Orchid Island Capital, Inc.
Q4 2020 Earnings Call Transcript

Published: 26 Feb 2021

[Operator:]

Good morning, and welcome to the Fourth Quarter 2020 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, February 26, 2021. At this time, the company would like to remind the listeners that 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.

[Robert Cauley:]

Thank you, operator and good morning. I hope everybody had a chance to download our flipbook, which we posted on our website last night. And as usual, I'll be going through the flipbook over the course of the call. I just want to start off by saying that Orchid had another very strong quarter of continued book value recovery from Q1 and strong earnings. We continue to pay a very attractive dividend that is covered by earnings, which in turn allows our stock to trade at or above book value, which it has for several months now. And again, this in turn allows us to opportunistically raise capital by either our ATM or our secondary whenever opportunities in the market present themselves. This of course gives us a chance to enhance the earnings power of the company. With respect to the slide deck, we do maintain the majority of the slides from quarter-to-quarter depending on the quarter, some are more relevant than others given that we're kind of late into February, I will be skimming over some especially the ones on the market focus slides. And then also given the significant changes in the market especially over the last two weeks, I will spend some time going over steps that we've taken with the portfolio since year-end. With that, just go over the slide deck now. As usual, start off by giving you the highlights for the quarter of our results. As I said we'll go through the market developments relatively quickly, discuss our financial results and then spend the most of the time talking about the portfolio, our hedged positions and changes made to bulk over the course of both the fourth quarter and year-to-date. With that on Slide 4, Orchid reported income per share of $0.23. This is net earnings per share of $0.30 excluding realized and unrealized gains and losses on our RMBS, asset and derivative instruments including net interest expense and interest rate swaps. We had a loss of $0.07 per share from these realized and unrealized gains on our RMBS and derivative instruments including a gain in net interest expense on the swaps. Book value per share was $5.46 at the end of the year, an increase of $0.02 or 0.37% from the end values into the third quarter of $5.44.

[Operator:]

Our first question comes from Jason Stewart with JonesTrading. Your line is open.

[Jason Stewart:]

Thank you for the update for the 1Q activity. I was wondering, it sounds all great in terms of the way that rates have been incredibly viable and sort of resettling out here. Can you put a pin in it and sort of estimate what book value per share is, after doing all that?

[Robert Cauley:]

It's quite challenging, we're certainly going to be down slightly. I would say yesterday accounted for at least half of the move quarter-to-date. The problem is, I mean we have a rough estimate, Jason. But what we don't have is a lot of exposure to spec pool levels. There was very little activity yesterday, and the day before, and nothing that you can really benchmark off of, for instance, we saw some 50 wallet door five 4.5% trade and very seasoned higher coupons. Next week, we will probably see in all the origination lists, we'll get some levels on specs. And we're also seeing some recovery today in the market. Very choppy as I said for the last two weeks and meaningfully so yesterday. I would guess that - all of the move in our book value of quarter-to-date, over half of it occurred yesterday. So, it's definitely going to be down a few percent. But I would be hesitant to put too fine a pencil to that level, and also probably going to be changing in a few days anyway.

[Jason Stewart:]

Right, and the quarter is not over, correct?

[Robert Cauley:]

Yes.

[Jason Stewart:]

When we think about the IO positions, how big? You know, it's been trending down for quite some time for good reason. How big do you think it could be? And do you really think it's a true hedge against spaces widening? Maybe put some thoughts around that, that will be helpful?

[Hunter Haas:]

Yes, the basis aspect of it is a little bit challenging, because the - mortgage derivatives tend to widen with just - regular pass-throughs or TBAs or what have you. I think what we find, though, as just as it relates to the refinance ability of the underlying instrument. That does present an opportunity when you have a large widening and say, like TBAs. And you have primary rates increase. There will ultimately be kind of dollar-for-dollar if you will impact in the derivatives because they are so sensitive to prepayment. So, but on a mark-to-market basis, as you're going through a period of widening basis, we’ll definitely experience the same sort of problems and on a levered fashion that mortgage as well. But the fundamentals are vastly improved when something like that happens. My answer to the question in terms of how much more would we add, I think its very opportunity dependent. Bob alluded to the fact that we added an inverse IO off of a front sequential that we've been holding in the portfolio for a couple of years. That collateral was off of New York force, and has been behaving rather well. We thought like the floater market would have caught enough of a bid with this sell-off and the demand taking up for those that we could sell one with a really low cap. And maintain a short cash flow and - that really dovetail well with our kind of our macro view that we will see bearer steepner and the long end could get quite volatile. But we believe that the Fed is going to remain anchored at or near zero for the next couple of years. And so, if that plays out, while that cash flow does have exposure to higher rates on the front end, we like that trade, something that - I think we would do more of if we found the right opportunity.

