Earnings Call Transcript - DX Q1 2021

Operator, Operator

Ladies and gentlemen, thank you for being here and welcome to the Dynex Capital First Quarter 2021 Earnings Conference Call. All participants are currently in a listen-only mode. Following the presentations, we will have a question-and-answer session. I will now turn the call over to your first speaker, Alison Griffin. Please proceed.

Alison Griffin, Investor Relations

Good morning, and thank you for joining us today for the Dynex Capital first quarter 2021 earnings conference call. The press release associated with today’s call was issued and filed with the SEC this morning, April 28, 2021. You may view the press release on the homepage of the Dynex website at dynexcapital.com, as well as on the SEC’s website at sec.gov. Before we begin, we wish to remind you that this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, forecast, anticipate, estimate, project, plan, and similar expressions identify forward-looking statements that are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. The company’s actual results and timing of certain events could differ considerably from those projected and/or contemplated by those forward-looking statements as a result of unforeseen external factors or risks. For additional information on these factors or risks, please refer to our disclosures filed with the SEC, which may be found on the Dynex website under Investor Center as well as on the SEC’s website. This conference call is being broadcast live over the Internet with a streaming slide presentation which can be found through a webcast link on the homepage of our website. The slide presentation may also be referenced under Quarterly Reports on the Investor Center page. Joining me on the call is Byron Boston, Chief Executive Officer and Co-Chief Investment Officer; Smriti Popenoe, President and Co-Chief Investment Officer; and Steve Benedetti, Executive Vice President, Chief Financial Officer, and Chief Operating Officer. With that, it is my pleasure to turn the call over to Byron Boston.

Byron Boston, CEO & Co-CIO

Thank you, Alison. Good morning, and thank you all for joining us today. I'm extremely pleased with our first quarter results, which Steve and Smriti will review in more detail in a minute. Our current total economic return for the quarter was 7.2% on a quarterly basis, and we have generated a total economic return of 34.8% over the last four quarters, averaging 8% per quarter. We achieved this during an unprecedented time in the markets. Most importantly, since this new era in history began in January 2020, we have outperformed our industry and other income-oriented vehicles with a 27.1% total shareholder return as noted on slide 5. Our performance during the first quarter continues to demonstrate that Dynex has the skills and experience necessary to navigate the current environment. The Dynex team relied heavily on our deep experience in managing the embedded extension risk and mortgage-backed securities, and we use this tactical expertise to take advantage of the environment. We created value during the first quarter in four ways. We managed the existing portfolio, optimized our capital structure, raised equity, and invested capital to generate an excellent return for the quarter. We have been strategically focused on our investment strategy and capital allocation, as well as simplifying and enhancing our capital structure. We have been executing a strategy to grow the company to drive operating leverage and to improve our common stock's liquidity while balancing our equity capital. This quarter was unique in providing us the opportunity to raise $128 million in new common equity and invest that capital accretively. We also called our higher coupon preferred series B, further optimizing the right side of the balance sheet. Both decisions added to earnings and book value in the first quarter and, in our view, will strengthen our performance over the long term. Now, from a macro perspective, we are at a critical inflection point in the global economy as the pandemic evolves in a disparate fashion and the impact of government responses and the vaccine take hold. We are preparing in our usual disciplined manner for multiple scenarios, as we have said before, surprises are still highly probable given the geopolitical backdrop. We firmly believe that we can deliver value to our shareholders across multiple market scenarios. As Smriti will elaborate in her comments, this remains a very favorable return environment with funding costs anchored and the curve steeper. We believe the liquidity and flexibility inherent in our agency-focused strategy are essential for a highly uncertain global environment with many complex and interrelated risks. Now I'll turn the call over to Steve and Smriti to give you more specifics about our returns and our balance sheet composition.

