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Dynex Capital Inc (NYSE:DX)
Q4 2020 Earnings Call
Feb 4, 2021, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Dynex Capital, Inc. Fourth Quarter 2020 Annual Results Conference Call. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Ms. Griffin. Thank you. Please go ahead.

Alison Griffin -- Vice President, Investor Relations

Good morning. This is Alison Griffin, Vice President, Investor Relations. Thank you for joining us today. With me on the call I have Byron Boston, Chief Executive Officer; Smriti Popenoe, President and Chief Investment Officer; and Steve Benedetti, Executive Vice President, Chief Financial Officer and Chief Operating Officer. The press release associated with today's call was issued and filed with the SEC this morning, February 4, 2021. You may view the press release on the homepage of the Dynex website at dynexcapital.com as well as as well as on 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 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.

And with that, I now have the pleasure of turning the call over to our CEO, Byron Boston.

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

Thank you, Alison. Good morning.

As CEO of Dynex, I'm very proud to report that in 2020 we delivered a 15.2% total economic return and a 17% total shareholder return. I've been at Dynex for 13 years and no other year has demanded as much active decision making as 2020. We stuck with our discipline and excelled. We didn't just protect shareholders money. We made money for our shareholders in 2020. Our book value increased and we delivered a solid dividend. This performance stands in contrast to most other mortgage REIT and many other investment alternatives for investors seeking income.

Now as you can see on Slide 5, Dynex has now delivered industry leading performance on a one-year, three-year and five-year basis. And when you look at our long-term chart on Page 17, you can see that we have delivered solid returns through multiple market cycles during my tenure at Dynex Capital. This performance reflects my distinct philosophy of how to manage a mortgage REIT for the long term and that same philosophy is guiding our investment approach today. We believe in risk management first, followed by disciplined capital allocation. As experienced and skilled investors, we have been cautious about leveraging lower credit illiquid assets since 2016. When spreads are tight, this strategy looks attractive during short term, but ultimately crumbles when liquidity dissipates in a crisis. This is what happened last year when the prices of illiquid assets dropped dramatically as COVID-19 intensified and creditors demanded more cash or margin in response. The takeaway here is that, it was no surprise that the market reacted the way it did. We witnessed the same reaction in every major crisis in recent memory. The Dynex management team has successfully managed through these intensified risk events throughout our careers and we were prepared.

2020 was a challenging year, but in our opinion, not a black swan event. As we indicated at the beginning of 2020, we saw the global risk environment intensifying. So, we were prepared for increased volatility. While it is impossible to predict the timing of specific events, we foresaw a higher risk profile building in the global financial markets. Our experience and insight gave us the edge to actively manage our portfolio to provide our shareholders strong returns. We managed our book exactly as we told investors we would. For years, we have emphasized liquidity and diversity in our portfolio, and this discipline served us well in 2020.

Our 2020 performance was not a coincidence or good luck, but rather years of thoughtful planning around our portfolio and a team of talented people ready to actively manage the book of business in volatile times. As a CEO and coach, I could not be prouder. Now from a human capital perspective, we have a world-class team with unmatched skills and experience. And 2020 was the year when the management team mattered more than anything. Our team has weathered significant crises in the past and long-term capital management to the Great Recession. And as we have learned again this past year, nothing surpasses experience. We have the institutional knowledge to address many market disruptions and to identify new opportunities that may come along. Our team is diverse, which is critical to our strategy. Risks do not stay within borders, and our teams worldwide perspective is invaluable when dealing with a global crisis.

Now, COVID-19 disrupted many work environments, but we already had the advantage of enabling our people to work remotely long before it became a necessity. Just as risk is border-less, so is talent. Our employees were accustomed to working outside the office. So, we remained calm, focused during the quarantine, filtered out the noise to actively manage our risk, and effectively maintained key relationships and the confidence with lenders, regulators and investors. So in the past 12 months we have taken a strategic view on both sides of the balance sheet with the goal of being able to grow and scale the Company efficiently, and in a stakeholder-friendly manner. We made several moves. We retired two of our higher cost preferred stock issues and we replaced them with our new Dynex Capital Preferred C. And during the last two weeks, we issued approximately $56 million in common equity in line with our long-term strategy to grow our capital base.

It's very important to note the return environment is conducive for absorbing any costs associated with our capital activities. Our ultimate goal is to increase our stock's liquidity and offer investors the opportunity to invest in Dynex via multiple products, including our fixed dividend C Preferred, and our higher yielding common stock. We've been in business for 30 years and we are fully committed to delivering solid cash flow, and attractive total returns to our shareholders well into the future.

