Orchid Island Capital, Inc.
Q2 2017 Earnings Call Transcript

Published: 1 Aug 2017

[Operator:]

Welcome to the Second Quarter 2017 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, August 1, 2017. 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 the 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. Now I would like to turn the conference over to the company's Chairman and Chief Executive Officer, Mr. Robert Cauley. Please go ahead, sir.

[Robert Cauley:]

Thank you, Operator and good morning, everyone. For the second quarter in a row, we placed a slide deck of supplemental materials on our website late last night after we released earnings at around 4

[Operator:]

[Operator Instructions]. And our first question comes from David Walrod of JonesTrading.

[David Walrod:]

Can you tell me were there any shares issued in the third quarter by the ATM?

[Robert Cauley:]

No.

[David Walrod:]

Okay. Can you talk, I guess -- it looks like, based on your average share count and then your end-of quarter share count that the capital raised in the second quarter, the timing was more back-end loaded. I guess, can you just talk a little bit about the speed with which you were able to deploy the capital and any drag that the capital rates may have had on your earnings for the quarter?

[Robert Cauley:]

I'll talk about the shares and Hunter can talk about the deployment. Yes, the most of the shares were sold in May and June. Actually, we -- I think around the 20th of June, we exhausted the program. So it was back loaded. And then I'll let Hunter talk about the deployment.

[George Haas:]

Yes. We're running in a little bit of lag in terms of the putting the money to work. When we closed the proceeds from the May sales and June sales, we really didn't have the portfolio invested for a full month associated with the proceeds from those respective monthly sales. So any capital we raised in May, we were buying bonds in May and really settling them, sort of, mid-month. June was the same. And in fact, we ended June with the leverage a little bit lower than we were targeting. So that has since ticked backed up a little bit. We're kind of in between that 7 and 9 number that we reported and maybe one turn higher. So upper 8s now. So I think, just from the standpoint of earnings, the -- in July, at least, not having raised any capital in the month of July, we would expect to see a little bit of an earnings rebound. And then just -- that will ebb and flow based on what we're able to do with the ATM to the extent that we're raising money going forward. We might -- we always going to have a little bit of a drag to the extent that we're not buying the assets or sort of prebuying the assets. So -- but I think -- as it stands today, we'll have a bit of a recovery and -- from whatever drag was caused by the second quarter earnings -- or second quarter capital raise, I should say.

[David Walrod:]

Sure. And my last question is just on speeds. They were pretty well controlled in the second quarter. Can you give us how they've come in, in the beginning of the third quarter in your outlook?

[Robert Cauley:]

So far so good. July was actually one of the better months, really since going back to early in the year. We had positioned for an uptick in, sort of, summer seasonals. And in doing so, we were just sell some slightly seasoned pools and buy some new issue stuff in the summer production months. And so it looks like that's working out and we'll know more early next week, whenever the August speed report comes out. But we feel pretty good about the way we're positioned.

[Operator:]

[Operator Instructions]. And our next question comes from [indiscernible]. Your line is open.

[Unidentified Analyst:]

I think you answered my question. I was looking at the leverage number and looked like there's a large payable there that was being excluded and I was getting leverage in the 8s and I think, you just said that the leverage is in the 8s post the settlement. So I guess, that was my question. And then my second question regarding leverage is, how should we think about leverage? I know you guys say that the environment is a little bit tricky. But leverage is still in the high side. Is that just an output based on the income you want to earn? So as mark-to-market goes down, leverage goes up? Or how do you think about that?

