Orchid Island Capital, Inc.
Q2 2021 Earnings Call Transcript

Published: 30 Jul 2021

[Operator:]

Good morning, and welcome to the Second Quarter 2021 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, July 30, 2021. At this time, the company would like to remind the listeners that the statements made during today's conference call relating to matters that are not historical facts are forward-looking statements subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Listeners are cautioned that such forward-looking statements are based on information currently available on the management's good faith belief with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in such forward-looking statements. Important factors that could cause such differences are described in the company's filings with the Securities and Exchange Commission, including the company's most recent Annual Report on Form 10-K. The company assumes no obligation to update such forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking statements.

[Robert Cauley:]

Thank you, operator, and good morning. Welcome to the second quarter earnings call. I hope everybody's had a chance to download the slide deck from our Web site. And as usual, I will proceed through the slide deck. As I go through our remarks before we open up the call for questions. I’ll just lay out the agenda for today's call. I'll start off with a overview, a brief overview of our financial highlights. And then I will go through a review of the developments in the market for the quarter and more importantly how Orchid reacted or interpreted these developments and the decisions that were made regarding the portfolio and our hedges and leverage ratio. I'll start off with just giving a brief review of how the company and the portfolio are positioned coming into the quarter. And then also provide some comments on our outlook, see you help in terms of how we see things evolving overtime in the future. And then I'll return it over to the financial results in bit more detail, as well as the portfolio and our hedges and then finally, just wrap it up with some closing comments and our outlook and then turn the call over to questions. So with that, I will turn to Slide 4, so the results for the second quarter 2021. Orchid Island had a net loss per share of $0.17. Net earnings per share were $0.24 excluding realized and unrealized gains and losses on our RMBS and derivative instruments, including net interest expense on our interest rate swaps. We had a loss of $0.41 per share from net realized and unrealized losses on our RMBS and derivative instruments again, including net interest expense on our interest rate swaps. Book value per share was $4.71 as of June 30, 2021 versus $4.94 at March 31, 2021. In Q2 2021, the company declared and subsequently paid $0.195 per share in dividends. Since its initial public offering, the company has declared $12.11 in dividends per share, including the dividends declared in July of this year, total economic loss of $0.035 per share for the quarter or $0.07. Turning to slide 5 and 6, we give the results of Orchid versus our peer group, which is defined on the bottom of the page and the note on each page. And you can see our results with a year-to-date and one, two and three, sort of look back as of June 30th, as well as for the calendar years. This is both on the case of Page 5, using stock price and dividends to compute total rate of return in the case of Page 6, we see book value. I'm going to have a few more comments on these slides at a later point in the call. So for the moment, I'm just going to move on and turn to market developments. As Orchid entered Q2 and as we positioned the portfolio towards the later stages of Q1, we had shed a lot of our exposure to lower coupons, production coupons in the 30 year space predominantly in our TBA positions we had added to our hedge positions. And we just started to deploy capital more towards IOs, that allocation has gotten actually inside of 10%. And since that we achieved two and it was 18 and is since actually slightly higher. In that we were positioned quite defensively entering the quarter.

[Operator:]

. Your first question comes from Jason Stewart from JonesTrading.

[Jason Stewart:]

Bob, thanks as always for the commentary and perspective. So I appreciate that. So I love the increase in the IO exposure. Maybe you could talk a little bit about what the levered ROE looks like in terms of the IO strategy versus just the core strategy?

[Robert Cauley:]

Well, the IOs, which we done chiming here too. First of all, a lot of the IOs that we've added are defensive in nature. So there's currently -- the collateralize by assets is in the money of prepaying fast. So those tend to be some negative yielding assets. The idea of being that in the backup in rates, those cash flows will extend in those will become positive yielding assets. With respect to the pass-through portfolio, I would say, they're comparable. As I went -- slide it was that the NIM is very comparable to where it's been. And so the combination of the two site compression and the overall ROE available but very much predicated on how rates in the market evolve overtime. If we were to stay here, we probably stay near those levels as you would expect. And then with upside in the event of a rate back up. And then I will open that up to Hunter if he want to say anything.