Now as a company, our greater purpose is to support two of our main stakeholders and constituencies, the individual savers and the communities across America. We are building this company for the long term, because we believe in America, and our role in helping individual savers achieve a respectable return on their savings from financing of real estate assets. The capital that we bring to the table is critical for housing and the real estate community. As long as savers need cash income and housing and real estate finance exist in America, our business model will remain relevant and critical. Most importantly, we are deeply committed to the highest ethical standards because savers need management teams with integrity as stewards of the capital. Our management team operates with integrity and an unwavering commitment to our values and to supporting our community. We take our fiduciary responsibility very seriously and strive to be good stewards of capital, transparent in our actions and good corporate citizen. At Dynex, we are building a diverse and multi-generational organization with a 30-year vision that we believe will create enormous value for shareholders, stand the test of time and prepare us for the future. I feel fantastic about 2020, and I'm very positive about 2021 and beyond.

And I will now turn the call over to Steve Benedetti and Smriti Popenoe. Well, look, I'm going to turn it over in a minute, I forgot something. Before I turn over the call, I want to highlight that we have promoted Smriti Popenoe to President of our Company. And this is another reason that I'm excited as the CEO and a coach. All of our stakeholders should be elated about her promotion, and what this means for the future of Dynex. As I said earlier, we have a 30-year vision that include getting the right people in the right places with the right skill sets and experience.

So now, with that, I'm going to turn it over to Steve and Smriti and they're going to give you some more detail about 2020 and beyond.

Stephen J. Benedetti -- Executive Vice President, Chief Financial Officer, Chief Operating Officer

Thank you, Byron and good morning everybody.

The fourth quarter continued the excellent performance for the Company for 2020. For the quarter on a per common share basis we recorded comprehensive income of $1.23, total economic return of $1.22 or 6.7% based on the beginning book value per share of $18.25 and core net operating income of $0.45. For the year on a per common share basis, we reported comprehensive income of $2.88, total economic return of $2.73 and core net operating income of $1.94. 2020 performance was highlighted by active portfolio and risk management and dynamic capital allocation, which enabled us to take advantage of improving asset valuations over the year, and declining funding costs. Realized and unrealized investment in TBA gains, net of hedges, were approximately $1.83 per common share, driving a large part of the comprehensive income and total economic return for the year.

For the fourth quarter, both comprehensive income and total economic return were bolstered by the strong performance of lower coupon RMBS during the quarter, particularly in TBA securities relative to associated hedges and to a lesser extent increasing value on CMBS IO securities. Core net operating income sequentially declined from $0.61 last quarter to $0.45 this quarter, principally as a result of the smaller average balance of interest-earning assets and modestly declining asset yields. In addition, general and administrative expenses increased $2.1 million during the fourth quarter from year end incentive compensation accruals reflecting a catch-up adjustment for accrued bonus expense for management's achievements of its corporate goals and objectives this year. Net interest spread and adjusted net interest spread, both slightly declined by 2 basis points respectively quarter-over-quarter. Prepayments increased, but were well within expected ranges. Agency RMBS prepayment speeds were 17.1 CPR for the quarter. While overall portfolio CPRs including the CMBS portfolio were approximately 15.1 CPR. Adjusted net interest spread continues to benefit from the favorable TBA dollar roll conditions versus on balance sheet repo.

As a reminder, the Company utilizes the perspective method for amortizing investment premiums, and as such, our results fully reflect the actual realized prepayments during the quarter and do not include cumulative catch up amortization adjustments that are based on long-term assumptions and could potentially distort near-term results. As it relates to book value, the driver of the $0.83 per share increase during the fourth quarter was net gains from continued spread tightening on investment assets, particularly in both lower coupon TBAs and pools. Treasury future hedges also helped to offset the impact on investment valuations from the sell-off in interest rates during the quarter. We estimate that book value per common share at the end of January is up approximately 1%, inclusive of the impact of the capital raise announced last week.

We ended the year with investment assets, including TBA securities of $4.2 billion and leverage at 6.3 times shareholders equity similar to the end of the third quarter. Overall investment assets, including TBA securities were down on an average basis by approximately 7% as compared to last quarter. This quarter we added 15-year agency RMBS investments through TBA positions and overall the portfolio composition is approximately 84% RMBS investments, including TBA securities and approximately 16% invested in CMBS and CMBS IO. Let me also mention that the tax character of the dividends on the Company's equity capital. For 2020, dividends in both the preferred stock and common stock were a 100% capital gain income.

That concludes my prepared remarks and I'll turn the call over to Smriti for her comments on the quarter and the year.

