Dynex Capital, Inc. (DX) Q3 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the Dynex Capital, Inc. Third Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instruction] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Alison Griffin, Vice President, Investor Relations. Please go ahead.

Thank you. Good morning everyone and thank you for joining us today. The press release associated with today's call was issued and filed with the SEC this morning. You may view the press release on the Company's Web-site at dynexcapital.com under Investor Center, as well as on the SEC's Web-site at sec.gov. Before we begin, we would like to remind you that this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, 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 on the Company's Web-site under Investor Center, as well as on the SEC Web-site. This call is being broadcast live over the Internet with a streaming slide presentation which can be found through a Webcast link under Investor Center on our Web-site. The slide presentation may also be referenced by clicking on the Dynex Capital's Third Quarter 2015 Earnings Conference Call link on the Presentations page. Again that's dynexcapital.com. I now have the pleasure to turn the call over to Byron Boston, CEO, President and Co-CIO.

Good morning. Thank you, Alison. In the third quarter of 2015, we continued to be a very disciplined allocator of capital. Over the past two years we have made a series of decisions that had a meaningful impact this quarter. To understand our results, we must first recap our strategy and thought process since January 2014. So far this year, the markets have been defined by uncertainty, volatility and complexity. This was no surprise to us. If you recall, at the beginning of 2014 we identified the current global financial environment as being extremely complex and not ideal for taking outsized risk positions. One year ago, our concern about spread risk increased and as a result we sold the majority of our lower rated credit bonds and redeployed the capital into higher credit quality assets. We booked gains from substantial spread tightening in these assets and increased the liquidity of the assets on our balance sheet. Our third quarter results of 2015 are reflective of these actions. We maintained our dividend by earning $0.24 per share, and although we were down 4% in book value, the results would have been materially worse had we not reduced our exposure to lower rated assets. Furthermore, we repurchased a meaningful amount of our own stock this quarter as we found the long-term returns from investing in our own balance sheet to be extremely attractive. On Slide 4 and Slide 5, we give you pictures to emphasize why an investor might want to join us in investing in Dynex Capital. First, the power of above average dividends will prove to be a large driver of returns over the next several years and will help cushion adverse movements in our book value. Second, if you look at Slide 5, you can see the long-term results for several mortgage REIT stocks. During this period, the Fed embarked on a near two-year tightening cycle and the global financial system nearly collapsed. At Dynex, we have built our long-term strategy on disciplined capital allocation and risk management. We have adjusted our balance sheet where necessary between cash, residential bonds, commercial bonds, government-backed bonds and non-government-backed bonds. Our results are reflective of a very rigorous and thoughtful deployment of our capital. I will now turn the call over to Steve and Smriti to delve further into the details of this quarter. Please listen closely. The global financial markets are extremely complex and we want you to understand the many variables that have impacted our Company in 2015.

Thanks Byron. This is Steve. I'm on Slide 7 and 8 for those following the presentation. For the third quarter, we reported a comprehensive loss of $0.22 per common share, consisting of core net operating income of $0.24 per share, unrealized gains on MBS of $0.50 per share, offset by unrealized losses on related hedges of $0.90 per common share and realized losses on terminated hedges of $0.06 per common share. Core net operating income to common shareholders of $0.24 per share represents an increase of $0.03 from the prior quarter benefiting from prepayment compensation received on CMBS and CMBS IO of $0.03, and $0.01 per share each from a larger investment portfolio, lower G&A expenses and less shares outstanding from shares repurchases during the quarter. Offsetting these items was an increase in RMBS premium amortization of $0.03 per share due to higher CPRs during the quarter and an increase in subsequent projected prepayment speeds. For the same reasons, adjusted net interest income, a component of core net income, and adjusted net interest spread, both increased in the third quarter. On Slide 9, we provide a reconciliation of book value per common share. If you look at the chart on this page, broadly the decline in book value per common share is due to the underperformance of our investments versus their hedges as unrealized gains on MBS were $0.50 per share versus unrealized losses on hedges of $0.90. The difference of $0.40 per share can be explained by spread widening on our investments, primarily on Agency CMBS and all CMBS IO during the quarter and basis risk from swap spread tightening versus treasuries. Smriti will have more detail in her comments on spread performance and book value performance during the quarter. Our share repurchases also benefited book value by approximately $5.6 million or $0.11 per share from a combination of the discount on the repurchases and a decline in the shares outstanding. We repurchased 3.5 million shares during the quarter, roughly 6.5% of our outstanding common shares, and leverage at the end of the quarter was up to 6.4x from 6.2x at the end of the second quarter due to lower equity balance primarily from the share buybacks. During the quarter, our wholly-owned captive insurance subsidiary increased its borrowing from the Federal Home Loan Bank of Indianapolis to $255 million from $108 million at the end of last quarter. Principally Agency CMBS collateralized the advances. In the next several quarters, we expect to expand the products at Indianapolis as Indianapolis becomes more comfortable with our asset mix and their regulatory risk with respect to mortgage reinsurance captives. We continue to believe that our business model aligns very well with the missions of Federal Home Loan Bank system and we view Indianapolis as an important and valuable business partner. On Slide 11, we show our book value per share since 2004. It's important to note the relative stability of our book value over that time through multiple market cycles. We'd like to remind you that we are a long term investor in MBS and much of the book value volatility over the last several quarters comes from unrealized losses on MBS versus our hedges due to credit spread widening amidst the uncertainty of the economic environment and the performance of risk assets. With that, I'll turn the call over to Smriti.

