Q3 2020 Orchid Island Capital Inc Earnings Call
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Good morning, and welcome to the same quarter tiny tiny things conference calls, but I can't I Lane capital.
This call is being recorded today October 30.
It's funny.
At this time the company would like to remind the listeners that the statements made during todays conference call relating to matters that are not historical facts.
Forward looking statements are subject to the safe Harbor provision.
The Securities Litigation Reform Act of 90 95.
No no I cautioned that such forward looking statements are based on information currently available on the managements. Good faith belief with respect to feature events and is 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 I described in the Companys filings with the Securities and Exchange Commission, including the company's most recent annual report on form 10-K.
The company it seems and no obligations to update such forward looking statements to reflect actual results changes in assumptions a chain given all these factors affecting forward looking statements now.
Now I would like to turn the conference over to the Companys, Chairman and Chief Executive Officer Mr. Roberts Holly. Please go ahead Sir.
Good morning, everyone and welcome I hope everyone had a chance to Oh poor slide deck off her website last night as usual I'll be going through the deck.
So its really touch on every slide but they're all there for your reference as needed as always I'll start on slide three what you just the TV contents just to give you an outline of the agenda for today.
The first thing we'll do is just give you a summary of our financial highlights for the quarter.
It is now spend some time talking about that market developments in the background for the quarter and how that influences. Our results and then I'll go into our financial results a little more detail and then finally delve into our portfolio credit hedge positions in some detail without I'll get started.
Well with respect to the quarter, we generated net income per share of 42 cents net earnings per share of 33 cents, excluding realized and unrealized gains and losses and our our B S. A derivative instruments growing net interest income on our swaps a.
Well, we had a gain of nine cents per share for net realized and unrealized gains on our RMBS derivate instruments, including interest on our swaps book value per share you ended the quarter with $5.44. This is an increase of 22 cents or 4.21% from the value at June Thirtyth.
During the quarter the company declared and subsequently paid 19 cents per share in dividends since our initial public offerings. The company has declared $11 52, and a half sense in dividends per share, which includes our most recent six and a half cent dividend declared in October.
Payable on November total economic return was 41 cents for the quarter or 7.9% that is not annualized.
Turning to slide five and this slide we show our performance on a stock basis. This is calculating total return based on the change in the price of the stock and dividends paid. This is through September thirtyth of 2020 of the peer group that is listed in the Middle column is actually described on the next slide I apologize.
Or that we typically show these large the opposite order up at the peer group has described the next page and what we show here is working to return in the first column on the top we show to date returns in other words, you're today with a one year look back to your and so forth and in the middle column, our peer average and then our performance.
Versus the peer average so as you can see looking back a year to date, one year two year three year, all the way back to inception, we've had very strong performance relative to our peer group.
The bottom of the page we show these returns for calendar periods.
So for instance, the top rose the third quarter of the current year and then we go back through the various calendar years, all the way back to 2013, which was the period when we had our IPO again very strong relative performance.
The next slide basically shows the same thing with this book value based total return. So total return would be calculated as the sum of the change in book value plus dividends paid.
As is often the case, we do not have all the return data for our peer group for the third quarter. So we tend to show this data with a one month or one quarter lag in this case. The most recent data would be the second quarter of 2020.
The same format on the top we show one year through a six year look backs, including inception to date in.
And on the bottom its pretty calendar periods, Oh with respect to the most recent look back data again from second quarter of 2020, all the way back to inception as you can see a very strong returns relative to the peer group and.
And even with the calendar periods and strong as well.
Now I'd like to talk about market developments on slide eight and we have a few slides here to give you a picture of what happened in the market.
The most important thing is the fact that rates are relatively stable as you can see on this slide both our.
Cash and swaps.
Were relatively unchanged for the quarter and this makes up for very favorable and rate environment for Levered MBS investors.
And we have reason to expect that this will probably continue into 2021, given the state of the economy and fed policy in the.
If you turn now to slide nine you see the same kind of thing in pictures only this year in this case, we're showing 10 year treasuries and tenure swap rates both for the quarter and with a two year look back and if you focus on the right side of the page as you can see a really since March weve been in a very stable rate environment, which again is very very afraid.
Trouble for both leveraged investing and mortgage backed securities as well.
Turning to slide 10.
The show the spread between the five in a 30 year Treasury and what's notable here's the simple fact that even though rates have been stable, where we have seen movement. It's been on the long end of the front end of the curve is anchored by Fred policy. So we've seen a steepening of the curve, which again is usually favorable for mortgage investors.