[Robert Cauley:]

Well that's very true. That happens as well. The biggest driver for us is just the allocation of the capital. So we're very high in our allocation to passage right now. And I didn't really mention that on the call I meant to, but normally, we would be much closer to 50-50. And also, when we raise capital like we have, we typically put the money to work by buying pass-throughs and then later on, IOs after the fact. The IO market is just not very attractive right now. So we're still a little on the high side with our allocation to pass-throughs as a result and then, of course, our leverage. The reason we're okay doing that, as I said, the market is really, especially in the last, say, mid-June and beyond, priced the Fed out to a large extent. And if you recall when the June FOMC, meeting, the Chair said that she viewed the recent negative CPI prints or low CPI prints as a result of transitory factors. She since backed off of that. We've now had four straight months of disappointing inflation data and the market has really priced the Fed out and the back end of the curve was -- we've had a big flattening. So we don't -- it's not that we think rates are necessarily going to go higher anytime soon. We just think that they've kind of come down as far as they can. I mean, unless you really think the Fed's going to -- or the market is going to price in and ease. they've kind of priced out all the tightening, I think, they can do. And in the market, especially with what is now viewed as almost a certainty that the Fed is going to start tapering their asset purchases. That's just going to -- if it takes there is any inflation, that's going to dampen it even further. So the market is content with the fact that we're not going to see much inflation. We're not going to see much Fed hiking and as a result, [indiscernible] very well. So we're comfortable and running the leverage and having the allocation. The pass-throughs be a little higher than it maybe would've been otherwise or certainly would have been the case earlier in the quarter. But -- so that's kind of how we look at it.

[George Haas:]

Yes. But we hate to reduce to leverage right after a quarter where, specifically, 4.5 coupons underperformed so bad. So like Bob alluded to in his prepared remarks, any 4.5s were up 0.5 tick and the 10-year treasury was up 24. So that's a pretty massive underperformance. And I think that we're reluctant to delever into that. Although it is, like we said, running a little higher than we would like because we're not able to buy the mortgage derivatives that we would typically want to acquire.

[Unidentified Analyst:]

Got it. And then, how much -- now that we're talking NAV and pricing. How much NAV or book value was created via the share issuance? I'm assuming...

[Robert Cauley:]

Well, we can't give you a precise number. Yes, we can't give you a precise number, but I would guesstimate the number is between $0.10 and $0.15 for the second quarter.

[Unidentified Analyst:]

$0.10 and $0.15. So close to 2% for the second quarter? It just looked like you guys issued 25% of the float or something. Don't have it in front of me, but it was a big number.

[Robert Cauley:]

Yes. I mean it was close to -- yes. This was a big number. The number of shares outstanding was up -- it was $125 million ATM program. We did a little of it March and blind share of it was done in May and June. So we took our capital base up quite substantially. No, I didn't say it also on the call, but this program, we've been running ATM since late in the second quarter of 2014 and the vast, vast, vast majority of these shares have been issued above book. So it's -- not only is it a cheap form of capital raising, but these are shares issued generally above book.

[Unidentified Analyst:]

And can we expect to see another ATM filed this afternoon?

[Robert Cauley:]

We may. And just because we put one in place doesn't necessarily mean we're going to be selling either. We look at the stock price, where our book is and what the market is. So we tend to like to have them in place, because you always want to have the option to do so. But that doesn't mean that necessarily we're selling shares. And by the way, we have a share buyback program in place as well. So to the extent of -- if the stock were to falter materially in the near term, we can start buying shares back again to the extent of stocks trading well below book.

[George Haas:]

The investing environment is a little bit challenging right now. There have been a few very large secondaries in our space and that is sort of sucking a lot of the oxygen out of the market in terms of -- so it's really a food fight for assets now. So I think we'll let that play out and put those folks get fully invested before we get too aggressive about raising more money.

[Operator:]

And we do show an additional question from Christopher Nolan of Ladenburg Thalmann.

[Christopher Nolan:]

Should we see more capital allocations towards the structured products going forward?

[Robert Cauley:]

We would like to. Hunter just mentioned the fact that the market is not that attractive right now. We're -- that's pretty far out outside our normal range, but the market has not been very attractive. So we're looking for opportunities to bring that allocation back into line, not necessarily 50-50, but certainly, we're well north of 60% in our allocation to pass-through. So we're looking to move that down, but it's just a little challenging right now, yes.