Stephen Benedetti, CFO & COO

Thank you, Byron, and good morning, everyone. The first quarter continued the excellent performance for the company. For the quarter, we recorded comprehensive income of $1.76 per common share, total economic return of $1.38 per common share or 7.2%, and core net operating income of $0.46 per common share. Overall, total shareholders' capital grew approximately $100 million or 15% during the quarter as we raised $128 million in net common equity through two public offerings, as Byron noted, redeemed $70 million in higher cost preferred equity, and added approximately $36 million in capital from excess economic return over dividends paid. The excess economic return was largely driven by our hedging strategy as we actively managed our position and timed our hedging adjustments as the curve steepened during the quarter, resulting in gains of $166 million, more than offsetting the impact of higher rates in our investment portfolio. Book value per common share during the quarter rose $0.99 or 5.2%. Absent the cost of the equity raises, book value grew approximately 7.5% during the quarter. Core net operating income to common shareholders sequentially improved this quarter to $0.46 from $0.45 in Q4, principally resulting from lower G&A expenses and the reduction in the preferred stock dividend with the redemption of the remaining $70 million in Series B preferred stock outstanding mid-quarter. Average earning assets marginally increased to $4.3 billion as we opportunistically deployed the capital raised throughout the quarter. At quarter-end, leverage was 6.9 times shareholders' equity and earning assets were $5.2 billion. With the growth in the investment portfolio and the continued favorable conditions for the TBA dollar roll market, we expect sequential core net operating income growth for the second quarter versus the first quarter. Adjusted net interest income was essentially flat, as declines in RMBS pool balances were offset by an increase in TBA investments. Adjusted net interest spread was slightly lower at 187 basis points versus 198 basis points last quarter. On-balance sheet portfolio asset yields and TBA specialness were 12 basis points lower during the quarter, which was partially offset by the benefit from lower borrowing costs, which declined 5 basis points. TBA drop income increased 33% during the quarter as we more heavily invested in TBAs but at slightly lowered net interest spreads as TBA specialness was lower in the quarter. TBAs have continued to offer superior returns versus repo borrowings and today our expert expectations are that adjusted net interest spread will be flat to modestly higher for the second quarter depending on prepayment speeds. With respect to prepayment speeds, they increased but were well within expected ranges during the quarter. Agency RMBS prepayment speeds were 18.4 CPR for the quarter versus 17.1 CPR for Q4, while overall portfolio CPRs, including the CMBS portfolio, were approximately 14 CPR. That concludes my remarks, and I will now turn the call over to Smriti.

