Orchid Island Capital, Inc.
Q1 2021 Earnings Call Transcript

Published: 30 Apr 2021

[Operator:]

Good morning, and welcome to the First Quarter 2021 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, April 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 the 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 everyone. I hope everybody as usual has had a chance to download our slide deck, which we put up on our website last night, and I'll give you a second to get ready and then we will as always walk you through the slide deck. As usual, I'll start on Page 3, just kind of go over the table of contents in other words set the agenda for today's call. Now, the first thing we'll do is as usual just go through a summary of our results for the quarter, spend some time talking about market developments that occurred throughout the quarter and then go through our financial results and then spend the bulk of the time talking about our portfolio characteristics, hedge positions both with respect to what happened during the quarter and what has happened since quarter end, if anything, which in those cases we did do some things and then just give you some comments on how we see things going forward and just some more high level comments on the performance of the company for the quarter. So with that, I'll turn to Page 4. For the quarter, ended March 31, 2021, Orchid reported a net loss per share of $0.34, net earnings per share of $0.26 excluding realized and unrealized gains and losses and our RMBS and derivative instruments, including net interest expense on our interest rates swaps. We had a loss of $0.60 per share from net realized and unrealized losses on our RMBS assets and derivative instruments, again including net interest expense on our interest rates swaps. Book value per share was $4.94 at March 31st, a decrease of 52% – $0.52 or 9.52% from $5.46 at December 31st of 2020. In the first quarter of 2021, the company declared and subsequently paid $0.195 per share in dividends. And since our initial public offering, the company has declared $11.915 in dividends per share, including the dividend declared in April of 2021. Total economic loss for the quarter was $0.325 per share or 6%, 23.81% annualized. On Slide 5 and 6, we present our results versus our peer group; the peer group is defined at the bottom of the page. The first page is as of March 31, which is using stock and dividends to calculate total rate of return as usual we’ll present this fall. When they look back date as of 3/31, so one year back from 3/31, two years, et cetera and then of course each calendar year as well. Slide 6 dose the same thing that for book value as always the case we do not know all of the book value numbers from our peers. So this data is presented with a one quarter lag, so it would be through the fourth quarter of 2020.

[Operator:]

Your first question comes from the line of Jason Stewart from JonesTrading. Your line is open.

[Jason Stewart:]

Thank you, and thanks, Bob. How are you? Thanks for the as always comprehensive overview. I was – two questions with regard to net economic spread. Could you give us a sense of where that's ended the quarter and just remind us how hedges like futures or so our TBAs would roll into that number that's being reported?

[Robert Cauley:]

Yes. But it was probably not meaning for giving what I just discussed, with respect to how those affect and, obviously, I'll just go through a laundry list. I'll turn it over to Hunter, because he'll have more to say. With respect to paying fixed on swaps, obviously, that's pretty straightforward. You're just paying whatever that rate is in the case of the 10-year swap; obviously, it's much higher than the five-year point in curve, given how steep the curve was? With respect to futures, as you roll through time, remember futures are March, June, September and December as you walk from contract to contract, there is a drop, and we use that component to do as an expense. With respect to TBAs, it's the drop we have used the threes because the drop was negative. That's no longer the case that's why we reduce those. And swaptions is basically the premium you pay.

[Hunter Haas:]

Yes, I would just add. We didn't add meaningful amount of what I would characterize is expensive long end rate hedges. So it was a modest increase to 10-year part of the curve, both through paying fixed on swap or 10-year part of the curve, as well as putting on a handful of altruist, which do have a rather large negative carry component to them when you're shorting them, just because of the shape the curve is so steep. We've subsequently, as we've increased our allocation to IOs, we have pulled back some of that hedge and done so at levels where we're not going to really earn out that negative carry so to speak. With respect to the TBA position most of what we rolled into April and May was down at negative levels, right? So the TBA performance of Fannie 3s has been so poor over the last several months, that just because cheapest to deliver the quality that keeps deliver collateral that coupon bucket has been so bad that you actually can short the coupon and clip a little bit of carry in a positive manner. So we've taken advantage of that where we can, it's justifiable to do so, because we own a lot of 3% coupon, specified pools, and in fact, we own a lot of times – we own a fairly large position of what we would characterize as a low payout pool. So to the extent that their performance decreases over time and they become more like the cheapest to deliver, we can always just cover their shorts by delivering pools into them and clip the carry on the specified pools while they're still a superior asset. So I think for those reasons, I agree with what Bob said about not being materially different at the quarter end than it was in the presentation.

