Q1 2022 Orchid Island Capital Inc Earnings Call

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And now it's a good thing.

If you look at the right side I'll, just make one point here and.

And this is kind of germane I think for what we see going forward you can see the primary secondary basis looks very volatile I think that speaks more to the volatility of the underlying which would be rates because they've been so volatile.

But it also points out the fact that originators now that the universe is at a discount are doing everything they can to maintain production volumes thats, primarily in the form of <unk>.

Cash out refis or turnover, but it also points to the fact that.

They're going to have a challenge to keep their production levels and their staffing levels higher and really just speaks to the fact that all rate sensitive.

The economy is going to be feeling things and all of our financial results Slide 17.

As you can see if you kind of try to dissect what happened there.

This left hand slide just shows our returns absent the unrealized gains and losses and as you can see those numbers were large and its really all because of the pass through portfolio. The pass through portfolio had an annualized return of almost negative 40%, obviously, a very big number and that was really driven by the performance of TBA is if you look on.

That chart, there you see realized and unrealized losses of $378 million.

Outside of realized losses over 80% of our mark to market losses for the quarter.

Were the result of changes in TBA prices about 17% 17, 5%.

Where the erosion of pay ups on specified pools and the rest was just.

Premium loss and you May wonder, how we could have premium loss, but that's just because that's a function of prices at the beginning of the period when the portfolio was still at a premium.

Turning to slide 18. This is just a picture of our NIM, if you will and shown kind of along with the dividend.

But it appears that our funding cost went down Thats really just some timing differences there.

Honestly, our funding costs will be going up even.

With hedges theres, probably going to be some modest upward pressure.

This number dropping down I'm just kind of reflects the fact that our hedges started to move up before are far faster than our funding costs.

You should see that stabilize you may see slight upward trend in the funding cost.

Hedges in the NIM remains to be seen that will be predicated on how the asset yields go.

Slide 19, just again this shows you our proxy for core income this red line as you can see.

<unk> been running in the low twenties, our ultimate low was back in 19 at <unk> and it's been fairly stable since then.

We expect it to remain so but there is still a lot of wild cards on the table, we'll have to see how things play out.

Slide 20, just shows you our dividend versus our peers.

We'll say that in this type of environment, where the curve is very very flat.

Liquidity is at a premium this is not going to be an emphasis.

Going to manage the portfolio as prudently as we can.

We don't know what our peers will be dividend wise, but as you know we.

We do starts twice just to reflect current market conditions, and we don't know what the future holds.

Hope that all of that is behind us, but again.

Theres just a lot of moving parts in the economy. So there's potential that you could have movements, both with us or anybody. So it's really hard to say, what's going to happen to relative dividend performance, but it's I don't think it is.

Our primary concern for any of us.

Slide 21. This just gives you the two important things the roll forward of each portfolio and in the capital allocation.

As you can see on the left side means development here is the allocation to iOS is increase in passengers has decreased we've mentioned last year that because of the current market conditions that we were going to take our allocation to iOS App. We had mentioned on previous calls a target of around 25%, we actually got up to 30.

8%.

Beyond that.

Now what does that mean going forward and it's kind of hard to say iOS of obviously you had a good run while we would like to own some more.

They're really becoming somewhat rich and it's hard to find value in it.

Might even be some good sale candidates and we have actually sold a few in early 'twenty.

Second quarter some of the.

Details of the change.

The sales that we did in the quarter were predominantly in the pass through portfolio I'll talk about that in a little more in greater detail in a moment and.

And then we had paydowns as well and then mark to market losses Cypress suffice it to say we were these asset sales occurred.

To maintain leverage but also just to shed duration.

And then we did not reinvest pay downs for the most large so that's how we migrated the portfolio, which current position.

Now I'll talk a little more detail about the portfolio before I do that I just want to say a few words kind of give you some background.

As you recall last year through most of the last three quarters of the year, we had talked about being positioned defensively, we thought that the fed was going to end their tapering program.

And that we were trying to do everything we could to minimize the impact on US. Obviously, we were an all agency Reits that we're kind of locked in the building. If you will we have to own mortgages. So we tried to avoid production coupons and we took our allocation to iOS.

To a higher level and we own spec since even to this day, we still see long term value in them, even though they are trading at a fairly distressed levels.

The fed we were right the fed did exit, but obviously the events of the first quarter, especially the second half have changed things quite materially and so that that positioning and the way we look things last year.

It's really doesn't apply as much to the current environment. So just again to review the actions that we took we did reduce the portfolio. We had one for approximately 1 billion of sales of pass throughs.

We're mostly lower pay up specified pools with lower coupons, two and a half.

At about $147 million, Paydowns and $10 $5 million in return of investment on our iOS, which was not reinvested.

And all of this was enough to not only allow us to maintain very high levels of liquidity.

But it also allowed us to actually lower our leverage ratio. So from the low rates for the mid sevens were actually below that today.

We might go probably won't go meaningfully lower than that this is probably the floor.