[Hunter Haas:]

Just with respect to the IOs specifically, I think we've been targeting really two types of asset classes. One is call projected securities with good underlying pool convexity. We have been sort of mostly focused in the 3, 3.5, the occasional 4%, primarily backed by loan balance collateral, some of which is paying a little bit faster. But where we're putting those on, those faster speeds and faster speed expectations are built, already built in. And our effective yields or option adjusted yields on those types of assets are generally kind of in the 2.5% to 3.5% model projected range. The front carry might be a little bit lower than that just because there is some burnout that's being baked into the model. So anytime you have a yield over cash flow or lifetime of cash flows or the remaining life of the bonds cash flows to the extent that speeds are going to slow down in the later years, it tends to be kind of back loaded. But I think that the ROE is based on where we are putting on, we’re repo-ing some of these, anywhere about 50 to 65 basis points sort of area. And so if we said, just as kind of a generic target, we were able to achieve a 3% yield on these IOs and 55 basis points, we're getting into that sort of low double digits return on our capital after taking effect of the haircuts, which are a little bit higher, say predominantly, I think the majority of our portfolio is on it with 20% haircut. So you're looking at maybe a maximum 5% leverage and maybe 2.5% NIM above funding there. But I think more importantly, the benefit for us is that we're able to decrease our reliance on rate hedges and that's particularly important. Bob spent a fair amount of time talking about how we always need to guard against a staff hiring rates, because that could be very devastating to us. But one of the things that we're also focused on is the fact that if we get something crazy and unexpected that causes us to rally and for rates to stay low that IOs tend to, or mortgage rates in general tend to sort of bottom out into a widening event. So it’s very simple mechanics. It's to the extent that mortgages widen then that means that the rates to borrowers are not going down as quickly as, say, the risk free rates, or treasuries, or swaps, or whatever. And so while we may experience some short term pain owning IOs and a basis widening move, ultimately, the cash flow streams are better, because fewer borrowers are able to refinance or at least they're not refinancing at the same sort of clip that we would have modeled into a lower rate environment. So that's -- the removal of those costly rate hedges and the ability to preserve a cash flow stream into a rally is something that we really like here.

[Jason Stewart:]

And so maybe, Bob or Hunter, how do we put, what you just said, with the disclosure, that plus 54 leads to $45 million loss to book value? Because it seems like that there might be some discrepancy between a perfectly parallel shift and some sort of elbow or steepening in the curve.

[Robert Cauley:]

Yes, that leads for a long time and we've been empirically trading much, much shorter than those rate stocks would imply. And so we like to look at those and certainly pay attention to them. But really last couple of years, we have been empirically much more flat than those rate shocks would imply.

[Hunter Haas:]

And I would say that the, just going back to the dollar amount of the losses, you had a very modest positive number on pass throughs, but then you have recapture, premiumization in that market. We also had a very big negative number on the IO book. So the portfolio was net negative. And then the biggest position in the hedge book that was a swap and also our swaptions, and we had a very meaningful erosion in those over the course of the quarter. And so the bulk of the loss was in the hedge book. But unfortunately that was not offset by gains in the pass through/IO book in fact, a loss. So it exacerbated it. So again, it was all -- if you had to summarize in one phrase, it was just meaningful underperformance of mortgages versus their hedges and that's it. I mean we got it both ways. The assets were down in price, as I said, mainly because of the IOs, but obviously, the hedges rallying across the curve. But our exposure -- we don't have as much exposure to long end of the curve but belly of the curve, we have plenty and it was still there.

[Jason Stewart:]

It just seems to me like that number, maybe overstating the projected net loss. But hopefully that that -- and then maybe the most important question my peers keep going. When we talk about levered ROEs with high single digit, low double digit kind of range versus 17% payout on book value. What's the reason for keeping the dividend at that level versus just changing it to a level that's consistent with levered ROEs?

[Robert Cauley:]

Well, I mean, I will say between the dividend at $0.065, it's certainly not because we earn $0.065 every quarter or every month, and we do have episodes where we earn above and below that. And what we're trying to do when we set the dividend is try to pick kind of the center of mass, if you will, of where we think we're going to earn going over longer periods of time. And there are episodes where you're above the line and there are periods where you're below the line. But unless we feel that that's a permanent shift then we're not typically going to change the dividend. Then given our outlook and what I said earlier about how we view the IO positions, we expect that we'll be at that number on average going forward. If something were to change, we were to -- meaningful deterioration in the economy or the outlook and it look like we’re going to stay in this low rate environment then obviously the allocation to IOs would probably not be warranted. The composition of the hedge book would not be warranted and the allocation to pass throughs will go back up. So there would be second transition in that direction. But if you go back to where we were in '19 and '20 and then when we entered even in early the first quarter when we had a very high allocation to pass throughs, over the last year and half when we knew were generally very attractive ROEs is that period. It’s just when you go through these periods of transition like we did in the first quarter and even this quarter, sometimes you get these outcomes. But we don't think that's going to change the long term outlook. And so -- and like I said, borrowing change in such outlook, we will continue down this path even if it means we're slightly under earnings for a few months.