[Jason Stewart:]

Got it. Thank you. That's helpful. And then on the capital raises during 1Q, can you give us a sense for how much those were either creative to book value or the approximate book at the time of the raise? Just trying to get a sense for how that impacted book value per share.

[Robert Cauley:]

The first one was slightly dilutive and the second one was right at book.

[Jason Stewart:]

Great. Thank you.

[Hunter Haas:]

And then at that time, yes. Those were deterioration in the quarter came and the last three weeks of March. So we'd have a small decrease in book up to that point. But, yes…

[Robert Cauley:]

I would just – I mean, I'm sure you're thinking about this. Book value for the month of January was probably up very modestly. February probably hung in until mid-month. Then we started to go negative, maybe slightly negative by the end of February. And I would say at least 75% of the client in the quarter occurred in March and really after, I forget what day it was, whatever the day non-farm payrolls was released. I want to say, it was on March 5th. It was really after that. I mean, one of the big drivers of that was and also you may recall was when Powell made it clear that he was comfortable with higher rates. That's kind of like green-light in the market for way to go much higher and we kind of crushed it right at the end of the quarter at 331, just sort of 175 and 110s.

[Jason Stewart:]

Okay. That's helpful color. Last one for me and I'll jump out. You just tie the – give us a reminder on the metrics there, KPI you look at to set the dividend and remind us, how that interplays is moving through with all the changes that were made in the portfolio towards the end of the 1Q and then as you're continuing to evolve in 2Q? That would be helpful. Thanks.

[Robert Cauley:]

Sure. We look at just to start big dividends and obviously, an artifact of taxable income. Well, we don't really look at taxable income. It's basically what we call economic income, which looks a lot like GAAP with two minor adjustments. So one, we look at more of our economic cost of interest expense which in therefore reflects hedge costs, because we didn't each hedge accounting for purposes of GAAPs. So all of the changes in the market value of our hedges are reflected in our earnings, but not all of that would necessarily be attributable to the current period, if we were using hedge accounting. And then the second one is just to try to capture premium amortization. The one thing that's unusual about the fair value option that contrast sharply with available for sale, available for sale. That will help for you buy an asset and at the time you booked yield and you use that yield assumption to amortize premium. Every quarter, you may refresh that level and then call that the retrospective adjustment. But in contrast to what we do, when we use our value every quarter. We mark portfolio to market, and that resets the level you use for premium amortization. So we reported on earnings released something called Premium lost due to pay-downs. But remember that's reflective of the levels that existed at the beginning of the quarter. So if you have a year like 2020, when asset prices are very elevated, it's going to make it appear like you're advertising a lot more premium that actually existed, maybe at the time you bought the asset. So that is just one nuance of our accounting, but otherwise those are the two adjustments that we make to look at for the purposes of adjustment. Now, I will say that I mentioned, we took off some of our TBA loans. We intend to put those back on. There were some adjustments to the head book and then subsequent adjustments to that and through replacing IOs. So there's a lot of fluidity here and the net interest margin if you will somehow calculated on a daily basis, you would probably see fairly meaningful fluctuations as we go through this process. But we expect when we come through the process when we're done and we're almost there that it should look pretty much as it did for the average of the quarter. As I said taking off some of these hedges, putting on the IOs and so forth, we still think that net of all this is going to be about awash. The unknown as it relates to the way we look at dividend policy is really going to be how much speed slowdown over the next month, two to three and we'll observe that. We're pretty bullish about the outlook for higher coupon mortgages and the IOs that we own, which are tend to be off of slightly cuspier assets, at least the ones we've been adding are off of cuspier coupons. And then we own another slug of high negative duration in the money loans, which we also expect a slowdown. So over the – we really are just positioned to – I think The Street is really just – at the point where it's expecting a slowdown and speeds maybe next sprint, but certainly over the next couple. And we'll see how we settle in with respect to the slowdown and speeds as a result of higher rates.

[Operator:]

Your next question comes from the line of Christopher Nolan from Ladenburg Thalmann. Your line is open.

[Christopher Nolan:]

Hi, Hunter, on your comments just now, I'm bullish on speeds, is that for the market in general or for Orchid Island specifically?