Thanks Steve. I'm going to discuss macroeconomic factors first and then drill down to our position and what our activity was over the quarter. In the first quarter of this year, we described the environment as complex and we told you about some of the factors on Page 13 that were in play. In fact, if you look at the charts on Page 14, this year just in the first three quarters we have seen every type of curve movement in the yield curve. In the first quarter, the long-end rallied with 10 year notes touching 1.63% in a movement known as the bull flattener, followed in the second quarter by a sell-off with the long-end now selling off more than the front-end, ten-years touched 2.4% in what's called a bear steepener, and finally in the third quarter we've had a mix of both a bull steepener where the front-end rallies first and a bull flattener where the back-end rallies. Ten-year notes are now back at 2%. We have seen interest rates this year at times buffeted by domestic factors and at times driven entirely by non-U.S. flows and factors. In the third quarter of this year, we also saw rate movements that were accompanied by a broad based widening of risk premium. Spreads widened across the board. Turning to Slide 15, where does that leave us? Global yields are still low. Central banks have continued easing. China most recently cut rates last week for the sixth time since last November to address their growth concerns. Europe and Japan are still aggressively easing. Spreads have re-priced led by the riskiest assets. Lower rated credits, credits exposed to slowing global growth, have all been re-priced, and the good news for us is that some of this repricing is creating some opportunity because fundamentally strong sectors have also suffered widening. Cash is still on the sidelines awaiting clarity from the Fed, and I'll talk more about this later. We still think surprises are likely and at this point we think we could see them in either direction, upside surprises or downside surprises. The market psychology is currently skewing to downside surprises. We'll learn later today what the Fed thinks of the data. Our view is that based on the data and our read of the global economic picture, particularly the inflation picture, the initial hike will now be delayed into next year, but we can't forget the psychology if the Fed remains biased towards raising rates and to a large extent what we see now is that the markets have bought into the measured slow approach and that's what's priced in. We have viewed this environment and continue to view this environment as being favorable to our business model. The yield curve is steep, asset prices particularly credit sensitive assets are now reflecting more reasonable risk premiums, financing costs are not expected to rise as dramatically as once predicted by the market, and our ability to generate an above average dividend yield with net interest income remains largely intact. Let's now turn to see how we've managed capital. Please turn to Slide 16. As mentioned during last quarter's call and as Byron mentioned in his comments at the beginning of this call, we exited our riskiest credit positions in the third quarter of 2014 and reduced our leverage coming into the first quarter of this year. We did this by selling assets, Freddie K Bs in particular, which is the fifth line down on this page, at spreads in the 130s in the third quarter of last year. We took profits on this position that we purchased when spreads were in the 500. This allowed us to enter this year with a significant buffer of liquidity and capital which we have maintained throughout the year. As spreads began widening early in the first quarter and late in the second quarter of this year, we subsequently increased leverage by investing in high-quality assets, Agency guaranteed multi-family securities, which have reasonable liquidity. We also invested in short duration credit sensitive assets, nonperforming loan securitizations that return capital rapidly for ease of redeployment. All this time, we have allowed our investments in Agency hybrid ARMS which have been a solid performer, as you can see on the top line. Those investments have run off and that's been the capital that we've used to redeploy into these other sectors. We increased our balances this year in high-quality assets because it was a way for us to maintain our invested balances and earn an appropriate return while preserving the flexibility to reallocate capital as we saw opportunities. Turning to Page 17, as the market suffered disruptions in August and September, we used our excess capital and liquidity to buy back shares. Through the end of last week we have repurchased 5.8 million shares for a total of $40.4 million under the currently authorized plan for $50 million. At an average discount to book of 15%, we believe this represents significant value and accretion potential to shareholders. We also believe that over time we should see improvements to book value from existing positions as our assets season and roll down the spread curve. During this quarter we also made investments as spreads widened in non-Agency and Agency CMBS IOs but the bulk of our capital allocation went to share repurchases. In terms of financing activity, I'd like to mention two items. As of the quarter end, we had about 255 million in advances at the Federal Home Loan Bank which has now grown to about twice that amount in the fourth quarter. We also continued to execute on our Direct Repo transactions and we're increasingly optimistic on that type of transaction as a market alternative to traditional tri-party repo that's financed through dealer balance sheets. You can see on the tables that we brought down our original days to maturity in the financing book. That's a reflection of our Fed view. We have actually captured significant net interest margin in 2015 as a result of this as well as our forward starting hedges and our willingness to shorten our repo maturities. We continue to see liability management as a value enhancing opportunity for our shareholders. Going forward, here is what you can expect from us. We ended the quarter at 6.4x leverage, $3.7 billion in asset balance. We have a good cushion of liquidity and capital entering the fourth quarter. We're seeing opportunities to add assets at attractive levels in the CMBS sector, both in Agency and non-Agency, and we're selectively adding assets in sectors where we believe there is