With respect to post quarter end, we have done some up in coupon trades, both 30 year and 15 year.

We continue to refine our hedge positions will talk about that a little bit more detail, but the important thing and the key takeaway here is that with a very difficult quarter, we were able to navigate through it successfully we did have to shrink the balance sheet somewhat to maintain leverage at prudent levels.

But we also did so in a manner, where we can maintain very high levels.

Liquidity, our target is to maintain 50% cash that's not even including unencumbered assets just cash relative to equity.

Because first and foremost we need to be able to weather any of these storms and we've obviously had some very volatile days in the market days with mortgage underperformance versus hedges margin calls and so.

We want to always be in a position, where we can deal with those quite comfortably and we have.

We know this is a difficult market environment. We also know it's not likely to last indefinitely and so given the very favorable opportunities that are in the market. Today, we wanted to be able to take advantage of those once market has stabilized and we're in a position to do so now with respect to the portfolio on slide 23.

Just going through the comp for fair market value on the pass throughs.

Two big changes with respect to 30 or two and a half we took.

Look that down very materially solar about $941 million.

Mostly in again low pay up specified and we sold over $900 million in 30 years same thing predominantly in low pay up pools. Our weighted average coupon is a result of the relative lean more sales to two in house versus three weighted average coupons are a little higher went from 293 to 301.

We did not reinvest paydowns and so our portfolio is H by four months.

Speeds remain very subdued.

High single digits, and we would expect them to stay there might even decline we did make meaningful changes to the hedge book will get into that a little more.

<unk> here.

But if you look at the notional amount of the hedges versus the total mortgage assets.

Coverage went from about 45% to closer to AAV.

Thats notional that's somewhat misleading because the D var, one of our hedges is quite high.

In fact, we have a lot of ultras and our swaption positions and so forth. So if you look for instance in the far right column.

And you look at our rate sensitivity to plus or minus 50 basis points shocks.

You can see it's a very flat profile given the size of this portfolio and thats much flatter than it was at the end of the year, So and that really is consistent with what we're seeing even though rates as I mentioned earlier have slowed up quite a bit in April .

And mortgages have widened.

Book value is probably down just a few pennies and we really trade pretty much inline to hedges net net so far so.

Basically reflects the fact that mortgages have extended and.

They kind of trade in line with the hedges, so even though it's a high rate environment.

Stabilized and that reflects the nature of the hedges we have in the assets that we own.

Slide 24 is interesting. This is something we used to takeaway propriety, because we've reflected well on our asset selection, our prepayments versus the cohorts.

This is of course backward looking so it's our legacy portfolio as I've mentioned, we have not been reinvesting too much we've done some up in coupon trading but.

It also kind of reflects kind of the.

The prior reality that we lived in which is where premium amortization was the thing you avoid and everybody was trading at a meaningful premium now obviously were at a discount. So you can see the slides change going forward.

Slide 25, just the same point the Red line or the Orange line. There is the 10 year Treasury. This one only goes through the end of the quarter that number is now at two nine or so.

But the prepayments you would assume in this environment are going to stay low kind of what they were in 13 and 14.

I've mentioned on slide 26, our leverage ratio is down it's actually down a little bit from where it shows here.

We're probably pretty much where we want to be.

Finally, slide 27, so our hedges just make a few points here on the top left.

We have we have our treasury futures and we've shifted those materially.

These numbers are off hire the five year sectors off by.

Almost a $1 billion in the ultras by not as much.

About $50 million.

We have no TBA shorts in place at quarter end, although we have placed some launch since quarter end, we have some short term feeding tubes.

And then with respect to swaps.

The belly or the three to five year has come down.

Moved our swaps out the curve that was about $950 million at the end of the year. It's only about 300, and then X ray than five years was about $400 million Thats $1 1 billion.

You can see the average pay fixed rate.

And those are all obviously are very much in the money in this current environment.

So they are.

<unk>, helping us with our increased funding cost with respect to the swaps and swaption.

I'm not going to say much about that if somebody wants to ask a question with detail on that what I would say about those is that we dynamically hedge those positions. So as our strikes move more or less in the money, we take action to ensure that theyre going to work as effectively as possible going forward. So in this environment.

We've taken some profits and extending strikes higher.

And that has worked very well for us and probably explains why we've had stable performance. We've had so far in April so with that that concludes my prepared remarks, operator, I will turn the call over to questions. Thank you.

Thank you.

Joining the call to ask a question please dial 1888.

510.

356, well pause for 30 seconds to allow time for you to dial in.

Yeah.

[noise] [noise].

At this time I would like to remind everyone in order to ask a question star one.

I'll pause for just a moment to compile the Q&A roster.

Our first question comes from Ryan with <unk>.

<unk> Securities Your line is open.

Yeah.

Hi, Good morning, gentlemen, hope everybody's doing well.

Good good.

I apologize I missed a good chunk of the.