Smriti Popenoe, President & Co-CIO

Good morning, everyone, and thank you, Steve. I will begin with a review of the markets, our performance, and then cover our current macroeconomic view and outlook. Starting with the markets, please turn to slide 18, and I'm going to bring your attention to the line at the top of the panel that says 10-year treasuries. We've now completed an incredible round trip, and the 10-year treasury yield as of December 31, 2019, was at 1.92%. That yield touched something like 50 basis points in the first quarter of 2020 and we've come all the way back to 174 basis points at the end of the first quarter. So, it's been an incredible round trip; I just wanted to point that out. The other thing to note here is just the incredible decline in repo rates; again, 12/31/2019 repo rate stood at 2%, and now the one-month repo rate is sitting in the mid-teens at 14 basis points. So, the curve is steeper, and it's been quite a ride in the markets. For the quarter, two-year treasury rates were up 4 basis points, while 10 and 30-year rates rose 82 basis points and 76 basis points, respectively. Implied volatility on swaptions broke out of the tight range of 60 basis points to 65 basis points where it traded in the second half of last year. It increased to an elevated 75 basis points to 80 basis points per day range, where it remains today. Shorter tenures were even more elevated during the quarter, prompting us to rebalance our hedges. As you can see on this chart, MBS spreads were within a range of about 15 basis points to 20 basis points with even wider ranges when you include intraday volatility. Agency repo rates on the quarter declined 7 basis points, reflecting significant liquidity in the front end and some technical factors that have kept favorable financing costs at record low levels. We had an excellent quarter in which the costs of our two equity raises were more than offset with active management of the balance sheet. As Steve mentioned, book value increased to $1.44 or 7.5% on a gross basis; less $0.45 cost of the capital raises, we get to the net of $0.99 or 5.2% increase reported for the quarter. Roughly 65% of the $1.44 or $0.90 of the book value increase was due to the portfolio positioning from the existing portfolio. MBS performed very well and our hedges were positioned appropriately for the move. As we explained on last quarter's call, we came into this quarter with a view that a steeper curve was highly probable given the vaccine development and deployment, fiscal stimulus, treasury supply, and inflation dynamics. Hedging positions in the long end and options reflected this view and this view largely played out over the quarter. The other 35% of the book value increase came from the timely deployment of capital from the two raises. As we mentioned last quarter, we expected curve volatility to create opportunities to add assets at attractive returns. And we were able to capitalize on the spread widening that accompanied large moves in interest rates. We're ending the quarter with leverage at 6.9 times, up about 0.5 turn from year-end. It's important to understand the numbers behind the leverage; earning assets actually ended up quarter over quarter almost $1.1 billion higher including TBAs. The decline in leverage also includes the fact that book value increased and the equity raise also reduced leverage. Peak month in leverage during the quarter was 7.7 times. So, you know the balance sheet is actually larger even though the leverage doesn't seem to have been affected as much. This last quarter we were active in managing all aspects of our balance sheet, both the left and right-hand side. As Byron mentioned, our options-based hedges on the long end of the yield curve performed very well, and we actually booked gains and rebalanced into more futures-based hedges to navigate the coming quarters. You can see that on page 11 in terms of repo management; our focus on the technicals was essential this quarter to position our book to be more short term to take advantage of falling repo rates. And we're now locking in much lower rates into the second and third quarter. Post-quarter end, we took some profits on our 30 and 15-year MBS TBA positions; we're expecting to reinvest at wider levels. Leverage is about 6.1 times, and book value is flat versus quarter-end. Turning now to our near-term macroeconomic view and outlook, we expect a range-bound environment to support MBS valuations with the ability to invest during bouts of volatility. Specifically, declining payups on specified pools, historically low repo rates, and unprecedented dollar specialness offer unique potential opportunities in our focus. In terms of rates and the curve, the front end is still anchored. The Fed has defined itself as being very patient, having an outcome-based response function versus a projection-based one. In our view, this means preparing for a more volatile set of outcomes in the longer end of the yield curve as the data begins to flow. The environment has shifted from rates just moving steeper and higher to more range-bound with possible surprises in both directions. While we think the market eventually evolves into a steeper curve and higher rates, we think it will chop through some range-bound action in the interim. The implications for Dynex in a range-bound environment are really that it’s a great environment to earn carry. And so, we spend time on disciplined preparation for more volatility and surprises. We focus on the data and we believe we'll have chances to add assets that deliver low double-digit returns just as we did last quarter.

Byron Boston, CEO & Co-CIO

Okay first let me finish with a couple of thoughts. Our team has always operated with great integrity and unwavering commitment to our values and a focus on supporting our community. Given our fiduciary responsibilities, our highest priorities are to be reliable stewards of capital, transparent in our actions, and good corporate citizens. Dynex is a strong, diverse organization building on a 30-year vision to create a multigenerational organization that continues to stand the test of time. In our annual report this year, please take a look. We shared our purpose, core values, and vision. We live and breathe these elements in our daily work and believe this is a distinguishing factor for our company. This is reflected in our long-term industry-leading performance as shown on slides 5 and 6. Dynex has the highest three-year and five-year returns along with the best job ratio among 15 peers comprising agency and hybrid mortgage REITs. Our management team, our board of directors, and I are personally committed to investing alongside our shareholders. As we disclosed in the proxy, together we are among the top five shareholders on a percentage basis in our common stock. Let me leave you with this thought, it continues to be a great environment to generate strong economic returns. We remain optimistic about our future and our prospects for 2021 and beyond. And with that, operator, I'd like to open the call for questions at this time.

Operator, Operator

Our first question today comes from Bose George. Please go ahead with your question.