greater risk adjusted return potential than where capital is currently deployed. We're not in a hurry. We think there will be time and pockets of illiquidity for us to step in and take advantage. We are doing the work to make sure that we find the best opportunities going forward and as always we have the option to buy back shares should the opportunity continue to present itself. I'd like to now turn to our risk position and an explanation of what happened to our book value for the quarter. Our book value was impacted by three factors, rates, spreads and swap spreads. This quarter, as we saw on the rates graph on Page 14, we experienced a bull-flattening of the yield curve. Keep in mind that we own very few negatively convex assets whose duration shortens when rates rally, so we did not experience a material shortening of our asset position. We actually adjusted our hedge position this quarter to get longer duration in August and those adjustments helped us weather the impacts of spread widening on our portfolio. The majority of our book value decline this quarter is attributable to spread widening on the asset side. If you go to Page 19, you can see that spreads have widened across the board, across all asset classes, both Agencies and non-Agencies. Our portfolio actually suffered a more muted impact than what is shown here for two reasons. The first is that we tend to own higher quality assets than what's shown on this page, and second, our asset portfolio is spread across a number of vintages. Seasoned bonds actually widened less than new issue securities. During the quarter, our hedges were also impacted by significant swap spread tightening on the long end of the yield curve. This was the result of what we believe to be a technical factor related to corporate issuance. Corporate issuers in the third quarter as well as those who had issued in prior quarters swapped out their fixed rate debt by receiving fixed rate cash flows in the swap market and paying floating rate cash flows in the swap market, as it became increasingly clear that the Fed would not raise rates in September. At this point, we understand this to be a temporary pressure on swap spreads but we're monitoring our hedge position to assess whether any further adjustments need to be made. So what does this mean for our risk position going forward? If you look at the chart on Page 17, and I'm sorry to flip back and forth, I guess it's Page 18 on the deck, I'm sorry, you'll see our duration exposure has come down slightly as has our spread position, but our biggest exposure continues to be the spreads. As currently constructed, our book value is more sensitive to spreads. We have seen a substantial widening across the board in spread assets and for the near-term we may continue to see pressure on spreads going into year-end. However, we see a few factors that are supportive for spread tightening over the next few quarters. First, reduction in uncertainty around the Fed's actions will be supportive. Currently many types of investors are on the sidelines awaiting some kind of clarity. This is a positive technical waiting in the wings. Second, central banks outside the United States are still easing. The U.S. dollar remains a strong reserve currency and the presence of negative rates in many countries should drive demand for high quality U.S. dollar denominated assets. Finally, even in the absence of any movement in spreads or yields, as our positions age, we benefit. So all else being equal, in 12 months, [indiscernible] can expect to tighten somewhere between 3 and 5 basis points and on CMBS IOs the tightening can be as much as 20 to 30 basis points. On the hedge side, we have incurred the cost of maintaining hedge positions in 2016 throughout this year. It has kept our book value from rising much, but if yields evolve as currently priced into the forward curve, which is now pricing in only two hikes in 2016, we should not see a further decline in book value from these hedges. In fact, as they come online and become current pay hedges, we should see a corresponding offset in book value. On the other hand, if yields evolve where rates are higher than what's currently priced in, we should see a book value benefit as the mark-to-market on these hedges goes up. As always, we always have the option to terminate these hedges to see – if we see fit earning back the cost in 2016 if we feel the environment will support that. These factors will be relevant as we think about earnings into 2016. Two things to keep in mind. One is that we have repurchased shares and that's going to impact EPS estimates. Secondly, any forecast from this point obviously assumes a static position and we haven't been static in terms of managing our hedge book. We expect to continue to manage that position very dynamically, and you can expect that that will have an impact on earnings and book value sensitivity going forward. And last but not least, we expect to manage our financing portfolio pretty actively and we think we can add value there by expanding what we fund with alternative financing sources such as the Home Loan Bank and Direct Repo. On Page 20, I would like to leave you with the following thoughts. As we have said before, we view this environment as being favorable to our business model. The yield curve remains steep, asset prices are now reflecting more reasonable risk premiums, financing costs are not expected to rise as dramatically as once predicted by the market, and our ability to generate an above average dividend yield and net interest income remains largely intact. We have a good cushion of liquidity and capital entering the fourth quarter. Our capital allocation decisions thus far have maintained the diversified nature of our balance sheet. We have reduced our exposure to the more volatile spread sectors and we have also insulated the portfolio from prepayment risk and negative convexity by investing in locked-out positively convex Agency multi-family securities. We are seeing opportunities to add assets at attractive levels. We're going to continue to selectively add assets where we believe that the forward risk reward is better than where the capital is currently invested. And while we have maintained our hedge position to reflect what we think are divergent outcomes in a complex environment, we expect to continue to manage our position fairly dynamically as this economic environment evolves. I'll now turn the call over to Byron.