[Jason Stewart:]

Thanks a lot.

[Robert Cauley:]

Space is hedged just to chime in a bit. I mean - let me on the basis close out. Like, I think it's really important understand that at the end of 2020 and into the early parts of the first quarter margin gain really, really tight TBA, OAS depending on your model, most people use benchmark off of yield book, minus 20, minus 25, very, very tight levels. And so, while we've come off a lot, you're coming off a very tight level. So mortgages are not at multiyear cheeps by any stretch or the imagination. Their fair or more fair wearing proper programmer is.

[Hunter Haas:]

At the end of the day, if you're trying to hedge that basis, you know, rates are not going to be 100% effective. The only thing you can really do is short TBAs or maybe put options on TBAs. We added this you know - when you are a REIT, you have limited ability to do that. I mean you can’t hedge a 100% of your mortgage exposure. You kind of have no reason to be in a business on a lease for any length of time. So, you're going to be net long, and you benefit when it tightens and you suffer a little when they widen.

[Operator:]

Our next question comes from GMP Securities. Your line is open.

[Unidentified Analyst:]

Good morning. Thanks for taking the question. Definitely we appreciate the comments on book value and portfolio positioning in the first quarter as well. Just the question on how you guys are thinking about leverage going forward? Obviously, it looks like it's going to be a pretty volatile while the year in mortgages and rates. And also how you guys are thinking about the dividend going forward? Thanks a lot.

[Robert Cauley:]

Sure, well yesterday I presented it to the Board, and the way I really deeply believes that, we were very well levels of rates all-time lows, and we started to sell off. And as we got more for 1%, approached 120, on the mortgage market started to get skittish, and my view was that 125 or 130 was that point where the 2.5% coupon, no longer refinancable, and mortgage investors were going to really become concerned with extension of the mortgage universe. But I also thought, if we went for instance, from 125 to 150, 110 that would be a very painful episode for mortgages. But once you got above that level, or meaningfully above that level, I didn't really think you could go much higher in rates, for instance, rates across the bond, either bond are still relatively low compared to ours. And so, there is that kind of our, there is also the potential impact on the equity markets and financial conditions and the likelihood that the Fed wouldn't tolerate that would step in. And maybe extend the land with their purchases, that kind of thing. So I really thought there was at least a soft cap on rates. And so if we could get to that level north of 150, where refinancing activity was meaningfully subdued, but the Fed hadn’t hiked, you had a very attractive investment opportunity. And so, we kind of got there much quicker than we thought. But now that we're here, if we stay here, it's not that bad of a place to be, yes, mortgages are wider, give up a little bit of both to get here. But the earnings are look a very, very attractive. And so maybe we stay volatile like this for the balance of the year, in which case, we'll just have to face that deal with it. But if rates stabilize in a higher range, call it 140 to 160, whatever it happens to be, it's really not a bad place to be. And I don't think that puts downward pressure on the dividend. Yes granted, we've had to change the hedges somewhat. We even took the leverage down a little bit, but we view that as temporary because we're just trying to protect ourselves through this move. But unless we stay in an extremely volatile market for the balance of here, I would expect we'd be able to remove those. And so, it gets us back to an environment where it's again, it's you know, the curve is steeper funding still cheap, prepays are lower. And the big challenge of 2020 was avoiding excessively high refinancing activity. So everything we talked about it every earnings calls of all the steps we're taking to keep refinancing down and we show you all these slides in the earnings call deck about how our portfolio prepaid versus the cohorts and so forth. But now that's less of a concern. We have a steeper curve and slower speeds, so I don't see anything negative.

[Operator:]

Our next question comes from Christopher Nolan with Ladenburg Thalmann. Your line is now open.

[Christopher Nolan:]

Any idea in terms of where prepays stand here to-date?

[Robert Cauley:]

Yes, we had two very good months. We'll get another one next week, but we did. We can get to those numbers, but they were in our most recent press release in February, we put out our February dividend, we had the January prepays, which were - the prepays released in January were 16.7 for the past three years and 44 for the structure, combined total was - I think it was 20. I think, in Q4, they were - not what that was. Chris, I don't have it in front of me, our February press release had the January level and February, which was not released yet, I expect to be in line. So it's been a good, slower than Q4.

[Christopher Nolan:]

Great. And then, I guess, how much of your capital you're allocating to IOs?