Bose George, Analyst

Good morning. First, can you give us an update on book value quarter-to-date?

Byron Boston, CEO & Co-CIO

Both, the book value is flat quarter-to-date.

Bose George, Analyst

Okay. Great. Thanks. And then just in terms of leverage can you just talk about what you need to see before we see that again moving closer to something more normalized?

Byron Boston, CEO & Co-CIO

We've remained within a certain range over time. Our leverage peaked at 7.7% in the first quarter, but it decreased after the quarter ended because we realized some gains. Typically, we operate at around 7% to 7.5%. To increase our leverage again, we need wider spreads and improved returns. We identified a strong buying opportunity for bonds in the first quarter, and we experienced significant gains from those purchases. However, we believe that trend has stabilized, and we're now looking to see if returns improve in the upcoming quarters. We need returns to reach a double-digit return on equity for us to reinvest, and even with our current lower leverage, we anticipate that core earnings per share will significantly surpass the dividend level in the second quarter compared to the first quarter.

Bose George, Analyst

Okay.

Byron Boston, CEO & Co-CIO

So, at this point, it's just really a risk-return tradeoff and we'll get our way back to 7x here, and it's going to be a matter of what opportunities we see.

Bose George, Analyst

So. Okay. Great. Makes sense. Thanks a lot.

Byron Boston, CEO & Co-CIO

Hey, Bose. I didn't quite catch all of your comments, as there were some audio issues on my side, but I want to highlight that when we describe this as a great environment, it’s important to note that what we observed in the first quarter included some fluctuations that analysts or other investors might not notice unless they are involved in the mortgage market. This situation creates excellent investment opportunities. From a broader economic standpoint, I believe the markets will keep presenting us with chances to invest. It has been a beneficial environment; our refinancing costs are stable, and the markets will continue to offer us great investment opportunities and ways to manage our leverage. We are very tactical and strategic with every decision we make, and we plan to maintain that approach moving forward.

Bose George, Analyst

Okay. Great. Thanks, Byron.

Operator, Operator

Your next question comes from the line of Doug Harter with Credit Suisse. Please proceed with your question.

Doug Harter, Analyst

Thanks, Smriti. You mentioned that specified pools and pay ups are declining this quarter. Can you discuss how they performed compared to hedges and expectations, and provide more detail on potential opportunities in this area?

Smriti Popenoe, President & Co-CIO

Sure. That's a great question because performance is closely tied to your hedge ratio. With specified pools, there are a few nuances to consider. When rates rise, the TBA underlying will extend, and the specified pool pay-up will decrease. Therefore, your duration for unspecified pools, which can significantly benefit you when rates fall, may actually pose risks if not modeled accurately. You need to thoroughly evaluate how cash flows adjust as interest rates increase and the curve steepens. Generally, specified pools move in accordance with their duration; however, payoffs for higher coupon specified pools have decreased, while the dollar price of the underlying TBA has not fallen as much, which serves as an offsetting factor. Overall, the unexpected aspect in spec pools was mainly the extent of the drop in payoffs. For instance, you can observe that payoffs for the 3% coupon were present and trading above TBA, but those values have now declined significantly. Ideally, if you held those, you managed them for a long duration and hedged appropriately. Our specified pools have had lower payoffs, particularly those with 2% and 2.5% coupons, which we consider longer duration instruments, and the hedge performance in the first quarter was strong. The hedge ratio was accurately captured. In terms of current opportunities, the 2.5% coupon stands out as a significant area, especially since New York-only pools have decreased notably; the max was around $1.10. We see attractive returns in those relative to repo rates. Additionally, TBAs still provide good returns when including the role. It's important to note that the level of financing compared to repo rates is significant; as rates rise, the yield on the underlying keeps us ready to deliver also increases. Currently, the nominal carry from TBAs is higher compared to year-end. With repo rates being low and pay-ups decreasing, the relative appeal of specified pools is becoming a favorable option for diversification away from TBAs.