Thank you, Smriti. Let me make a couple of additional long term observations that I think are relevant when you are in the mortgage REIT universe. On Slide 23 where we say Homeowners and Renters, we're basically showing that there has been a meaningful increase in the adult age population for the past 10 years as the millennials have moved beyond the age of 18. As we look out into the future, we expect an increase in demand for shelter, whether through rental properties or homeownership. We view this trend as a large positive for Dynex since we have been lending money and investing in assets backed by residential and commercial multifamily properties since 1988. Furthermore, as the government continues to encourage private capital to take more risk in the housing finance system, we expect our shareholders to benefit as we – from the growing opportunity set to deploy our capital. We continue to believe the global financial system is complex but we have now been handed a more attractive opportunity set. The key to understanding our future results would be to understand that we are not going to deviate from our long-term investment focus, our disciplined approach to capital deployment, our intense focus on risk management, and most importantly the fact that we at Dynex like to invest in ourselves and hence we will always approach the market from an owner-operator perspective. So far this year we are happy to have maintained our dividend and we are extremely happy that we had reduced our exposure to the riskiest sectors of the marketplace in 2014. And just one additional point, a little off script but I want to make this point. If you look at Slide 24 and you look at Slide 25, and you'll note on Slide 25 historical mREIT performance. You will note there are approximately four mortgage REITs versus the S&P 500. Please note when we think about business models, there's been a fallacy in the marketplace, I heard it last week, I heard it again this week, a fallacy about a securities business model versus an operating business model. We at Dynex believe in diversity, we have from the very beginning. We started our position in 2008, invested in Agency mortgage-backed securities. We then diversified and started to invest in CMBS product. We started at the top of the capital stack, we moved down to the lower part of the capital stack, we then moved back up to the top of the capital stack. Disciplined capital allocation is important. We have chosen not to rush into an operating business model or rush into [indiscernible] purchasing home loans because those models have proven to be more difficult especially in stressful market environments. So when we think about our business over the long-term, we continue to look for opportunities to diversify over time. But if you look back throughout history, the most successful mortgage REIT business model has been one that has had a solid security strategy at the core of their overall long-term focus. Why? Liquidity on the balance sheet is extremely important, and when you look at this long-term chart since December 2002, really understand that within those results are about approximately two years of Fed tightening cycle and a near total collapse of the global financial system. So we're happy to be disciplined in our approach to the business, we are happy to have a securities based liquid balance sheet at the core of our strategy, and as we get into the future we'll continue to look to diversify. Whether it happens to be in a home loan strategy, maybe it's something from some other types of strategies, lots of opportunity is being created as the regulators continue to hammer the financial system. But there is a fallacy in the marketplace and I'm trying to point this out to you. The most successful model has truly been based with liquidity at the forefront of the investment strategy, and at Dynex we take a long term focus, and as I mentioned a second ago, we're owner-operators. With that, I'm going to open the call back – turn the call back over to the operator for questions.