The Cogs, a little trouble getting on so I apologize if you mentioned if he covered something that I'm about to ask but I do believe I heard you, saying that I OS are becoming a bit rich.

You've already sold some in the second quarter.

If that's the case how much have you sold.

So we are.

Oh I've got some numbers here I can feel more specifics so in the.

In the first quarter, we sold roughly $80 million worth of iOS backed by loan balance threes.

So that you know.

The profile.

As of March 31st those would be out of that and then in the last months, we have or this month I guess I should say we've sold another 200 million, it's like 35 million.

Market of loan balance three and a half.

Okay and those are again as I had alluded to the <unk>.

Extended pretty much as far as they could they just get toward the profile is very asymmetric you don't get much Bang for your Buck in future further selloff in the downside exposure. So it's kind of kind of like what we mentioned about the hedges, sometimes you kind of re strike to a higher level.

And that's probably what we're looking to do there just have to find the opportunities to do so now that's exactly right. It's.

Unfortunately, I think as Bob alluded to earlier, if you I don't know if you were on an Ottoman only.

1% of the mortgage universe is not.

Refinancing will at this point so it's.

It's tough to find the iOS that are not have.

Have they don't have a great deal of extension already baked in even if they're paying faster.

Not something we're.

Highly constructive on right now so we've been focused more on doing things and ray derivatives and trying to improve the convexity of.

Our profile.

Through an increased focus on options that will that.

And that will.

Increase in value at an increasing rate into a continued sell off and have limited downside.

If we were to rally from here, whereas the iOS or sort of the opposite of that they have a tremendous amount of downside into lower rates and you know the.

The durations on some of that stuff had gone from negative 15 to 20 down to negative four to six so.

It's not the case and and in a lower rate environment that a lot of value that can be lost at this point. So we.

We think it prudent to trim back our exposure there at least until some enough.

A higher rate mortgages have been produced at the <unk>.

CMO with machines turned back on and focused on.

Something that's that buyers that can continue to extend and that's a good point just add two cents to that.

Production of new Isles is minimal.

I mean, the CMO machine as it's referred to.

Have shut down to a large extent, but new Io creation is very sparse.

Well that makes sense. So you say like about $200 million sold in the second quarter that effectively kind of zeros out the portfolio all of us at the moment.

That was the face amount it was starting to buy.

5 million market, Okay, I Gotcha alright.

Sorry for the confusion there no worries noise and then you mentioned on book value only down a few pennies thus far in the second quarter. Despite the.

The spread widening in the volatility and what would you guys describe that.

Relatively strong performance.

In the month of April two.

Well, we didn't reposition the portfolio meaningfully so I mentioned, we've done some modest up in coupon trains. So we basically on a lot of threes.

And you know theyre very extended it makes them a lot easier to hedge and we extended the duration of the hedges and we keep re striking in the case of the swaption sort of swaps so that even with what we're down in book something that reflects the widening but it's really the fact that they're just much easier to hedge our exposure.

<unk>.

Part of the reason for what.

Uh huh.

Not everyone has reported their earnings yet, but we felt like we had a particularly rough quarter and a lot of it had to deal with the fact that we had such a heavy focus on specified pools.

Whereas a lot of our peer group had.

A much higher concentration on the TBA portfolios.

That's you know so we felt maybe are paying disproportionately in the first quarter and if I download managed to do a little bit better.

And again, it's all I think attributable to this focus on improving the convexity profile of all of our net asset and hedge book.

Great So beyond me.

Maybe stepping up further and coupons do you guys see yourself, maybe stepping up the 15 year mortgages as well.

No not materially.

We've done some.

We think there's some opportunities in TBA space, we've rolled out of some of the.

Specified pools, there that just looked fully valued in and Theres. Some special versus some of the 15 year roles and so you know it could be an area, where we add a little bit but on the margin that's using it.

Relatively small part of our board and also with this curve. This slide 15 your production is pretty light.

So what's up Theres been pretty picked over I think now the market is really starting to focus given that we're in a discount environment.

At seasoning.

And theres not a lot of trading that would be obviously, we get the cash window. All the production has come out and you see how new production specs trade you don't see a ton Oh I'll put this way there are seasoned pools trading you don't always get the colors of a price discovery has been challenging at times, but theres no question that the market is very much so.

The value of seasoned pools and.

And they pay faster and when they are at a discount and so one of the benefits that we have is that because we haven't rolled the portfolio much.

Vast majority of it is season than it has greater value for that reason.

Got you thanks for that color that's pretty helpful.

That's it for me best of luck going forward and the continued difficult environment. Thank you yeah. Thanks. Thank you.

Okay.

Again, if he would like to ask a question Thats Star one.

Okay.

There are no further questions at this time I will now turn the call back over to Robert Cauley for closing remarks.

Thank you operator and thank everyone.

To the extent there are those of you who were not able to make the call of the live call and Theres two call later with the questions, we'll be glad to take those are office number $772 311400.

Otherwise, we look forward to checking in with you next quarter.

Great weekend. Thank you.

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

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