[Hunter Haas:]

For Orchid specifically. I think, all the models we use – I look at and all The Street research shows a significant slowdowns in speeds especially for higher coupon collateral that would be a big part of our portfolio, so 3s, 3.5s, 4s. I mean, we have some loan balance 4s that are paid in the mid 20s. And I think the expectation is for those to slowdown into the mid-teens over the course of the next few months. So that's not an enormous position for us, but I think it's a good example of what has – developments that have not fully played out yet.

[Christopher Nolan:]

And what is – can you share with us what the allocation of capitals to IOs in the second quarter so far?

[Hunter Haas:]

We added about $46 million in market value. So at quarter end, Chris, it was 40 – just over $40 million, which was 10%. So we've added 46. So it's approach, it's probably 20%. So it's 86 in the calculator. We have 86 divided by 4.60 is or 4.65.

[Robert Cauley:]

Close to 20%.

[Hunter Haas:]

It is probably getting a little higher still.

[Christopher Nolan:]

Great. And Bob, in your comments in terms of steeper curve, I mean, higher rates, do you mean by that a steeper curve?

[Robert Cauley:]

The curve is steepening now, and the Fed keeps doing a very effective job of talking to market , whenever it starts to price in any form of policy removal in the near-term. They generally did it this week, but I think – so the curve will stay fairly steep as I mentioned this quarter to date. We've kind of backed off the highs in rates and we've flattened, but really modestly. I think the curve is going to stay steep for some time, but in the camp that the Fed is not going to be able to wait that long to start tightening. I think – and I'm sure you hear the same things as I do. Anecdotally, there's evidence of inflation. It's not obviously the baseline effect. So like if you look at today's number PCE looking back at April of 2020, it's a very low bar, so the number looks high. That's transitory. I agree with the Fed 100% on that. But when you hear Procter & Gamble and other entities that are raising prices and Amazon is going to give raises to 500,000 employees. Those aren't transitory. And then The President's speech on Wednesday night to the extent he's successful with these programs, the systems already awash with liquidity. I don't know if anybody follows the RRP market that's the reverse repo that the Fed runs. So that's where people are trying to get rid of cash and taking the assets. That's at zero or very close to zero. Yesterday, the Fed did, or the treasury did a one month bill option at zero, maybe they eventually go negative, but we're just awash of liquidity. So the combination of pent-up demand, substantial demand for goods and services COVID induced supply shortages, whether it's labor because people aren't coming back to work or all the other things you hear about bottlenecks commodity prices, chips for automobiles and everything else, a combination of huge demand, constrained supply, and then a fed/treasury that is flooding the market with liquidity, I hope they are writing its transitory, but I'm beginning to think that that may not be the case. And they are overly sanguine with respect to their concerns with inflation. So I just think it's hard-pressed for that not to play out that way. And the Fed as much as they say that they're not going to tighten them, at what level could inflation run where they had to change their mind, 4%, I don't know. But I would expect non-farm payrolls to be very robust, retail sales to remain robust. Everything is going to be very strong. And over time I just think that they're going to have to move their timing forward and then you're eventually going to see the curve flatten, and they're going to start pricing in hikes than they're eventually going to have to.

[Hunter Haas:]

Yes, Chris, that's potentially germane as it relates to our fourth quarter results. We saw a steepening of the curve, mortgages selling off, and then really in March that full sort of convexity effect started to hit the portfolio where we started to see the deterioration in pay-ups of specified pools and an extension in mortgage assets. And as you know, we have for several years preferred to shorten the belly of the curve and we just didn't get as much satisfaction being in that point because it hasn't moved yet. The two year is still very much anchored near zero. I mean two year treasuries are in the near 15 and 17 basis points. So the market is not pricing in higher rates on that part of the curve yet, which ultimately affects the belly of the curve hedges that we have on such as the five and even to a lesser extent the seven year swaps we have on. But that I think we will sort of have our day at some point when the market feels like the Fed can't stay on hold forever.

[Christopher Nolan:]

Okay. That's it for me. Thanks guys.

[Hunter Haas:]

All right thanks, Chris.

[Operator:]

There are no further questions at this time. I turn the call back to management for closing remarks.

[Robert Cauley:]

Thank you, operator. And thank you everyone for joining us today to the extent you aren't able to do so live then you listen to the replay and you want to ask a question or if you have another follow-up question from today and you did listen, feel free to call us as usual number in the office is [phone]. Again, I thank you for listening and I will look forward to speaking to you at the end of the second quarter. Thank you.

[Operator:]

Thank you everybody for joining today. That concludes today's conference call. You may now disconnect.