instruments, that's the exact trade that we walked out of, last fall. We walked into the trade in '09, 2010, 2011. We walked out of that trade last fall, we moved up in credit quality and up in liquidity. So that's, as they're along the same lines, I want you to listen to it from a top-down approach that we take to this market. We believe the market is complex. Why do I say complex? That it's very difficult to take a bearish or bullish stance on this market. We also believe that there can be potential liquidity squeezes. And liquidity squeezes, I don't want to have lower credit rated instruments on repo. I prefer having higher credit quality assets on repo. And if you're a 100% certain that you're going to have some type of global meltdown, then I don't want any asset at all. I'll reduce the size of the balance sheet. Hard to make those large restatements in a complex environment, but I want to emphasize that in credit risk transfer. The key here happens to be for me to get the appropriate returns I have to use leverage. And the returns aren't attractive enough with leveraged, to offset we just buying a much more higher quality instrument put it on repo.

Thank you.

The next question comes from David Walrod of Ladenburg. Please go ahead.

Good morning everybody.

Hi, David.

Hi, David.

Could you expand a little bit on the prepays, what your outlook is going forward, how they came in July?

Sure. So really, again, these prepays are reflecting the market environment in March and April. So March, April you saw a dip in rates -- 30-year rates below 4% David. Again, on an all-in basis, I think our speeds were somewhere in the mid-teens to high-teens 16.5 CPR, they're still relatively low given just where the rate environment is. So we think that in the next couple of quarters, again, since rates have backed up that we're actually going to see those come back down. Does that help?

It does, thank you.

Let me just throw in one other point too. Again, I always like to chime in with the longer term perspective. If you go back to July of 2013, when rates rose, and we had what's called the [indiscernible] and we went through a long process, probably the last of trying to just reeducate on our business model. One of the factors we talked about being a shock absorber when rates rise or prepayments fees. And that's exactly what has taken place over the last two years. Rates went up, our prepayments speeds came down materially from somewhere probably in the mid-30s to almost as low as 10 CPR. We've benefitted greatly from that period of time. Rates dropped again earlier this year. Prepayments speeds, as Smriti pointed out, prepay speeds increased. As you move into the fall, and the winter months again, we are looking to see a cyclical downturn in terms of speeds. But again, I want to tie this in with our overall strategy. I you'd listened to us a couple of years ago, we talked about prepayment speeds being a shock absorber, as they slow down adding to net income, as they have been a huge positive over the last couple of years. To have, what I would consider a minor tick, such as this, up is something that has taken place. But if you really look closely, and you see how much the CMBS prepayment positives offset the negatives of the residential prepayment speeds, that portion is a very bright light or shining positive within the results.

Okay, thank you. Turning to the FHLB, how much do you envision borrowing through that group, and what type of assets are you pledging?

Right. So, Dave, Steve here. We have a credit limit with Indianapolis at 575 million. Today, we are pledging only agency CMBS. As I've mentioned in my call, Indianapolis is not necessarily that familiar with all of our assets. So we're going through the process with them on educating them on our assets so that we can expand what we would be borrowing and pledging against the advances there.

Okay, great. Just couple of other little housekeeping things, can you give us a little color on your partnership in the re-performing loans?

Sure, that's our investment in a -- and we talked about that in the past. It's a group that buys re-performing loans. We have made investments with them over the last several years. The activity in that partnership on a quarter-to-quarter basis will be a combination of income earned or coupon on the underlying loans, as well as in that particular model there's often sales activity. So you clean up the credit, and then sell the credit. So the activity this quarter reflects a combination of those two items. Probably around 60% of which is sales activity, and the rest of coupon.

Okay. And last thing, Steve, you mentioned in your prepared remarks that G&A expenses were up this quarter. Is there anything one-time of nature in there or is that good run rate going forward?

I would say that that's a good run rate for the next couple of quarters, yes.

Okay, thanks guys.

Thank you. The next question comes from Eric Hagen of KBW. Please go ahead.

Hi, good morning guys. You guys have been through a tightening cycle before. So I'm just curious as the Fed actually begins to tight, how do you manage hedge book? Are you actually putting on swaps or you kind of running with what you have now, or you've been rolling off? How do you manage something like that?

Right, so are you saying that -- are you -- in terms of how do we manage through a cycle such as this?

Yes, I mean you're positioned for eventual Fed tightening as of today, but as the Fed actually begins that cycle, what is the hedge book look like?