Smriti L. Popenoe -- President, Co-Chief Investment Officer

Thank you, Steve.

Let me start by saying that I appreciate the confidence that the Board and Byron has placed in me. I'm honored and delighted to serve the Company's shareholders in my new role as the President. I'm going to briefly cover our 2020 performance and then shift to our outlook for 2021. In extreme volatility events like March 2020, there can be a lot of risk and with that comes opportunity. With thorough planning and expecting the probability of such events, we were positioned with higher levels of liquidity. We successfully managed the portfolio rapidly in February before conditions deteriorated, positioned ourselves to weather the extraordinary market events of March, and rebalanced our investments in April to take advantage of the remarkable recovery in asset prices through year end. Our annual total economic return of 15% is only the third best in Dynex's history since 2008, but it is remarkable in that it was earned in an outlier year like 2020.

Moving on to 2021. I'll start with a summary of our macroeconomic view. To deal with the pandemic and its after effects, central banks have implemented highly accommodative policies, designed to increase employment, increase inflation and put the economy on a growing trajectory. A flood of unprecedented liquidity has raised the price of financial assets globally. Governments around the world are also implementing debt financed fiscal policy to close the gap on lost GDP from the pandemic and to drive future growth. This is likely going to lead to a period of massive deficits. Against this backdrop of unprecedented monetary and fiscal stimulus, we have the health crisis that much of the globe is still dealing with. In the near term, we expect to see a period where there is a tug-of-war between the negative impacts of the pandemic and the positive impacts of the vaccine.

In the medium term, the stimulus plus the impacts of more vaccination could eventually lead to a period of higher growth, as more of our services-driven economy is able to come back online. The Fed also remains committed to a broad recovery in employment, and an overshoot of inflation over 2%. In the long term, we believe the world has been permanently reshaped by the pandemic and its impact will continue for many years to come across broad segment of our economy and many aspects of our daily lives. This will continue to be a focus for Dynex in our macroeconomic process. Right now, our macroeconomic view leads us to prepare for a somewhat bumpy transition to a steeper yield curve as one of the more probable scenarios for 2021. We believe this is also a more favorable environment for higher returns.

Turning now to our current positioning and economic return outlook. Our goal is always to manage the balance sheet to generate a total economic returns to meet or exceed the dividend. Rather than think solely about core earnings versus the dividend, we are focused on capital preservation and generating returns over the long term. Our experience shows that this focus results in higher total shareholder returns and creates long-term value for shareholders. We believe the broader investment environment remains favorable with financing costs anchored well into 2022 and beyond. First, financing costs are anchored well into '22 and beyond, agency MBS are liquid, lower risk assets. And third, we believe the market will evolve to a steeper curve environment that is ideal for earning wider net interest spreads. We expect returns to move into the 10% to 12% range and could offer mid-teens returns if spreads widen. We are entering this period with solid performance quarter-to-date. Book value since year-end is up about 1% net of the equity rate. We have a strong liquidity position of $375 million and tremendous upside earnings power on the balance sheet. Leverage stands slightly over 6 times today and we still believe a liquid strategy is appropriate for the environment.

Let me explain why we believe a steeper curve is possible. While financing costs are expected to stay close to zero through 2023, the back end of the yield curve will face pressure from treasury issuance, possible increases in realized inflation and expectations for inflation, as the economy begins a path to recovery and gains traction in the second half of 2021. This will likely result in higher long-term treasury yields. A steeper yield curve is a very positive factor for net interest spread expansion as it offers a chance to invest at higher yields, especially as prepayments slow. In steeper yield curve environments, agency RMBS spreads also tend to widen because they now have to compete with other assets, including treasuries that offer higher yields. And realized volatility in steeper yield curve environment is usually higher. This has the potential to further add to returns.

If you go back to 2012, 2015, 2018, all periods were tight MBS spreads to start the year. The curve steepened, and MBS widened. In 2012, it happened even with the Fed doing QE. So, we're not predicting this will happen, we think there is a path for the scenario. And if it happens, it will be one where we can invest capital at higher return. We also see a scenario where the low volatility environment keep spreads range bound and book value stable. At this point, we're seeing a massive revision to net supply number for 2021, not just because of refinancings and low mortgage rates, but also because of new household formation, a migration out of cities, home prices appreciation, all of which are causing MBS supply to balloon much higher than expected. We believe this will afford us the opportunity to also invest at better returns.