[Operator:]

Your next question comes from from .

[Unidentified Analyst:]

I echo his sentiment. You guys did great call. You gave a lot of information on where you are and where the market is and quarter for that. Can you refresh me when you came into this quarter our book value?

[Robert Cauley:]

Into the second quarter, it was 494.

[Unidentified Analyst:]

Well, the end of the second quarter…

[Robert Cauley:]

471.

[Unidentified Analyst:]

Do we have an update as to where you are, where you expect to do right about now from maybe …

[Robert Cauley:]

We were up slightly from that number.

[Unidentified Analyst:]

And you were …

[Robert Cauley:]

, you’re breaking up a little up…

[Unidentified Analyst:]

Have you updated your -- your release of about a week ago or so shaped you to have been very active going into quarter end with your ATM, as well as into this new quarter. Is it still active or will it be as soon as this call is done?

[Robert Cauley:]

Yes, we’re probably likely to do so.

[Unidentified Analyst:]

And how much accretively, how much of the book value maintenance so far this quarter in a quarter where it looks like rates have moved long direction? How much of the this quarter so far can be laid at the feet of the accretive offerings you've been able to make so far this quarter?

[Robert Cauley:]

In Q3?

[Unidentified Analyst:]

Yes.

[Robert Cauley:]

I would have -- well, we're only up slightly . We had -- our equity issuance this quarter is modest. So I don't think it would -- I don't have that number I apologize. But I do not think it's significant just because we haven’t issued them, it’s just now we did -- some of the sales that occurred at the end of the second quarter settled in the first. So they're not reflected on the June 30 balance sheet. But the share issuance in this quarter obviously is much, much less than Q2. And by the way, equity issuance through the ATM in Q2, I wouldn't say was so much backloaded. We announced a new ATM on June 22nd but we have sold quite a few shares under the previous program in Q2 up to that date. So we’ve assumed there are programs of a certain size it ended and we started new one on June 22nd but at that point, we had already so far from share. So we were selling shares accretively to book throughout most of Q2 and much lesser amount early in Q3. And we would assume after this call, depending on market conditions and price -- performance of the stock that we may so in the future. But I wouldn't say that was so back loaded.

[Hunter Haas:]

I would attribute that most of the gains this quarter in the portfolio is being from, specifically, the Fannie 3 specified pools perhaps, so those have really done very well, especially into the end of -- the first three weeks of July, they really ratcheted it tighter versus where they were at the end of June and has outperformed -- and general mortgages have outperformed over the last week or two. So we’ve seen a lot of tightening in the last week or so, even in the TBA markets. But specified pools for the first few weeks of the quarter did quite well.

[Unidentified Analyst:]

Just regarding the earlier ATM, and will your Q have, will the Q be able to give a little bit better run down as to the characteristics of the slide relative to IO and the inverse IO positions?

[Robert Cauley:]

It's not in the Q and so we can do it now, but it's not in the Q.

[Unidentified Analyst:]

Just what the general lack in and what kind of seasonings characteristics and I'm sure you would grant me that IO spend to be a little bit leveraged selection of security selection and general pass-throughs?

[Robert Cauley:]

So there's really sort of a barbell approach. And so we have some higher coupon predominantly, predominantly fours with gross racks and say in 430 to 450 range. There's a handful of 4.5s in there that are really more generic in nature. These are pools that have very, very large negative durations and very high positive convexity. And then the other side of that barbell is really this collateral types that we've been adding over the last -- really starting in the second quarter and then it continued through the third, which are loan balance, predominantly loan balance, higher loan balance, say 150, 175 pay 3s, 350 to 375 gross WACs off of -- that are paying a little bit on the pass through side. The price then that continue to pay on the pass through side, and then some really pristine collateral that use IOs were ones that we made off of specs that we used to own. So 85K Max 4s, New York -- slow pay, New York 3.5s that does really on kind of the 20s, while good gross WACs. So less than 40 -- less than probably 50 basis points of spread above the coupon. So for the 3.5s, call in the 390s and for the 4s and the 445 sort of area. And so the idea is pairing possibly convex fast paying IOs with slower paying IOs that have a much flatter S curve that also have good convexity characteristics in the underlying pools. I don't have the combined gross WAC. I think that will actually be in -- I do have it, I’d take that back -- 441 for the kind of …

[Hunter Haas:]

IOs are 419 versus 440, but they’re much smaller..