Okay, so it is a dynamic process. Since you brought up history, so let's compare. So in 2004, Smriti and I ran another REIT called Sunset Financial. At that point and I really want to draw a contrast here, we drove our duration gap to a negative. Negative half-a-year to one year, because it was easy to make -- to go with the Fed that they were going to raise interest rates, and they were going to raise them consistently. So we made a decision, and that was a change in strategy right in the middle of the quarter. Very few analysts could've predicted it, that we would change our duration there. That was the right strategy. It proved to be extremely profitable throughout the entire Fed tightening cycle, very difficult; so now let's contrast that to today. Our basic argument here is it's very difficult to make any type of large, let's call it, a stance or bet or place too much money in one directly. We can't make an outright bearish market call. And so we haven't made that call, because we think it's more dangerous to get caught off guard if rates drop rapidly though. Those type of moves can put a REIT out of business, whereas an orderly move up in rates, we can dynamically change our position. In effect, we're sitting here saying that we can dynamically change our position. So if you compare back to -- I appreciate the question, that '04 through '06 period. In fact, I've traded every bear market since 1986. And I will put my track record and training to bare walk at against anyone else. But this is a very different situation. We can't get you in a bear market. And so it is dynamic. We will adjust our risk position as necessary. We are not afraid to hedge this book down. If it looks as if that's what we're supposed -- but I want to emphasize Smriti points earlier. Well, she said it was already priced into the market at about an eight or nine time hike over the next two or three years. Smriti, you want to add anything to this?

So if you look on page 33, Eric, we've given you our derivative position essentially in a chart. And what you'll see is that we have about a billion dollars notional for the remainder of 2015. That reflects our view that really, again, if there's a hike coming that's what we've hedged out of the position so to speak. You can see that next year, our hedge position increases substantially. But again, as Byron always says, that we reserve the right to change my mind in the next second because we have to manage this position versus what's already baked into the market. The market is saying, next year, there's -- between now and the end of next year, there's going to three-and-a-half hikes. If we believe that there's going to be two hikes, some of those hedges are going to come off. If we believe that there's going to be five-and-a-half hikes, there's going to be hedges being put on. So we've had to manage that position very dynamically. Right now, the beauty or the art in what we do now is really managing versus what the market already has priced in. So the key thing; and I think a lot of folk don't really focus on this. If you're hedging today, you're hedging against what the market has already baked in. It's not that you're locking in today's rates. You have to look at forwards. That's the real difference.

Let me throw in one other point on this. If you look at past tightening cycles, in every situation you saw the curve flat, so the long end outperforming the short end. Now, let's fast forward to today, and what happened in this second quarter here. See, if you go back and look at Dynex two years ago, all of our duration exposure was in the front end of the curve. That's where we felt most comfortable. That was the right position at that time. Somewhere near the beginning of 2014, we stared to move some of our duration out to the long end of the curve, meaning, between the seven and 10-year part of the yield curve. Well, it so happens that this second quarter, the yield curve is steeping with long rates rising more -- materially more than short rates. And as such, that had an impact on Dynex. However, again, we're managing for the long-term. If in fact the Fed starts to tight, and they go one time or two times or three times; I anticipate this curve will flatten, unless there's a material change in inflation or inflation expectations. And by material change I mean, they start to expect inflation at 3% or 4%. Without that my -- our assumption is that the curve will flatten. We will continue to try to trade from that perspective. So we've got exposure now in the long end of the curve, even though we lost some book value on that position this second quarter, we believe that's the right position. I've tried to give you a little history in terms of how we've adjusted this position over time. But we have adjusted. Where we got some duration in the short end another chunk in the long end of the curve, and the reason it's in the long end because we're anticipating that potentially we could have the Fed make some type of move either later this year or sometime next year.

Got you. That's a really helpful explanation. I'll switch gears a little bit, and ask a follow-through question. How do you think a single security from the GSEs will impact the market, if at all?

Yes, I've got it. I'm very opinionated on this, and I have been for 20 years. I applaud the effort to get to a single security. The structure of Freddie Mac and of Fannie Mae, and then a poorly trading Freddie Mac security makes no sense to me. I think it's cost tax payers over time, and it would just be -- I just don't understand why it's taken so long to get to a single security and realize that is a value overall. I think it will increase liquidity. There may be some short-term gyrations. But long-term I believe it is an absolute positive to get into a point where you have a single security, more standardizations, and be honest with you, I don't see there's any value in having these two agencies. But the single security is something that's live, something that they're working toward. I hope they move as rapidly as possible.

Thanks. I would agree. Thanks, Byron. That's really helpful.

The next question comes from Jay Weinstein, Highline Wealth. [Operator Instructions] Please go ahead, Jay. Jay, your line is open. Is it possible that your phone is on mute?

