DFR earnings

DFR finally reported Q2 results and explained their liquidity position (very strong) and the level of credit risk they have in their mortgage portfolio (its high quality) so that was reassuring. They refused to provide any guidance about the future both in terms of their dividend or the earnings potential of the management company they are buying in the next week, which was not reassuring.


It would take a lot of problems for DFR to become insolvent given the level of liquidity they have now (slightly less than 75% of mortgage portfolio is agency while the other 25% is in AAA rated mortgages that have various provisions to reduce credit risk but most important their funding sources do not have the ability to make margin calls most of the time -- only when they are repricing one of their repurchase aggreements (every 30 to 90 days). They also have an extra 10% of their AAA mortgage balance available to use as extra collateral if needed. The only squishy part is that they are assuming nothing goes wrong in the agency side but since those mortgages are guaranteed by either Fannie Mae, Freddie Mac or Ginnie Mae, there is an extra layer of protection for those assets.

I am not sure what the dividend will be going forward. This is a hard one to figure out. Their portfolio yield should be steady but one would expect they are suffering some losses in the credit portions of the portfolio -- even if its just market price declines on the fear of future defaults. The deal with DCM could actually be the biggest drag on the dividend since they are handing out almost 10 million new shares and taking out $145 million in new debt to fund the deal. Being a fixed income manager of CDOs and hedge funds dealing in higher credit risk products, DCM's revenues are probably under pressure. The extra shares mean an extra $4 mill per quarter in dividend payments at the current rate. The debt expense is probably an extra few million per quarter. so if DCM isn't able to provide an extra $7 mill or so in income or cash flow to DFR per quarter, that means a dividend cut.

Pre-crisis, I expected the dividend to reach $2.30 to $2.70 over the next couple of years -- perhaps its now going to take longer to get there. I still think its possible they reach that goal in a reasonable time though -- maybe its 4-5 years instead of 1-3.

I expect the stock to continue to be volatile depending on how other financial stocks are performing.

With any luck DFR will participate in a conference later this quarter and provide some more info on their current operations -- maybe even give some range for the dividend. I'm hoping that by September the credit markets will have settled a bit.