[Operator Instructions] The first question comes from Doug Harter of Credit Suisse. Please go ahead.

You guys talked about spreads being at a more appropriate or attractive level. I guess is that going to change any of the investments so you are willing to sort of move down the capital structure at all in those investments now that yields are wider?

It's Smriti. So the answer is, we are looking at doing that, and I think at this point the difference between now and other times where spreads have widened in the past is really making sure that, A, the underlying credit fundamentals are good, and B, that there really is opportunity to earn not only just the carry or the spread versus whatever your hedges are but also try to understand to make sure that there is some spread upside from here in a lot of these sectors. So that's something we're looking at. Again, we view the risk return at this point as being more reasonable and over time I think we are going to get opportunities to decide whether or not those are actually attractive enough to put capital into, but at this point they have widened and we are looking at them.

And then let me add one other thing here, Doug. We have put this in context from a macro perspective. When we look at the lower credit assets, and just from a principle, when you have a model such as a mortgage REIT, you want to carry a lower credit asset on repo or some other type of shorter-term financing generally when that's really cheap and you're really comfortable with the risk reward. So we're slow to do that. What Smriti said, what she's really trying to point out to you is we're very disciplined in looking at it. So we've got our eye on it and we ask ourselves the question, is that really attractive enough. The BBBs or A rated, even AA rated asset, of 2015 are not as attractive and are not as well structured as those assets in 2009, 2010 and 2011 when we originally went into those assets. So it is something that when you see a spread movement like this, we raise our eyebrows and we take a closer look, but we really have to put this in context of a larger macro environment. We still don't have the opinion. In 2011, if you make the comparison, assets were cheap. Today they are just – relative value has adjusted.

They are relatively less expensive.

Yes, exactly.

So I guess can you talk about how you feel you're positioned from a leverage standpoint if we were to get a further widening and you would find the assets at attractive enough levels to want to kind of add to the investments, how do you feel – would you have the capacity to increase leverage?

Yes. The way we think about that, Doug, is we stand ready to do both things, which is from a macro standpoint if we think the environment is really treacherous and it's really going to be one where we need more liquidity and capital to survive some kind of more draconian scenario, because we have liquid assets on the balance sheet we are going to have the flexibility to reduce leverage. However, we ended the quarter at 6.4x. We have a pretty decent liquidity and capital position coming into the quarter. If we find those opportunities and we're comfortable with that macro environment as one where we're not going to get tripped up, we have the flexibility to add assets and increase leverage. And don't forget, we can reallocate existing capital as well.

And I think that last point that Smriti made about reallocating existing capital, right now you do have the opportunity to sell what's rich and buy what's cheap. So one thing is great about when the duck chairs are shuffled, we want to put it in that or draw that type of an analogy, it gives you more opportunity to make relative value trades, which actually I think Smriti and the team has done an excellent job, such that you see our net spread actually improving. So as we look forward, we'll be looking for relative value opportunities and then we'll just consider as spreads move around the absolute value opportunities.

Great. Thank you.

The next question comes from Trevor Cranston of JMP Securities. Please go ahead.

I guess listening to the comments, it sounds like you guys find spreads to be relatively attractive today, but over the near-term at least it sounds like you're a little concerned about potentially more volatility or some additional spread widening. So can you comment maybe where we sit today, how you're kind of viewing the trade-off between having new assets where spreads are versus buying back additional shares?

So I think it's really the same thought process as we're thinking about it. So, for us, we are looking at the probability that on existing capital where our capital is allocated and we are looking at the risk reward that we are going to earn from that capital. And to the extent that spreads are going to remain – go sideways or widen from here, we can take our time deciding on what the best relative risk reward is, right. And we want to incorporate into that thought process the potential for price appreciation or spread tightening as we're deciding whether to allocate capital into that versus buying back your own shares at this point is actually a relatively much less risky proposition. We know what's in our portfolio. We like what's in our portfolio. It's trading at a discount. And you can see that our capital allocation in the third quarter kind of reflected that. So going forward, we're still making those types of decisions, and yes, spreads are wider, and I apologize if I gave the impression that we thought they were attractive, they are definitely looking like they are more reasonably priced. At this point it's reasonably priced enough for us to take a second look and really try to assess whether these are spread levels at which we feel we can have confidence that we're actually going to get not only that carry return but also that price appreciation as we go through time. And sometimes that trade-off isn't always clear but that's the calculus as far as we're concerned.