Because it has positive implications for both Carrie Ann.
And also prepayments, although we have a lot more to say about prepayments in the next few minutes.
Let's turn to slide 11, and look at the mortgage market and there's several slides here that are very important and this is really what drives the decisions, we make with respect to the deployment of our capital.
I want to start off by saying that the market today is very much dominated by the fed.
Although the fed is very active purchaser of mortgages. They typically are they not cynical exclusively by P.B.A. The fed does not buy spec pools and they tend to focus their purchases on the production coupons. Those coupons that are most production had been drifting down in fact yesterday or the day before rather the fed announced they would be buying one of.
In house, starting in the next cycle, what typically happens is they add one coupon and drop another one that gets dropped suffers if you look at the bottom left you can see the dollar roll market for various coupons and if you'll notice that red line. There that was for Fannie threes, when they dropped out of the fats purchase bucket.
Since then tooling in house were expected to be dropped it turns out they were not just reduce but that coupon has languished over the last few weeks that all being said Oh, the true Mark Fannie choose for any one of the house those rural markets are very strong.
Andy the net interest margin and that market is very very attractive. These are these bonds roll implied financing that is materially negative.
And the all in spread is 200 250 basis points. So it is a very attractive market to invest in.
And we do invest in that market.
Well as I said, the fed is dominating through their purchases of the production coupons, which basically means the coupons, they're not buying are languishing. If you look at the top left you can see these lives for various coupons and then TV a form they have not done, particularly well with respect to force.
Fours are pretty much not produced anymore.
And so it's really not a current production TB a coupon so really what you're seeing there is more seasoned bonds and they've been beaten up so bad.
They didn't recover somewhat this quarter, but what that means is given that the TV market other than the production coupons is so weak the alternative area to invest in an area that we invest heavily in is the spec market. So if you look on the right side of the page you can see the low loan balance 85, K, Max three and an option for those pay off.
Ups are extremely high levels, we just now going through the most recent cycle. They remain very elevated and then on the bottom right. We show pay ups or just new production coupons.
Those are less desirable because the advantage of that carries usually fleeting and only last a few months, but in the spec pulls, especially the higher quality ones.
They have very attractive carry versus TV and as a result, those pay ups remain very much in high demand.
Moving on Slide 12, we did show a picture of implied vol and the market as you can see it's quite subdued subdued. Although this ends at the end of the quarter since quarter end in anticipation of the election. There has been some movement higher although I would suspect that once the outcome of the election is determined which may or may not be on a less.
Sunday I would expect that to fall off as well.
On the next slide is basically historical information Dr. Irrelevant for todays discussion someone that's going to skip that.
Slide 14, just shows you as we always do returns across the various asset classes, though many of the investors. We compete in are investing across multiple asset classes and this just gives you a nice picture of the whole market.
As you can see on the top of the quarter on the right hand side, the riskier sectors high yield emerging market high yield in the S&P 500 did very well and it's just because it's been generally a risk on environment for the most part.
As a result of fed policy fiscal policy, although we haven't quite seen much of that lately, but generally it's been strong or rumor to be strong in the near future and so as a result risk has done well and.
Safe Haven assets have done a little less but if you look at the entire year year to date are.
You can see that the S&P at least through the end of September was only up modestly in fact emerging market high yields negative.
A lot of the more safe Haven, or RIS less risky assets still look very attractive on a year to date performance basis.
Now turning to slide 15.
This is a little more relevant for US a couple of things I want to point out if you look at the top left the Blue line there as the level of the mortgage bankers Association to refi index and as you can see it's quite elevated it's moving at a very narrow range, but at a high level.
The Red line as the mortgage rates available to borrowers as you can see it continues to drift down and is now under 3%.
So we expect that to continue if you look on the right side. What you see is the primary secondary spread and.
And if you look at the period over say 2019 that spread was 100 or a little over it's still quite elevated and as a result, there's still room for that spread to continue to come down we expect that it will originators are adding capacity mortgage origination business is very robust housing market is very very small.
All it and in spite of all the impact at cobalt has had on the economy, it's not really reflecting the performance of each of the housing market or the mortgage finance market. They are both very very robust.
As a result of this spread all we are assessing.
She has an implication for us and that we continue to on spec pools and the reason is kind of.
The next slide.