[George Haas:]

We're certainly running things every day and looking for assets or stories that we can get behind. In particular, in the IO space, it's just so tight that you really have to take specific risks and, I think in our last call, we talked about how we bought but IOs backed by jumbo loans. Those have a lot of convexity. We did that at a time when they were still prepaying rather quickly. So we were able to take advantage of maybe a slight market disconnect. But absent having some sort of a strategy like that where we think we see something that is not very well known, then it's a challenged add there. So we'll keep looking, but it's kind of a tough environment for adding those assets.

[Robert Cauley:]

Simply inverses, right?

[George Haas:]

Absolutely, absolutely. Inverses have pretty terrible convexity here. If we go into -- if we rally more, the IO starts acting up. And if we sell off, they can start getting really long and have a lot of LIBOR exposure. So we're really in the middle of the range where it's not -- the rate range, where it's not real clear. It's not as easy to say we should be adding or subtracting IOs and inverse IOs.

[Christopher Nolan:]

And then on your comment in terms of your outlook for the economy. It seems like, if anything, you are positioning yourself possibly for a further flattening for the curve, possibly even in inverse if inflation ticks up and the Fed becomes more active in tightening. Is that a fair characterization?

[Robert Cauley:]

Sort of. I would think if -- no, I don't think we stay like this. I mean, we think that we would do okay if the market stays exactly as it is because we don't really think that the Fed's going to ease. So -- and the market is priced out all -- most of the Fed hikes going forward. Our view is if the Fed did indeed start to hike, say, along the lines of their dot plot, there have to be a reason and that would have to be, for instance, that inflation turned and went the other way. The economy remains strong. If that's the case, I would be hard pressed to believe that the long end would continue to be as flat. Specially, with the tapering about the begin both here and domestically. That's a lot of extra treasuries that are going to have to be sold. And then the other thing is, even looking further down the road, we all know, for instance, that potential growth of the economy has been reduced because population of dynamics. Demographics, right? So we have the aging of the workforce. We have a lot of baby boomers, they're leaving the workforce. And so it's caused potential growth of the economy to slow. But it also means that they're about to start drawing Social Security. And I was looking at some forecast late last week. But the budget deficits forecast 5 or more years as a result of the significant uptick in entitlement payments from the government. These were going to have a meaningful increase in supply. Now academics will tell you that, that the crowding out effect, as it was referred to, by extreme government issuance has typically not driven rates higher. Maybe that's the case, maybe not, but it's hard to see that long end of the curve stayed where it is and so we would think the curve would start to move more in a parallel fashion. So we're not really expecting an inversion of the curve, at least not in the near term. We would view it -- somewhat of a more parallel shift. And that's kind of what we're expecting.

[Operator:]

[Operator Instructions]. We have a question from Frank Benosa of FWG Limited.

[Frank Benosa:]

I have a question about the dividend right now which is rather high. I was reading an article last week that this author seemed to think that there's no way you can hold the dividend where it is currently.

[Robert Cauley:]

We can't say anything about our dividend policy. That's been the -- our policy is, we don't talk about the dividend going forward. I'm very much familiar with these articles. Certainly the stock trades at a high dividend yield, but we declare the dividend monthly and I can't say that it's going up or down. We just don't discuss it publicly. We've only had two dividend changes in our history. We went from $0.135 which was our initial dividend to $0.18 in late 2018 and backed down to $0.14 in July of '15. The dividend is -- it's just not something that we give guidance on.

[Frank Benosa:]

Okay. The current net asset value is $9 .63. Is that correct?

[Robert Cauley:]

$9.23.

[Operator:]

[Operator Instructions]. And I'm showing no further questions from the phone line. I would now like to turn the call back over to management for closing remarks.

[Robert Cauley:]

Thank you, Operator. Again, thank you everybody for listening in, taking the time to hear us. We appreciate all of your questions. To the extent we were unable to listen to the call live and you have any questions, feel free to call us. Our number here at the office is 772-231-1400. Otherwise, we look forward to talking to you at the end of the current quarter. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.