I'm going to add, just want to reiterate one point here, Trevor. Main message today, this is business as usual. We're really disciplined about our capital deployment. We don't get a hunch and get excited about anything. That's why I pointed out the operating business model versus securities. We're real disciplined in how we make that decision, whether it involves that certain asset class or not. The difference here today, let's call 2015 versus 2012 or 2011, it's a daily issue. The global financial environment is extremely complex. It puts pressure on us to be really focused, and in our chair strapped in, analyzing [indiscernible] on a daily basis whether to make these decisions to sit on our hands, invest in our own capital stock versus investing in some other type of security, whether at the top of the stack or even reintroduce some lower rated assets into the balance sheet. So this is business as usual and we are going to approach this from a disciplined perspective, but given the overall complexity of the financial system, I wish I could predict to you exactly what we're going to do from day to day to day. I could have done that back three or four years ago, I can't do it right now, because we are subject to so many changes and surprises that we just want to be prepared to react in an appropriate manner.

Got it. That's helpful. And then on the Agency prepay speeds, can you guys just comment on what you've seen so far this quarter and kind of what the outlook is for the remainder of the year given the drop in rates we saw in 3Q?

Right. So we have actually seen a decline month over month coming into this quarter, and again, because we own slightly different securities in TBAs and the MBS that are out there in the marketplace, we tend to have more of a seasonal factor coming to play for us. We also own a lot of securities with IO features in it that are relatively locked out from refinancing at this point. So as we are looking at it, there is a factor that cause us to think that speeds would be faster than we had originally thought and that's why we made some adjustments to our projections, but their seasonality that's going to basically offset some of that going into the end of this year. The winter months, we almost always experience slower speeds.

Trevor, I want to make a broader – point out something from a broader perspective regarding prepayments. So we talked about our strategy being diversified. One of the kind of hidden gems that you may not notice in the value of this strategy is, we may have had some over the last summer months some increase in terms of prepayments on our Agency residential book of business, but what may have been a negative on the residential side of the business, was a positive on the commercial side of the business. And so we've had offsetting factors which may or may not be noticed in the marketplace, I want to point it out to you, and that has led a muted the overall impact of faster prepayments piece once you consider the entire portfolio. So as I look at our concept of diversity and see how it's played out in 2015, again faster speeds negative on the resi side, faster speed is real positive on the commercial side as we are compensated because we have a prepayment protection in the commercial assets.

Yes, I did notice that in the press release, but thanks for pointing that out. Okay, thanks everybody.

[Operator Instructions] The next question comes from David Walrod of Ladenburg. Please go ahead.

Most of my stuff has been touched on, but just wanted to talk about the funding diversification and how much of your total funding you think you can place both with the FHLB and through the Direct Repo line?

We have a limit both imposed by our Board and also just our internal risk management limit in terms of the amount of financing, and it's also limited by the amount of capital that's in our insurance sub. So I think at this point, we're close to the maximum of what we're going to borrow from the FHLB, and I think I had mentioned in my comments that it was double the 255 or thereabouts that we had at the end of the quarter. In terms of Direct Repo, this is something I think that is going to get more and more acceptance in the marketplace. We've been able to repeat trades with our counter-parties and we've actually been to a number of conferences where there are money managers, other buy side accounts, that are starting to really respect it as a genuine potential option. So I think it's probably something that will really develop in 2016 and it's not a material amount of our portfolio right now, but it helps. The financing levels are substantially lower than where you can finance repo on the margin. So every little bit helps. It's a little bit like picking pennies up off the ground, but at this point we think that we've invested in putting this process together and we are actually benefiting from being one of the first folks out there to get it done.

And at this point do you have one relationship and you're looking to expand those or do you have multiple Direct Repo relationships?

We have more than one and we expect to continue to expand those.

Okay, thank you.

There are no additional questions at this time. This concludes our question-and-answer session. I'll turn the conference back over to Byron Boston for closing remarks.

Simply put this morning, I think we've kind of tried to give you as much information as possible for you to understand our overall third quarter results. We want to thank you for joining us during our conference call and we look forward to seeing you on our next conference call at the beginning of next year. Thank you very much.

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