Finally, if rates decline and the curve flattens, given the current tightness and high dollar prices of MBS, we feel that spreads will move wider in a lower rate environment. And we have the capital and liquidity to invest in that scenario. While they may not occur as exclusively as I've described, my point is that we believe all of these scenarios offer us the opportunity to manage and invest our capital accretively. Our core portfolio is also positioned to benefit in a steeper curve. This has been the market scenario so far this year. We currently have an RMBS portfolio allocation of 20% to 15 years, which outperform in a steepener relative to 30s [Phonetic]. We've increased our allocation to long-term option based hedges to better insulate the portfolio from rising long-term rates.

You can see on Page 10 of the slide deck that the portfolio performs relatively well across several types of rate shocks, both parallel and non-parallel. I want to reemphasize that we have tremendous earnings power on the balance sheet. A one times increase in leverage, invested at 8% total economic return, adds $0.19 per share per year in economic return. At 10%, that's $0.24, at 12% it's $0.29. We think we have the room to take our total leverage up at least 2 times from today's levels at the right time and possibly higher if the return environment is better.

Here is what I'd like to leave you with. The favorable investment environment is supported by low and stable financing costs well into 2022 and beyond. We expect to be able to opportunistically invest our capital at more accretive levels as the market evolves over the year. There is tremendous earnings power in the balance sheet and we're comfortable with our ability to generate returns to cover or exceed the dividend over the year.

I'll now turn it over to Byron.

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

Thanks, Smriti. Let me reiterate and summarize real quick. We believe this is a favorable investment environment that has the potential to improve as the year evolves. Having our financing costs low and stable for some time into the future is an enormous benefit for our shareholders. Nonetheless, we continue to maintain our discipline of scenario planning to ensure we are prepared for future economic or market surprises.

Now, please take a look at the long-term chart on Slide 17 again. And let me emphasize, for those of you who have listened to us over the years and you're long-term investors, we always close with this chart. You'll see the difference on the chart. We've used the Russell 2000 value index and the shift is mainly because of the unusual attraction and performance returns of this tech sector. So we tried to create something that is a little more comparable, but we could have created charts with 10-year charts. We could have created with numerous of other different types of vehicles, and the picture looks very similar. This displays the power of above-average dividends, the power of a long-term risk management strategy and the power of successfully managing through major credit market corrections.

We have proven time and again in my 13-year tenure, that our philosophy, disciplined process and long-term thinking leads to superior returns, achieving over this time period what many of us could not. The management team, our Board of Directors and I are delighted to invest alongside of our current investors because we believe in our future. Now, there are many other investors out there who should have Dynex in their portfolio. So, we invite you to join us.

And with that operator, I'd like to open the call for questions.

Questions and Answers:

Operator

[Operator Instructions] Your first question from line of Bose George with KBW.

Mike -- KBW -- Analyst

Hey, everyone. This is actually Mike on for Bose. I just wanted to say congrats on a really strong year. I know it was challenging and very great results. So my first question was, you recently did a secondary offering. I was wondering if you can just kind of talk a little bit about the decision to do this at a slight discount to book value, given the backdrops that spreads are fairly tight. And then, I was wondering if you could also provide a little bit of color on the expected timeline for capital deployment?

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

Sure. Let me start and I'll let Smrit chime in on here. I mentioned a second ago when I -- appreciate this question. This is a phenomenal time to absorb the costs of us managing the right side of our balance sheet. And that's what I consider this capital raise to be. So, let me recap the last couple of years, beginning of 2019, we raised about $50 so million. We then issued a preferred stock, we refinanced our higher cost of Preferred A, we then paid off our Preferred B, we come back in 2020, with a well time thought out issuance of equity. We have already absorbed the cost of issuing equity. It's not so much about above, below book, what's the cost of issuing the equity and growing the Company? Can we absorb the costs? Are our shareholders are still in great shape over the long-term? The answer is yes.

What's the benefit of it? We're trying to give our shareholders more liquidity. We've been told multiple times that, you guys have great company, great management team, but you're below $500 million. We'd like to see you guys get above $500 million, then we will be able to join in, join the party. And as such, the more other investors, we can get involved with Dynex, we truly believe that we should be in more portfolios. We believe that the management team, we have something to offer over the long-term.

That's our goal over the long term. And when we say we want to grow the company in a shareholder-friendly manner, that means that the time is very attractive now, given how the potential power in the balance sheet for generating income, to absorb any of the costs, in terms of overall growing the Company at this time and that's the key, is how do you -- what do you do with the cost of growing the Company? This is a phenomenal time for being able to manage through that. And all of our shareholders should benefit as we bring down our cost ratio and other decisions that we're looking to make for the long-term.