Maybe he hung up.

Hello?

There he is.

I apologize. I stepped out to get a cookie.

We love you Jay.

So I took one easy question and one hard one. The easy one is while you were discussing rate movements in the second quarter, spreads and such, that sort of reversed I think since the end of June 30th. I saw the two-year I believe is up 1 basis point or two basis points and the 10-year down about 13 basis points. So is that offsetting some -- I mean obviously, you pick a point in time, but is that I'm assuming from what happened in the second quarter, is that more beneficial to your positioning?

It's beneficial. There's a positive, but it's not a huge amount. I mean, we really -- with the short end and the middle of the curve really rising, and some of the Euro-dollar positions again doing more of a twist, it's a positive. But it's -- you really haven't had the impact that you had for the second quarter of reversal. So that's a very -- that's actually a very, very good question, Jay; it's a positive impact. It is a positive, but it's not like a ginormous impact as short rates have continued to [indiscernible].

The 10-year of course is at a strange -- and you were plummeted for two months, then stood like stone and now literally I think it's back to exactly where it was on January 1, correct?

Right.

It's a very volatile period.

Here is the harder question, Byron. So I know that most mortgage REITs are given and yield oriented. I won't speak for the other people on the call, but I'm a total return guy. I don't care if paid no dividend at all, if the stock actually goes up; it's all the same to me. I think I can make the case that you guys should actually shrink your balance sheet quite dramatically and be repurchasing significant amounts of stock at this discount, assuming you can keep and maybe even take down leverage, obviously it would depend on how much capital you -- which assets are rolling off and capital applied against them et cetera, et cetera, but not in a small -- meaningful amount, 10%, 15%, 20% of the overall outstanding. Why is that either a good or bad strategy?

I think that's a very legitimate option, Jay, and it's one that we talk about internally. Again, that's a big decision. So big position, so in that category I'd put that where you say just shrink the balance sheet dramatically, I'd put that in the same category as me closing my duration gap of going negative in terms of duration. And so those are large decisions. And what we're trying to do is slice the salami thin, if I use that analogy. So we bought back shares, and we bought back a certain amount of shares. And we haven't jumped in and said, let's just buy back everything. We are limited in terms of how much you can be on any point in time on any given day. But we want some key component there is -- one of the biggest challenges is being able to take a large stance of any time in any manner. I agree with you though, that's a very legitimate -- it's a very legitimate strategy for mortgage REIT stock if they're trading at discount of 10% or more, we got to run the math, and compare versus buying our stock, versus investing a fixed income asset. It's a legitimate strategy but we have to be very cautious in taking huge stances.

I would say, if I'm doing the math right here because as of last trade, you're looking at, I think, over 20% discount to book and on the other hand, the other thing is, the thing I always liked about you and Thomas, is you were willing to take those big stances and you've got that right certainly -- you got it right going into 2008, you got it right during 2008 and coming out in 2009, which is -- if the market is providing that opportunity personally, I'm happy for you to make that big call, but [indiscernible].

Well I appreciate that. We're not afraid to make that -- make a big call. We're not. And the discount as it, which is, it is over the last trade today. This is actually a new zone for us. So it is new information, and it'll be something we'll evaluate -- your value going forward, but it is a development that has happened here today.

I understand that. You've always been quite clear that that 10% to 15% discount zone is where you got interested because [indiscernible] versus alternative investments, and obviously this makes that more attractive. So anyway, as I think about it, I think probably most other mortgage REITs, they don't want to shrink their balance sheet. It's like shrinking the size of their feet. But you guys don't work that way. That's not of interest and I know that. So if it makes your shareholders more money by shrinking their feet down, I know you will do it. So that'd been an interesting conversation.

Yes, this is -- we will, when we hang up the phone call today, we will be evaluating the world from this perspective as it has evolved. But I can't -- the great thing I like about the team of people I work with, that includes Tom, the board, and then the professionals that work around me is, when we run the analysis, and we put it on the chalk board, if it makes sense, then that's the route that we want to take. If it makes sense for our shareholders, which of we are material shareholders, that's the route that we would want to take.

I'll be interested to see how that discussion plays out, that's why that was the hard question.

Yes. Now, I appreciate that, Jay. As always, I appreciate you as a shareholder, I appreciate your focus. And I appreciate the question.

I guess that's fine. That's what you pay me for, right, to ask you all those hard questions? All right, thanks, guys.

Thank you.

Thanks, Jay.

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

No closing remarks. We've kept you quite a while today. And we really appreciate it. I hope you understand our efforts trying to give you as much information as possible. We look forward to you joining us for our third quarter conference call. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.