Doug Harter, Analyst

I appreciate that. And then just one last as you think about your hedge construction today seemed like you guys increased the treasury futures position. Just I guess how do you weigh that versus swaps versus options in today's environment?

Smriti Popenoe, President & Co-CIO

We prefer treasury futures for their flexibility and have not yet returned to swaps due to the uncertainty surrounding LIBOR, as the swap market is still developing. We are considering this for locking in financing rates, but we currently do not find it liquid or flexible enough. In the options market, we noticed an increase in implied volatility in the first quarter, which allowed us to adjust our hedges by taking profits and shifting towards more straightforward duration-based hedges. This shift is due to two factors: taking profits on successful trades and the steepening of the yield curve. Moving forward, we see ourselves in a wait-and-see mode as we anticipate range-bound trading until real data emerges, which will inform the yield curve's direction. Therefore, we feel it’s prudent to be patient at this time. Additionally, we have been utilizing options, futures, and swaps to manage our portfolio's movements, but we are now moving towards rebalancing on the asset side. This may involve increasing coupon rates or using more specified pools, allowing for adjustments in our hedge ratio to better manage the market. Consequently, we are comfortable maintaining our futures position while transitioning into options or exploring different coupon profiles, which we plan to do in the upcoming quarters.

Doug Harter, Analyst

Great. Thank you.

Smriti Popenoe, President & Co-CIO

You're welcome.

Operator, Operator

Your next question comes from the line of Eric Hagen with BTIG. Please proceed with your question.

Eric Hagen, Analyst

Hey. Good morning, guys. Thank you. So when we look at slide 18 and we see the negative OAS in the 2% and 2.5% coupons. How do you think investors should square that with the really healthy return that you guys are generating with 7 times leverage? Like in other words where are you guys maybe not hedging that allows you to earn that higher spread? And then second question can you just maybe hone in on some of the rebalancing that you expect if rates do back up further where is there maybe some more extension risk in the coupon stack and can you share what types of specified pools you guys are buying to?

Stephen Benedetti, CFO & COO

Sure. Yeah. So I always have a saying which is you can't eat OAS. So yes, you've got this OAS but you can't eat it. And I think the big difference just in terms of where returns are just nominally the yield on Fannie 2s started the year at 1.4% and we're now at 1.9% on Fannie 2. So just the nominal yield is 50 basis points higher. The other thing that the OAS doesn't show you is the specialness in the roll. So that's an additional 20 to 40 basis points of return that you're getting. So our performance in 2% and 2.5% and how we performed in the first quarter is less a function of the OAS and more a function of the mortgages performing well due to the technical factors from Fed and bank demand. So mortgage prices didn't move as much; they didn't move as much as OAS or duration even suggested. Right? And the second piece is just our hedge positioning. And the second piece is just our hedge positioning. So our hedge positioning was in the back end of the yield curve. And we had options on the back end of the yield curve. And that's what we were hedging. So you asked the question why weren't we hedging? We were hedging the back end of the yield curve and that’s where we expected most of the move. What we weren't hedging was the zero to five year part of the yield curve which didn't move as much right.

Eric Hagen, Analyst

Got it.