[Robert Cauley:]

The inverse IOs book is relatively small, it's a little bit of a carry play We've added some kind of higher risk structures there with that. I think there is only like $5 million worth on the books. But they're like low strike inverse IOs off of custody collaterals. So it was sort of the same concept. They have very high sensitivity to interest rates and are going to do well. Most of the -- this was put on one trade, and it was basically sort of fading the fed in the short term. So by a relatively short cash flow that was very dependent upon money market rates staying low or LIBOR is staying low. And so that cash flow is working it’s way up pretty quickly and going our way so far. So it's been on the books for a while though.

[Operator:]

Your next question comes from Christopher Nolan from Ladenburg Thalmann.

[Christopher Nolan:]

raise in the ATM in the quarter?

[Robert Cauley:]

Which quarter?

[Christopher Nolan:]

Second quarter.

[Robert Cauley:]

I want to say 125 million at a average price of 540 in the second -- but it's almost 125 versus 540.

[Christopher Nolan:]

So is that net or gross?

[Robert Cauley:]

Net.

[Christopher Nolan:]

And follow-up on the previous question in terms of -- using the ATM going forward. Bob, given your comments in terms of your keeping the leverage ratio, it seem to be not that much changed. But given the outlook, it sounds like it's somewhat an attractive environment for you. Is the capital plan to continue to grow equity aggressively through the ATM?

[Robert Cauley:]

Well, it positions , so to speak. The price of the stock versus book value and the investment opportunities are there, we will because obviously it’s accretive to book value in doing so. And then hopefully it's maintaining earnings. If it's hurting earnings then it's kind of a short-term gain long-term loss. So we don't want to do that. And as I said, the leverage ratio may be down, it probably will go back up slightly. There's somewhat of a lag as you raise capital and deploy the proceeds and you don't earn the income on the assets right away. So that and just towards IO allocation, which is part of the reason why the leverage ratio is lower, we're not at but nearing kind of the target range for that. So at some point that will level off. And then I think from there, it really is just a question of how the market looks at the time and where we want to deploy the capital. Right now, it's 3% coupon and to a lesser extent, 2.5 and 3.5, mostly coupons are the vast majority of the portfolio and then IOs is those 100 related to the IO strategies kind of on the barbell in terms of different strategies, simplifying that that's kind of where it is. And then the other thing that might affect net income and earnings would be substituting IOs in for rate hedges, because those IOs have the potential to be obviously yield versus paying something. And the far outlook on rates materializes overtime and we're pretty confident that it will, but it's been a rough year-to-date. But if it does that will bode well for us book value and earnings and that would be in fact again happens then that would be very attractive time to be raising capital. Because we would be raising capital into a raising the current environment given our portfolio, which would be higher coupon and IOs. So if we see whatever drives it and if we see rates moving up over the balance of the year and the next year, that's good for us in terms of our positioning and also good for our earnings outlook. So yes, we would love to be able to raise capital into that scenario.

[Christopher Nolan:]

And on top of IOs, I mean, given your comments where you expect that at least for the next 12 months or so, short term rates to remain somewhat low and the yield curve to steepen. Given that, are you trying to keep your IO allocation -- capital allocation at current level?

[Robert Cauley:]

Yes, that's the idea, right? We didn't see that steepening occurring, which would be good for those positions. You never know how it's going to play out. I mean we saw in the first quarter, it didn’t play out very quickly and very moderately. And so we don't know that. We kind of never knew what we think we're going to hit but we don't know necessarily how that plays out. If at some point we thought we were kind of seeing the full extent of the sell off, and yes, you want to start getting rid of some of those, because you would have been monetizing those gains and maybe going into pass throughs. But yes, I mean, that's -- I mean, you never say never. And I heard Board this morning thinking that the fed should start raising rates early next year. But I also heard Powell on Wednesday and I don't see them raising rates anytime soon. So as a result that means the curve, which we think are on the front end has to steepen. So you never know but I think that's the way it's going to play out. I think it's going to take a while before they start raising rates.

[Operator:]

Your next question comes from Mikhail Goberman from JMP Securities.