If we do get some movement up in rates.
There's still a possibility that even if rates were to go higher this spread could compress and therefore that red line on the left hand side of the page, but still stay very low which would keep refinancing activity very very high and as a result, we expect and.
High degree of confidence that speeds will remain fast for some time.
And that gives us comfort and don't expect polls realizing that rates could probably go even over a 100 bips probably as high as 110 120, before we think you'd see a meaningful impact on speeds.
I just wanted to let the listeners know that I was told that the link to the presentation materials was not working or was missing from the website. It's been that's been remedied and has now there. So if you were trying to follow along and did not have the materials.
They should be on the web site now Paul Jives profusely for that sorry, sorry, Thank you for bringing that up.
[noise] I'll give everybody a moment here to catch up to the extent there just getting the slide deck.
My next slide I'm going to discuss his slide 17, we're going to start talking about our financial results.
As usual, we continue to use the same format.
Hopefully that makes it easier on our listeners because they can fault, but easily the left hand side just as the de composition of our earnings and you can see we show it bottom or earnings per share.
Our proxy for core although it's not exactly akin to what most of our peers report, but it does this aggregate the 42 cents per share and show the realized and unrealized gains on a separate call. As you can see it's kind of noteworthy with respect to the realized and unrealized gains both on our RMBS assets in.
Our hedges that they're all positive.
That's not typical obviously certainly something we welcome but it just showed that the quarter was a very favorable environment for us on the right hand side.
We show the returns from our respective strategies pass throughs in our structured securities mainly iOS and as you can see the 9.6% return.
It was very strong.
But as strong as the second quarter, but.
But nonetheless, a very high number and the number we expect to continue in this as long as this current environment remains and we would expect it to do so.
With respect to iOS was a negative number as you might expect prepayments are very high.
Those securities we own pre pay at a fast rate, we want them to be in the money so to speak.
And the reason is to the extent rates would have backed up.
They have room to extend and work is very effective hedges that's precisely why we.
Looking at slide 18.
Kind of describes this environment, which we see as very favorable and we expect it to be going forward.
Nonetheless, if you look at the Green line on the top of the page.
We could see that the economic return.
Stabilizing improved off the troughs of the recent past and we expect nems to remain quite strong, especially relative to the absolute level of rates.
And that's why we're bullish on our performance moving forward.
Slide 19 is just another picture of the same story. It just shows our core versus all that earnings per share.
Slide 20.
We show our capital allocation and it continues to drift more towards pass throughs de emphasizing aisles of late using other hedge instruments.
Not materially changed.
As I said.
The Io position has continued to dwindle, we may replenished that although we're not looking to build that in a meaningful way in the near term will be using vault related rate products. So swaptions and combinations of Swaptions is effective hedge instrument for us.
Turning now to the portfolio on slide 22.
This picture does not look materially different than what you saw at the end of the second quarter. In fact, we if anything we probably made more changes since the end of the quarter and you saw during the quarter. So since the end of the third quarter EBITDA.
He'd be Asia as I mentioned in the very attractive investment.
Area, we have increase those positions worked out about 465 million.
With respect to our pools, which are almost all picked on are all spec pools.
Really.
We have reduced our exposure to some of the higher coupon 30 year Fives 30 year fours and we've added 230 year threes.
Otherwise not a lot has changed in that regard.
Slide 23, again, just goes to show that our allocation to the spec pull market. These are high quality specs.
It remains very high and this is a cornerstone of the strategy in conjunction with the GBA market.
We expect this to remain high for the foreseeable future the.
The next slide shows the benefit of doing so and.
In this slide we are showing our prepayments speeds for the most recent three months three months in the third quarter in comparison to the Fannie Mae fixed rate coupon cohort so for each respective column.
As indicated 30 year, three or 30, or 30 or three and a half. These are all Fannie Mae cohorts. Some of our securities are in fact, Freddie but the results would not be materially different if we were to combine them. As you can see our securities have been prepaying at a very small fraction of what the cohort has and in fact, if you look at the bottom right.
You can see the rolling four quarters. The most recent four quarters in each case, what we're showing here is how our securities our prepaid as a percentage of the cohort as you can see with the exception of 30 year, fives, which which since reduced.
Very very low in most cases, well under 50% of the cohort.
Thats, what critical for us to maintain the carry and the returns that we've been able to generate.