Mike -- KBW -- Analyst

Great. That's very helpful content.

Smriti L. Popenoe -- President, Co-Chief Investment Officer

In terms of when -- you asked a question about the timing. I think, again, that the number one thing we think about is investment opportunity and not just the investment opportunity today, but what we think we can do with the capital over the long-term. So as I mentioned, we're thinking about not only the return environment today, but the evolution of the return environment that we see actually being very long-term accretive to our shareholders. So at lower returns, you should expect the balance sheet to have lower leverage. At higher returns, we'll be increasing the size of the balance sheet.

Mike -- KBW -- Analyst

Great. That's helpful. And then, another question was, so dollar role income remains pretty strong and 2020 was obviously a great year for this. I was wondering if you could just talk a little bit about the expectations for 2021. Do you expect us to remain above, say, 2019 levels?

Smriti L. Popenoe -- President, Co-Chief Investment Officer

So dollar role income in 2020, especially during the last two quarters of 2020, I think, was extraordinarily favorable. The implied financing rates at the time were somewhere in the minus 50 basis point range. I think that those types of levels for 2020 will probably not be repeated in 2021. All total specialness should be lower, right? So right now we're seeing specialness be somewhere in the 20 basis point range versus the 40 to 50 basis point range for last year. So, will there be special dollar roles in 2021? Yes. Will it be as much as it was last year? No. And I think that's generally the expectations for the markets at this point as well.

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

Let me chime in and then go back to one other -- let me just roll one other thing and I want to go back to your first question because I want to make sure everyone understands the long-term view of Dynex Capital. When we're growing our company, we're really excited about showing you last year what the word nimble means and the value of nimble. So, we're not trying to be the largest in this industry. We have zero desire to go out and repeat and just issue equity, issue equity to become the largest in the industry. That's not our goal. We only want to be of certain size because we believe it offers enormous value, size/cost ratio, all this stuff that I see a lot of people talk about didn't mean anything in 2000 -- in fact, it did mean something. There are certain -- their balance sheets were so large, they couldn't adjust their balance sheets, couldn't adjust it. So I want to make sure you understand that when we make strategic moves on the right side of our balance sheet, we're very thoughtful and very disciplined about those decisions. The same way we're disciplined and thoughtful about the decisions on the left side of our balance sheet.

Mike -- KBW -- Analyst

Great. Thank you so much for taking my questions and congrats on a good year.

Operator

Your next question is from the line of Eric Hagen with BTIG.

Eric Hagen -- BTIG -- Analyst

Hey, good morning, guys. Couple of questions here. Can you first -- one on the portfolio, and then, one on the capital side. Can you talk about which hedges you think you'll be most active in incrementally adding here, and what your threshold is for either rates or volatility before you look to change course from using short dated options? And then, on the asset side, is there anything that would get you more constructive on specified pools? And then on the capital side, definitely support the move to retire the press is one way to manage leverage on stockholders. And I guess, I'm curious now whether that modification to the capital structure changes your overall outlook on leverage for the macro portfolio, the overall portfolio? And how much leverage we can expect you guys to carry here?

Smriti L. Popenoe -- President, Co-Chief Investment Officer

Hi, Eric. So I'll take the portfolio questions and address one part of leverage as well. So you asked -- your first question was about the hedges and what we're thinking about there? In general, I think we're favoring Treasury-based hedges. Treasury-based hedges are liquid. That's something that that we think in general, really offers us a lot of 24/7 flexibility to trade. So futures, is something that you should see be a very big part of our hedging strategy. We've chosen to put our hedges in the back end of the yield curve, given our slight lean toward a steeper curve here to protect the portfolio. So that should also be a consistent theme. I think we've been very successful with using Treasury options and shorter dated options as a, I would say, relatively inexpensive way to manage this rise in yields up to now. In the fourth quarter, we shifted that strategy to including longer dated options into the mix. So we're -- we did that a little bit last year, that's something again that's on the table, as the shorter dated options mature, or expire to go into next year. So you should see that shift happening just as we're rebalancing the portfolio here.

In terms of specified pools, into a steeper curve, you should see specified pools start to cheapen as the expectation for prepayments flows and the relative value of a specified pool starts to diminish relative to TBAs. So once we see that type of cheapness come back into the market, I think that'll be a situation where specs starts to look interesting, again. By our metrics, a lot of the spec pools are trading very full to theoretical pay outs at this point. And I think there's some risk to -- of higher rate scenarios to those payoffs coming down. So that's what it would take for us to get back in there. And then, in terms of the leverage the way I think -- we think about it is, when returns are sitting in the 8% to 9% range, our leverage will be somewhat in the 6%, 6.5% area. As returns get higher, you should see the balance sheet start to grow. I think that we're prepared, regardless of how this scenario evolves, right. So, for example, if we have a grinding spread scenario, you can invest in that scenario, when there are imbalances between supply and demand. We expect to be able to invest capital at better returns there. None of this precludes our ability to quickly put the money to work, should we believe the opportunity exists to really earn that total economic return over the long term. So there's a lot of flexibility and upside here.