Stephen Benedetti, CFO & COO

In terms of twos versus two and halfs, you know again the important thing to remember on these two coupons, you know twos I would say look to us more like a duration or curve trade and two and a halves have more convexity and prepayment risk. So you're combining those two things in by investing in those coupons. You know, at some point the risk in two and a half especially with lower dollar prices in that coupon has shifted to where that prepayment risk in that coupon has actually come down, right. So that's another reason for us to include two and a halves in the mix of our coupon selection at this point. The spec pools that we're purchasing they are either state-specific spec pools. So New York is a big place for us to play. Florida is another state that offers something like almost 30% lower speeds than typical TBA cheapest to deliver. We haven't yet played in the loan bound space. But you know we're really looking at the coupons and the spec pool areas where specified pool payups have come down substantially. And those are areas where we think that there's value. Your second question was about rebalancing and what we expect to do as rates go higher from here. Okay so I'm going to answer that in two ways. One is you know our macro view from here is that we actually are going to be somewhat range bound until the next catalyst comes through for a move in the markets either higher and steeper or lower and flatter. And we think both of those events are actually quite probable. So we have to be ready to rebalance in either direction. We're choosing at the moment to have a fewer hedges in options because options prices have gone up a lot and there's a lot of demand for Puts. And so we think that that's maybe not as efficient a way to buy uprate protection. We think we can actually manage the asset side of the balance sheet a little bit more flexibly to address any kind of rates up type of scenario. And then we have to be ready, and this is why we have futures, to be able to withstand the rates down. So you know the hedging is going to be more of a day-to-day, quarter-to-quarter type thing. And any purchases of options from here will probably be more balanced in terms of both call options and put options quite frankly because that's kind of how we're seeing the macro environment. And then you asked the question about extension; know, at this level of rates, Fannie 2s are probably pretty fully extended. 2.5%s have the most negative convexity between the two of those coupons. And then obviously the 3% coupon is a very negatively convex coupon as well. So those two coupons in our opinion will be where most of the duration drift occurs. And that's why you need to be ready to be very flexible on the hedging side.

Eric Hagen, Analyst

Thank you for the very complete and detailed response as always. Thanks.

Stephen Benedetti, CFO & COO

Sure.

Operator, Operator

Your next question comes from the line of Trevor Cranston with JMP Securities. Please proceed with your question.

Trevor Cranston, Analyst

Thank you. I have a question about the composition of the portfolio, particularly with the TBA position becoming a bigger part. Can you discuss any considerations regarding retests if TBAs continue to make up more than half of the portfolio for the rest of the year? Are there any potential issues related to income or asset tests that we should be aware of throughout the year? Thank you.

Stephen Benedetti, CFO & COO

Hey, Trevor. It’s Steve. We've looked at that and we're comfortable with the TBAs at this level versus our exposure, if you will, on retests or compliance with retests in the regulations; we don't see that as an issue at this point.

Trevor Cranston, Analyst

Okay. Got it. Thanks. And then as you guys think about the Fed potentially announcing taper at some point maybe later in the year, can you share your thoughts around sort of how you think the CMBS market is likely to react to that? Obviously, we've already had a pretty significant movement in rates and a lot of extension, but I guess just in terms of MBS performance can you guys kind of talk through how you see that playing out once taper is announced?

Stephen Benedetti, CFO & COO

Thank you for the question, Trevor. I believe people tend to link the term taper to what happened in 2013, but we don't see this situation as comparable. The Fed is now more focused on providing forward guidance and signaling their intentions clearly. We will be aware in advance if they are considering any changes. The key factor regarding the taper is the percentage of the market that the Fed is purchasing compared to the net supply available. Currently, the Fed is buying a considerable amount, and there is also additional demand from banks and other investors. We think the announcement will not be a surprise, and mortgage returns will be influenced by the basic principles of supply and demand. A positive aspect for mortgages this quarter is that we've seen higher rates, slower speeds, and reduced supply. We anticipate two key developments: as the Fed pulls back from the market, net supply will increase, which we believe will widen mortgage spreads if no one else steps in to fill that demand. This could present an opportunity. However, unless there’s a significant communication failure from the Fed that creates a sudden market reaction, which we consider unlikely, we believe the most probable scenario is a gradual withdrawal by the Fed. We will observe how this impacts supply and which investors might take on that extra demand. We see this as a favorable moment for us to capitalize on that opportunity.

Trevor Cranston, Analyst

Okay, that makes sense. Thank you.

Stephen Benedetti, CFO & COO

Sure.

Operator, Operator

Your next question comes from the line of Christopher Nolan. Please proceed with your question.

Christopher Nolan, Analyst

Hey, guys, nice quarter. On the strategy front for capital, given where your share price is, where are you thinking about raising additional capital? Now realize that your leverage ratio is low, but given the comments you know there is a potential attractive market opportunity out there. Is it thinking to raise more capital and would it be preferred or common? Will detail be great?