Slide 25 is just one point I want to make here you can see the Orange line is the tenure treasury as you can see it's dropped in stabilized at the current level, but the Green line is our prepayments and this is shown to normalize the effects of changes in the portfolio side. So what we're really doing years dividing prepay.
Payments in dollars by the unpaid principal balance of the portfolio and as you can see with an extremely low level of tenure.
While its elevated versus norms and slightly outside of one standard deviation above the mean, it's still lower than it was in 2019. So our allocation suspects has paid off and been able to realize attractive returns as a result.
A few more points before we wrap up and start to the Q and a session. Our leverage ratio continues to be in the high eights low nines, we anticipate that being the case going forward given the environment that we're operating in.
And.
Moving on our interest expenses you can see is basically bottomed at 1% one cent and it looks like we'll probably stay there for some time and then finally on slide 20, I just want to say if you make a few points on our hedges in the top right. We show our swaption positions as you can see we've added to that slightly.
We like these as hedges for two reasons, one obviously they give us.
Positive performance in the event of a rate increase but they also benefit to the extent volatility increases and we strongly suggests I suspect that if and when we do get a meaningful move higher in rates. It will be accompanied by a commensurate increase involved in these instruments tend to benefit very well when that happens otherwise our euro.
Dollars on the top left are pretty much at a four type level, we do not anticipate adding to those we have a modest position in treasury futures and our swaps were stable as you can see for the quarter. We may add to those that are not very near term. So otherwise that is it runs through the the market environment.
Our results in our positioning and with that we will open up the call to questions operator.
Thank you Sam late.
Ladies and gentlemen, if you have a question at this time. Please press Star then the number one I will touch on Palestine.
Again, if you have a question is definitely enough can you reconcile that with number one on your Touchtone Palestine. If you would like to withdraw your question, we can pass to partner with hospitals the momentum Patrick you any roster.
So your first question comes from the line as Jason.
Jones trading your line is now like go ahead. Please.
Thanks, Good morning. Thanks.
Good quarter.
How are you doing today.
That's.
Good yourself.
Good good thank you and thanks for taking the question.
I wanted to dig in a little bit more on spec pools and wondering if you could give us some more color on the types of pools you won.
That's your favoring versus deemphasizing given your comments on primary secondary and the current rate environment.
Sure Yes.
Yes, this is John or Jason.
So as we alluded to in that slide towards the end of the deck.
We have a high concentration of very high quality specified pools, so those would be lower loan balance.
$5000 maximum balance within pool, one can hundred 10000.
120, fives to a lesser extent the higher loan balance stories have just not really been performing very well. So 175 200 K Max.
It.
There, obviously are better than TV, but it's just not enough.
Not slow enough to.
Not put pressure on earnings if we.
Hell of a lot of those.
So we have.
175 to 200 kids have never been much of a core position for us and we have actually reduced some of some of that position even further so.
Yes, that's predominantly in the up in coupon space. So call. It three street has fours Ford has.
We even have a few fives, it's not a.
Huge position.
And then in the lower coupon space as I think Bob alluded to Weve been allocating more towards.
BA trades and lower pay up stories so.
Just sort of.
By new new issue lower coupons, which are.
Just by virtue of the fact that they have relatively low note.
Note rates to the borrowers are going to tend to prepay a little bit slower. So we've been transitioning a little bit of the portfolio into that bucket as well. So I guess to sum it up I would characterize it ends up in coupon very very high quality specified pools gotta Kupol and more.
Generic types LTV FICO stories, which are.
We're just not going to really have much of an incentive to refinance at this point I'd add one grant point to that Jason is we probably de emphasize the New York story.
Because of credit for Barents Sea those elevated most because we have been adding those yes.
Okay that makes sense and when you pull that together with a you know there's a big allocation to three knives and 13, while it's pretty pretty new but the CPR is is quite impressive when you pull all that together and where do you think.
CPR is trying to you know assuming constant stay you don't make major changes I mean are we talking about a CPR that's going to stay in the teens do you think or does that migrate into the twentys overtime.
No I think we would I think we're going to manage and deploy.
The portfolio in such a way that.
We would target dose teams.
The.
Speeds that were released in October which are reflected in our presentation materials because they reflect.
Paydowns that would have.
Occurred during the month of September were a little bit on the fast side.
I think it caught me.
Most of the market off guard.
There's a little bit of a surprise to the upside just in terms of how fast the speeds were.
I think going into the end of the year, we'll see speeds remain elevated.