Byron, I don't know if you wanted to add anything to that.

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

Yeah. Really, the key one on that is back to being very strategic and disciplined and thoughtful about what we do. In my 13 years, being here, our leverage is gone from zero to 9.5% to 10% and back down again in the middle. We're very thoughtful about how we make those decisions. Last year was unusual in the sense that we did have to move our leverage up and down a couple of times. And I do remember when we took our leverage down, right after the March period, it seems like a few of you out there were a little skeptical about our ability to move our leverage backup. We told you, we could move it up in a nanosecond and that's exactly what we did. We moved it back up again. So these are not just haphazard decisions. We have a philosophy. We have an opinion about how to manage this Company over the long term. We're really skilled at managing leverage. Our resumes have years and years and decades of managing leverage portfolios. So I just want to make sure you understand that we're not haphazard about these decisions.

Eric Hagen -- BTIG -- Analyst

Thanks for the comments. And Smriti, congrats on your promotion.

Smriti L. Popenoe -- President, Co-Chief Investment Officer

Thank you.

Operator

Next question from the line of Trevor Cranston with JPM -- JMP Securities.

Trevor Cranston -- JMP Securities -- Analyst

All right. Thanks, good morning. I may have missed this, but given your comments on spec valuations being fairly full, did you guys mention if your intention with the capital raise was to deploy primarily into TBA? And I guess, if that is the case, can you maybe comment on more broadly speaking, how much room you have, in terms of, how much TBA you have in the portfolio versus pools? Thanks.

Smriti L. Popenoe -- President, Co-Chief Investment Officer

Hi, Trevor. Yes. So we didn't really talk about TBAs versus specs in the comments. But in general, I would say at the moment, we would favor TBAs, lower coupon TBAs, at the right time. Spec pools in both lower coupons that we look at this point are somewhat full. So we're going to really favor TBAs. The second issue that you brought up regarding the room, if you will, there's a couple ways to look at it. The number one constraint, and Steve you can jump in if I'm saying this incorrectly, is really -- it's an income test, not an asset test. So the percentage of TBAs that you can have on your balance sheet at any given time, isn't really a function of the amount relative to the total amount of assets, it's really how much income they generate. And by our estimates, we actually have a fair amount of room with respect to how large the TBA book can get relative to the rest of the portfolio, before we run afoul of any of those metrics. I believe the number is north of 50% at this time.

Trevor Cranston -- JMP Securities -- Analyst

Okay. That's it. Thank you.

Smriti L. Popenoe -- President, Co-Chief Investment Officer

Sure.

Operator

Your next question from the line of Jason Stewart.

Jason Stewart -- JonesTrading Institutional Services -- Analyst

Hey, good morning. Thanks for taking the question. One more on the preferred, if you don't mind. Could you talk a little bit more about your decision to retirement with regard to the cost of the preferred? Or was it more of a decision to lower that as a percentage of capital over the long-term?

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

You know, what, in terms of the cost period, as far as I'm concerned, the cost of it, we now have one preferred. That side of the balance sheet is, I call it simple, for our shareholders. Two choices, preferred C, common stock, preferred C, coupons fixed, lower yield, common stock, higher yield. You choose which one you want to invest in. We've simplified the right side of the balance sheet. Now in terms of -- I always get in these debates with whether bankers or analysts around what's the right amount of preferred. There is a questionnaire about it depends on our global environment or global macro risk opinion. And everything literally runs through our global macro risk opinion. We're very disciplined top down approach shop. So right now, we're in a period where our financing costs are fixed. When you evaluate leveraged investment or mortgage REIT, understand that the start of good return environment starts with where's your financing cost. And are they lower and are they stable? And so that's the position that we're in today. That will have an impact also on which instruments we will use on the right side of the balance sheet. So it's not a simple a plus b equals c. It is definitively an environment decisions that are made in the same discipline process as we make others.

Jason Stewart -- JonesTrading Institutional Services -- Analyst

Got it. That makes sense. And Smriti, I think you said in a steeper yield curve environment, and I'm using quotes, prepays should slow. I'm wondering if you could elaborate on that and maybe discuss the factors that perhaps make prepay slower or don't, including primary, secondary spreads and how you think that plays out? Thanks.