[Robert Cauley:]

Well, it's - now it's probably just about marginally over 10%. No, it has gotten well under 10. With his inversely took back and it just kind of said, you know, that may be an attractive asset for us to pursue or other IOs. We typically looked at IOs as much as hedges versus income. And so we wanted IOs that had a lot of extension potential, in other words, something that was paying fast now, but in the event of a sell-off, would extend and slow down. And so there were plenty of others available before, terrible carry instruments. And they've done well quarter-to-date, very much so. We'll look maybe to opportunity add those, I think the allocation to past year is well, north of 90 is probably no longer warranted. But as Hunter said, it's really opportunity driven, when the opportunities present themselves we'll take a step. Really what's been driving, I will say this is that I kind of mentioned, part of the reason that we got away from high coupon, high pay up premiums in Q4. And this continued into Q1 is the demand basically, it's from the street, a lot of these CMO desks pay up for this collateral, because they can carve it up and create far reach price bonds for banks, the bank demand in the mortgage space has been very, very strong, Q4 and Q1. Deposits are very high, and loan growth has been modest. So they've been big buyers of mortgages, and they tend to buy around par, so the street can buy attractive collateral that looks great on a OAS model, and create a par-ish price script on bond, and then whatever is left gets set off to the rest of us. But it makes it very challenging to compete against that when you're participating in these origination cycles or auctions, because they're very aggressive bid. And that's really what drove us away from those securities. And that's in our minds, it's like, you know, this is a chance to sell these payoffs at very high levels, rates are going higher, and these payoffs are going to be imperiled, if rates shoot higher in a short period of time, which is in fact what happened. All of a sudden, the low loan balance Fannie 3 or 3.5 is that pay up premiums going to drop, so we were selling those, and adding lower quality specs and lower coupons, and we realized very low speeds off of those so. So that CMO bid, we'll see if it stays there now that we've moved higher in rates, but that was a big driver of spec levels up until the most recent few weeks.

[Christopher Nolan:]

And then two more questions, I appreciate the detail Bob. In your comments, you indicate that you're shutting the lower coupon, position is particularly for those with really long terms, 30 years and so forth. What are you focusing more on now if you can just - because I missed that.

[Robert Cauley:]

to added maturity, 20 years and 15 years. And we actually just - we didn't actually sell 2.5, but we did add 2.5 TBA shorts. We view that as kind of a temporary trade just to kind of get us through this turbulent period. The 2.5 will probably continue to own those going forward. We may not have those shorts in place, but otherwise it's just been shorter maturity mortgages. And we may add some higher coupons are probably going to start seeing more than produced. Probably going to start seeing some 3s get produced in the next few months. So we'll revisit those - with the levels - drive our decision making a lot.

[Christopher Nolan:]

Final question. In terms of - as you're going forward and the environments changed a lot. And from my position, it looks like it's pressuring book value, but your earnings outlook looks good, where is the balance for you in terms of sacrificing book values to protect earnings and so forth, or vice versa?

[Robert Cauley:]

Well, it's fortunately, when you get a move like this, it's so sudden, you can get very cautious and add to your hedges, which are going to put downward pressure on earnings to protect the book. And if it does episodes over quickly, then you know, it's a minimal impact on earnings. I mean, our thought process is, we're willing to sacrifice a little bit of earnings in the short run to protect the book. If it's a long, long grind higher in rates, then we have to fine tune our analysis to find the appropriate balance. This played out quite quickly and we expected this to play out over the first two or three quarters, and in fact, it played out in three weeks. So like I said earlier, on the last call, if we get to a level of rates, especially if it's north of 150, and appear to be rich standing into a range, then we can get - take off some of the hedges and not irresponsibly. So - but be able to attract generate pretty nice returns in that environment. But like I said, I think there is a soft cap on rates, I don't see that tenure blowing through 2% anytime soon, I don't think the Fed is going to be willing to - the equity markets going to tolerate that and which in cases force the Feds hand.

[Christopher Nolan:]

Okay.

[Hunter Haas:]

Chris, just may just do a follow-up on the on the speed question, the current mix of the portfolio. The one month speed as of the most recent prints, which was earlier this month was 13.7. And three months speed was 11.2 for the specified tools, which are of course the most sensitive. So one other point to add there is a correlation between the drop down lowering coupon from the end of the year into the New Year here, because the premiums on those assets are substantially lower. So we have been sort of two factors going on. One is speeds are a little bit slower, but two is the negative impact of those speeds is a little bit smaller as well, because the premium on the assets isn't quite as high.

[Operator:]

And there are no callers in queue at this time. I'll turn the call back over for closing comments.

[Robert Cauley:]

Thank you, operator and thank you everyone. As always, if you have additional questions, please feel free to call us. The number in the office is 772-231-1400. If we're not at the office, which is often the case these days, we can be reached by cell, but I will leave that to our office manager to end that up. And otherwise, we look forward to speaking with you next quarter. Thank you for your time today.

[Operator:]

This concludes today's conference call. You may now disconnect.