And then going in to next year I think you'll see.
We start to see a little bit of burnout kicking in so.
That coupled with the fact with the gses aren't going to be.
By now delinquent loans until they're 24 months delinquent as opposed to.
90 days should give us a.
Couple of CPR relief, which.
Does it sound like a lot but for this portfolio. It it has a meaningful impact on earnings and by the way I did mentioned.
Jason that we had done a fair amount of trading since quarter end and most of that has been focused on bringing the wall off of the portfolio the average well.
Out of an oxymoron, whatever but up bringing that down so our wallace probably lower than that number in the slide.
Today, Okay, Okay fair enough, one more and I'll jump in let other people ask questions. When you think about more broadly TV A's, where they're trading terms, especially us how high the allocation of the portfolio could that get too.
Given how special they are today.
Well, we're probably nine or 10 to one specs too.
CB eight.
I could see it getting higher I mean, they do carry extremely well, but there is a lot of duration with those because the duration with specs as well.
And I would say in a stable rate environment, there are probably a little more efficient from a cash management perspective, because you don't get paydowns.
Of course, you can get margin cost rates move higher.
Or lower this.
This case may be but I.
I could see higher I know some of our peers. Those allocations are quite high they are probably more like a two to one ratio specs. The TB I don't know that we would get that high but I can see it going higher I mean, Mike.
We don't have a set number in mind, it's more we go through the month and see how the role was performing and what we're looking to maybe on loaded where do we go into it how the auctions go I think the market kind of dictates to us kind of how we do that.
Yes, okay references to own pools, if we can but to the extent that the.
A special Nelson wall markets is.
Just so great than we're obviously going to shift and allocation of capital towards that portfolio I think its round, one and a half turns of leverage now and you can certainly see that becoming.
Double that position, but does now.
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Thank you.
And just to remind participants that Dan if you want to ask a question. Please press Star then the number one on your telephone keypad.
Our next question will come from the line of Christopher Nolan from Ladenburg Thalmann. Your line is now like go ahead.
Hey, guys, Hey, Bob did you in your latest comment did you did you indicate that TPS could double from the current level or just clarification.
Yes, okay.
Also.
The EPS to Corey Pos is very strong much stronger than expected.
It's well above the mid teen ROI target that you guys were discussing earlier.
Given your outlook for continued stable rates and.
Everything else should there be any sort of update in terms of what your core.
Core ROE target would be.
Oh, certainly stable I don't see it dropping I did try to mentioned that on the one slide.
We expect it to be stable I know a number of our peers they've had strong numbers just reflects the environment. We're in.
As I mentioned, the TB a roll market. The all in Nims are north of 200 Bips in the specs for coal space, there, maybe not quite that high but also very strong.
I wouldn't want to guide at much higher, but I would say that I see high level of confidence in and staying where it is.
Okay, and then what does that mean for the dividend outlook well.
Well.
We've been raising it oh speeds are the biggest driver a 100 mentioned that we did get a bit of a surprise this month.
So I think that was probably a combination of things that caused that we did have for instance, the first six months forbearance period, and there may have been some buyout activity related to that.
Otherwise the fundamentals if you look at the refinance index those kind of things those have been very stable they wouldn't have implied.
An increase in the speed, so I would expect them to normalize back to where they were and I.
I guess the other indicated would be origination we have the third quarter, especially in the early fourth origination was picking up which is an indication that.
Mortgages are being originated in because of speeds presumably.
So they are still elevated its not going to change.
But.
I guess, that's all I can say.
And final question do you have any update to the book value.
Since September Thirtyth.
No it's modestly higher.
Not materially higher.
I want to say, a nickel or something like that if that.
Great Thats it from me thank you.
Yes.
Thank you.
At this time I would like to remind everyone. If you do have a question. Please press star then the number one on your telephone keypad, well pause biggest a moment taking clean quiet for further my questions.
Hi, Good morning, I am seeing no questions on the phone line. Please continue.
Thank you operator, thank you everyone. Once again, we appreciate your time.
To the extent you come up with a question later or you Didnt catch I have a chance to catch the call live please feel free to reach us in our office or numbers seven seven to 2311 400 always look forward to your questions and otherwise look forward to speaking with you at the end of the year everybody. Please stay safe and talk to you again, Thank you bye.
Thank you. So much presented then again. Thank you everyone for participating. This concludes today's conference you may now disconnect.
So let me Paul.
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