[Mikhail Goberman:]

your prepared margins that you've seen some element of prepayment burnout so far in the third quarter. I was wondering if you could briefly just sort of expound on that a little bit. And also on the question of prepaying, how do you think they will respond to the removal of this adverse market ?

[Robert Cauley:]

I'll say a few words and then I'll turn over to Hunter. Well, just in the space that we reported, most of the -- what we’ve seen is an acceleration in speed and the lower coupons, production coupons, like 2.5s. And the reaction to the movements in rates has been much more muted in higher coupons. You have to factor in some other factors and if they count things like that, which vary from month-to-month, but not so much the last report but the one before that you did see slowing in higher coupons and somewhat of a continuation of that this month. And so like I mentioned on the call, you seen some very good performance of higher coupons late June and into July. Whether that sustained or not remains to be seen. But it seems if the focus from now of the originators is back to the production coupons it is obviously there, but much easier refi to actually to right, I mean it’s fresh, it’s the lowest hanging fruit. So that's where you're seeing those as they ramp up. Don’t forget in 2020 when primary secondary spreads were high and sales were high, a lot of the 1.5s, 2s and 2.5s that were originated had very high gross net WAC spreads, and typically hundred. So all the 2s were 3% coupons to the borrower, all the 2.5s were 3.5% coupons to the borrower, and now available rates are in the high 2s. So those people are the target. When we saw the first quarter and rates spiked higher than those borrowers were in the money, so the originators turned their focus to more seasoned higher coupon bonds or high SATO bonds. And we saw those speeds accelerate, but now it's kind of -- that’s reversed. And so that's what we're seeing. If we stay here at this level of rates for a long period of time, eventually they'll refi all the 2s and 2.5s and then they'll turn their attention to the higher coupon borrowers again. And I'll turn it over to Hunter to add his thoughts.

[Hunter Haas:]

Yes, I think that we've been investing with a little bit of a base line philosophy that rates aren’t going to get materially below, call it, 280s to the borrower. And so one of the trades we've been putting on and I've done so in quite large size are elbow shift strategies with low gross WAC, so call it collateral from -- where the property is in the State of New York that are say 330, 340, gross WAC where elbow shift is taking the real some incentive to refi away from those borrowers at 275, 285, call it, refi opportunities. And also, we've gone fairly deep into agency or investor pools. There was some release earlier in the year that agencies were going to strictly limit the number of investor pools that could come through -- content through in agency form. We've seen a dramatic drop off in terms of production that production has really shifted over to more private label side of things. And so, so far it’s been a strategy that has also sits with us over the elbow shift strategy where those are typically the ones that we added and I think were 330 to 350 gross WAC, but the GSCs really don't want to be focusing on those at the moment. And so it's proven to be a good strategy for us, and we'll continue look at other things. We had a little bit of a disappointment, and our loan balance collateral, I think that was about, in July, that was I think a byproduct of the refi now initiative, which is looking to refinance low income borrowers. Obviously, that's one of the risks you take when you invest in low loan balance collateral is that tends to be some low income borrowers in those pools as well. I think that's going to maybe have a month or two's worth of negative impact, and then all of the borrowers that really qualify for that, for that new program or that are at least receptive to refinancing as a result of it. And it kind of work its way through the system pretty quickly I think and through our pools pretty quickly. So we continue to be pretty bearish and hence the allocation to that I think similarly, I guess 2, 3 -- 3% buckets, so we've been very, very picky about the gross WACs in the pools that we've acquired in the 3% bucket and we’ll continue to do so, try to keep it somewhat under 3.5%, which really in conjunction with whatever specified characteristic we're layering on to that collateral, makes it at least at this point not really worthwhile to go through the trouble as some loan.

[Robert Cauley:]

And Mikhail, you mentioned the adverse market, that is pure cut to the rate to the borrower assuming they’re passed on to vast majority cases, that reduction or elimination of that fee is off savings to borrowers and just lower available rate available to borrowers .

[Operator:]

There are no further questions at this time. Presenters, please continue.

[Robert Cauley:]

Thank you operator and thank you everybody. We again appreciate you taking the time to listening on our call. To the extent that any other questions come up after the call or you listen to the replay and you want to call, as always we're available at the office to take those calls. The number is 772-231-1400. Otherwise, look forward to speaking to you at the end of the current quarter. Thank you.

[Operator:]

This concludes today's conference call. Thank you everyone for participating. You may now disconnect.