Byron Boston, CEO & Co-CIO

Oops, sorry, I was muted. Chris, this is Byron. I want to emphasize that we are very thoughtful about how we raise capital. I believe Stephen and Smriti have mentioned that this is a great first quarter for raising capital, which provides us with fantastic opportunities. We still believe these opportunities are outstanding, and we have a long-term strategy for building our company. I will be a bit lengthy but want to ensure you understand the principles guiding our operations. We do not aim to emulate the largest companies in our industry. We value being a nimble company and have a limit to how large we want to grow. We are not reckless; we are not simply pursuing capital indiscriminately. We do not earn fees simply based on the amount of capital we manage. We approach this thoughtfully and opportunistically, which was evident in the first quarter when we recognized a significant chance to raise capital. Consequently, we did raise capital and positioned ourselves to take advantage of what I refer to as the second amendment and the current intra-quarter volatility, whether it relates to spreads in hedge valuations or specified pool levels or TBA levels. There is sufficient volatility right now for our skilled team to create opportunities to generate returns for our shareholders. From a long-term standpoint, we still aim to grow our company. We want to provide our shareholders with greater liquidity in our stock and attract those investors who desire more liquidity and have not yet invested in Dynex Capital. We believe every investor should have the opportunity to own this management team, which we consider the most skilled and experienced. We intend to make ourselves accessible to all shareholders. However, to achieve this, we need to continue increasing the liquidity of our stock. This feedback has come from some of our largest shareholders who appreciate us but indicate that the liquidity of our stock is not strong enough. These are the principles that will guide our decision-making as we look ahead.

Christopher Nolan, Analyst

Great. And the dividend given that you guys are out-earning the dividend quite handily, I would think the dividend would have to go up just because of your REIT status; is that a fair way to look at it?

Byron Boston, CEO & Co-CIO

I will let Steve address some of the technical aspects regarding the REIT rules. However, I want to emphasize that our management team is dedicated to generating cash income for our shareholders, which is the primary focus of Dynex Capital. We are also committed to our overall return experience. We do not want to pay a dividend that does not align with our macroeconomic outlook. Currently, we are facing a very uncertain economic environment that continues to evolve. Although it has been about 15 months since the pandemic began, it remains an ongoing health crisis and economic situation. Our macroeconomic perspective will be central to our considerations about the dividend. Steve can now provide details on the technical aspects of our payout requirements and our flexibility in this area. The key message I want to convey to our shareholders is our commitment to generating cash income for investors while also being cautious not to distribute excessive cash income that could negatively impact our book value. We are actively managing our risk. Steve, would you like to discuss the technical limitations on dividends?

Stephen Benedetti, CFO & COO

Yeah. Sure. Hey, Chris. Just thinking about the first quarter I mentioned $36 million in excess economic return over the dividend, some of which is realized and some of which is not realized. You think about that as potential taxable income. We have carryforwards from many, many years ago that have not yet expired that we can use to manage the dividend requirement as well as some losses from hedging activity many years ago that we also are carrying forward that can offset that distribution requirement at this point. So we have the flexibility as we sit here today to be able to, from a technical tax compliance perspective, be able to manage the excess earnings and retain those to grow the capital base. So we have that flexibility. It becomes then a strategy, as Byron just alluded to.

Christopher Nolan, Analyst

Great. That's it for me. Nice quarter.

Stephen Benedetti, CFO & COO

Thanks, Chris.

Operator, Operator

And there are no further questions in queue at this time, I turn the call back to Mr. Boston for any closing remarks.

Byron Boston, CEO & Co-CIO

Thank you, operator. Thank you all for joining the call, and for those of you who are investors, we really appreciate you owning Dynex stock along with us at the management team and at the board level, and we look forward to seeing you next quarter during our second quarter conference call. Thank you. Have a wonderful day.

Operator, Operator

And this concludes today's conference call. Thank you for your participation. You may now disconnect.