Smriti L. Popenoe -- President, Co-Chief Investment Officer

Yeah. That's a great question. Yeah. That's why I said should, as opposed to will, right. So I think at this point, you're really seeing a very, very strong move in primary, secondary spreads. There's a real impetus in the mortgage origination community to make hay while the sun shines. And so, we don't -- I don't believe for the next 10 basis points or 25 basis points, you're going to see prepayments slow immediately. It will take some time, mortgage rates to actually meaningfully rise, I would say, between 3% and 3.25%. And at that point, as mortgage rates kind of stay in that level, for some period of time, that's what it's going to take for prepayments to slow. So we're not counting on prepayments slowing for that higher yield to manifest itself as other ways you can actually learn that incremental curve steepness returns. The other piece is eventually as the curve steepens and some of the low-hanging fruit get taken out of the game in terms of the refinancings that are in the money, you should start to see burnout. And that burnout is going to maybe not come next month or the month after, but in the third or fourth quarters, you're going to start to see burnout in the mix here. But for the very near term, I would say in the next few quarters, we're not expecting to see even with higher rates, much lower speeds. Will they slow? Potentially, but not as much as maybe we were seeing in the past for a steeper curve environment.

Jason Stewart -- JonesTrading Institutional Services -- Analyst

Got it. Thank you.

Smriti L. Popenoe -- President, Co-Chief Investment Officer

Yeah. I'll just add one more thing on that, because I think a lot of people forget this, which is one of the more interesting things that happens to mortgage valuations in a steeper curve, it's not just the prepayments, right? It's the realized volatility we get with the back end of the yield curve moving up and down. That starts to really influence whether those higher yields people want to own mortgages versus other assets. And eventually, the pricing in mortgages starts to change to reflect that incremental risk. And that's what causes mortgage spreads to widen when the curve steepens. So if you're thinking about where will you get your return, you're not just going to get it only -- you're not just counting on just the prepayment slowing down, evaluation implications of that scenario as well.

Operator

[Operator Instructions] Your next question is from the line of Christopher Nolan with Ladenburg Thalmann.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Hey, it's Chris from Ladenburg Thalmann. Smriti, I want to congratulate you on your promotion, well deserved.

Smriti L. Popenoe -- President, Co-Chief Investment Officer

Thank you.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

I think between you and Bryon, and Steve, and everyone on Dynex is in good hands and continues to be in good hands. I'm looking at Page 15 of your presentation. If I'm reading it correctly, it looks like you guys are implying that your target leverage ratio is increasing to 7% to 9% turn from 7% to 8% before, is that a fair reading of that?

Smriti L. Popenoe -- President, Co-Chief Investment Officer

So the 9% would only happen in a really attractive return environment, I think that's really the key.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

And should we expect the leverage ratio to increase, including TBAs in the first quarter given, taking into account the redemption and the new issuance and so forth?

Smriti L. Popenoe -- President, Co-Chief Investment Officer

What I would say is that we're -- here's how I would answer that question. Right at this moment, we believe there's a significant chance of net supply, overwhelming demand, even demand from the Fed, OK. And so we think that that is -- that will offer an opportunity to deploy capital. If that scenario occurs, we will be in there deploying capital. And the question, so it's -- it is a matter of timing. One thing, I think, we've learned over the years is that when you focus on the short-term, a lot of times you end up losing return in the long-term that's not our goal here. Our goal is to really put the capital line in at the right level. So we're not -- we're going to be disciplined about it.

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

And let me just add one thing. One thing when we think about, we think about our macro of top down process. We just also ask ourselves, what is it that we really know here? We know our financing costs are low and stable for some period into the future. The next thing we know is, the federal government, sovereign governments, especially United States, is selling an enormous amount of debt every single week. The other thing we know is that net mortgage supply is increasing. And mortgage originators are selling a ton of bonds every week, even with the Feds involvement. So spreads are tight. But they're not just tight because the Fed involved, the spread is tight because the Fed plus other investors. At any point in time here in 2021, you have the probability of imbalance in the current occurring, either for short durations, or for longer duration periods of time.

If you think about it, 2013 everyone talks about a taper tantrum. And basically what you had was a short-term imbalance. We had an enormous amounts of sellers developed. Actually, one of the leaders that were mortgage originators, spreads go out to really wide spreads, and then in 2014, spreads came back, yields dropped again. So you're in a situation again, it's really important to understand this. Financing costs are fixed. There's an enormous seller of treasuries and there's an enormous seller of mortgage-backed securities. And the only thing the key fields in check is as long as a few additional buyers, in addition to the Fed, try to stand in a way of the selling. So in my opinion, our opinion, this creates a phenomenal opportunity in 2021, for the potential for steeper curve, and wider spreads. It doesn't have to be some massive, enormous event that takes place. These things can happen in a very orderly fashion. But I'm telling you, I'm giving you three things that we know for a fact. We can't predict the future. But these are three things we know, I will reiterate. Financing costs are fixed and stable. There's an enormous seller of Treasury and that seller is getting larger as more bills are passed in Congress. And there's an enormous seller of mortgage-backed security that happens to be mortgage originators and mortgage net supply is growing.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Great. Byron given that, it looks like to me reading the presentation that you guys are increasing your core ROE target range to 10% to 12%, from 8% to 10% before, is that a fair reading of that?

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

What we believe is that, with the movement of spreads and the steepness of the curve, you listened to how I just said it, my financing costs are fixed. Steeper curve means that overall yields are going to rise versus my financing cost, that's going to increase returns. If you layer on top of that about the widening in spreads, that increases returns. And that's the way we look at it. And that's how I strongly feel about this scenario in 2021. So then, when we give you the numbers, we're just giving you the numbers and saying, this is what we think things can widen out to given an environment today where the yield is low, 10% to 12% is a phenomenal return. But you're probably -- highly probably you may see some other bouts of yields of returns above 12%.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Okay. Given all that, where you're thinking on the dividend, because it looks like to me that you guys are poised for increasing the dividend.

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

That's what I want to emphasize. So many mortgage REIT investors choose mortgage REITs by yield. And anything you should have learned in 2020, is that the mistake? We believe in generating a solid cash dividend for our shareholders and a total return and total economic return experience. So we're always balancing. Well, how much yield are we paying versus how much risk are we taking with our book value? And that's why we start with our macroeconomic view, because we don't want to take so much risk in the short term, jack up our dividend to some level and then blow our shareholders away with book value deterioration. And then, you have this long-term hit the book value. That's not our goal. That's why we use the long-term charts to show you our performance. It's not understood by many people. And we know when we tell you this story, there's some of you out there who just don't get it. You didn't get it 10 years ago, didn't get it five years ago. And that's -- we're really emphasizing. This is the way we think in terms of yield growth, the cash yield and a total economic return experience.

Smriti, you have anything you want to add to this?

Smriti L. Popenoe -- President, Co-Chief Investment Officer

I do. I mean, I think Chris, one of the things I want to make sure that we are communicating is that we're not calling for Armageddon, right? We're calling -- we're saying, if as spreads mortgage -- mortgage spreads widen, you should expect us to deploy capital, right. We're also saying that we're focused on this total economic return, which means today, we actually believe, we're better off working our way into that higher return environment to deploy capital. And we have actually seen opportunities even, quarter-to-date, to deploy that capital. So, I think we are very cognizant of the different scenarios that could play out here. We're very disciplined about when we put that money to work. We're not calling for any kind of Armageddon spread widening or any such thing. We do believe a steeper curve environment is better, more bullish for wider net interest spreads. And eventually what that will mean is that the returns are higher overall for the entire sector. So, I think that's a very positive thing to leave with. And then, as you know, the level of our dividend is always going to be commensurate with the economic return that we've generated to the extent that we're generating that return, then we make that decision with the Board on how much to distribute versus retain.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Great. Thank you for taking my questions and good show. Thanks.

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

Thanks, Chris.

Operator

And I would now like to turn the call back over to Mr. Boston for final remarks.

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

Thank you all for joining us today. We're just again really as I said earlier, we're excited about 2020 and we're excited as we look into the future. Thank you for all of our shareholders for joining us on this journey. And as I said earlier, we would like to have others take a closer look. Thank you again. And please join us for our first quarter call sometime in the month of April. Thank you.

Operator

[Operator Closing Remarks]

Duration: 53 minutes

Call participants:

Alison Griffin -- Vice President, Investor Relations

Byron L. Boston -- Chief Executive Officer, Co-Chief Investment Officer

Stephen J. Benedetti -- Executive Vice President, Chief Financial Officer, Chief Operating Officer

Smriti L. Popenoe -- President, Co-Chief Investment Officer

Mike -- KBW -- Analyst

Eric Hagen -- BTIG -- Analyst

Trevor Cranston -- JMP Securities -- Analyst

Jason Stewart -- JonesTrading Institutional Services -- Analyst

Christopher Nolan -- Ladenburg Thalmann -- Analyst

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