Q3 2022 Orchid Island Capital Inc Earnings Call
Excuse me, ladies and gentlemen, this is the operator today's conference call is scheduled to begin momentarily until that time your lines will again be placed on music hold thank you for your patience.
[music].
Yes.
Good morning, and welcome to the third quarter 2022 earnings conference call for Orchid Island capital.
This call is being recorded today October 28 2022.
At this time the company would like to remind the listeners that statements made during todays 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 managements, good faith belief with respect to future events.
They're subject to risks and uncertainties that could cause actual performance or results to differ materially from these 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.
Thank you operator, and good morning, everyone. Hopefully you have received the deck that we put on our website last night as always I'll be walking through that.
And then we will have a question and answer session just to start on slide three just to kind of give you a.
The agenda as always I will start with the highlights our financial highlights for the quarter, then I'll talk about market developments, which kind of.
Drove those results.
I'll go through our financial results in detail and spend some time talking about the current portfolio hedges and so forth and what we did during the quarter and then finally I am going to provide a financial conditions update if you will just to update everybody in terms of all of the aspects of our liquidity and borrowing capacity and so forth.
Both for the quarter and as we sit here today, so with that onto our financial highlights for the quarter, we had a net loss per share of $2.40.
Net earnings per share of 26 cents, excluding realized and unrealized gains and losses on our RMB acid derivative instruments, which includes net interest income on interest rate swaps.
We had a loss of $2 66 per share from net realized and unrealized losses on those same RMB as assets and derivative instruments, including net interest expense on our interest rate swaps. Our book value per share was $11.42 as of September 30th versus 14 36 at June 30th.
In Q3, the company declared and subsequently paid 54 and a half cents per share in dividends.
As a public offering of the Companys declared $64.33 in dividends per share, including the dividends declared this past month total economic loss of $2.40 or 16, 7% for the quarter.
On October 30, the company effected a one for five reverse stock split.
All share and per share numbers have been retroactively adjusted to reflect this in all of these slides in the deck today.
Now just to go through the market that we've been operating in a as you can see on slide six.
This story has been the case now for some time if you look at these lines on the left side or the right side.
Red line areas.
The treasury curve or the forward swap curve as of June 30. After the Green line is the same care beds at 930, and then the Blue line is the one as of last Friday and the development that you just continue to see is the front end of the curve keeps rising as the market continues to price and not.
Not only higher fed increases, but bringing those increases forward.
The market expects the fed to raise rates 75 basis points next week and either 50 or 75 again in December and likely a few more hikes, although probably smaller in size in 2023, and so that trend continues as we move through time this year as the fed, especially in Q3, and we'll talk about this more in a minute.
Has become extremely aggressive in hawkish and their desire to not only raise rates into restrictive territory, but to do so as soon as possible.
Well, if you look at slide seven and I don't need to spend a lot of time on a lot of these slides you're all familiar with the story, but this is just inconvenient pictures as you can see with respect to the tenure or the 10 yourself or swap really starting right at the end of July a meaningful shift.
Tenure was at 260 10 yourself our swap is inside of June 40, and that God is over 4%.
Since.
The data point last data point here, it's come off a little bit but both of these numbers got well over 4% so very meaningful shift in a short period of time and if you look over a much longer period on the right. You can see the same thing. These all reflect the steps that the fed talked really starting about mid August when they pushed back very hard against that.
Notion that was being priced in the market at the time that the fed was going to contain inflation and by sometime in early 2023 start to ease.
Made it abundantly clear that is not the case that they're going to do everything they can to contain inflation.
And raise rates as much as needed as soon as possible.
I look at page eight you can see.
Just I'm sorry, I got ahead of myself.
That's right page eight you can see the effect on the mortgage market.
There's two slides here on the top you see the most recent data just going back one year, but on the bottom. We tried to give you. Some historical perspective, and you can see the spread of the current coupons of the 10 year Treasury. There are many measures two.
So you use to look at to get a sense of the relative value of mortgages. This is just one but it is representative and as you can see especially on the bottom chart the spread of the current coupon mortgage to the 10 year Treasury really starting in 2013 through.
Onset of the pandemic was very stable trading in the high eighties for the most part in March of 2020 numbers spiked out quite a bit.
But really this year, it's gotten much higher we peaked at about 190.
Recently and as we sit here today or as of last Friday was 183 basis points. So obviously mortgages have done very poorly.
But really it's just all risk assets I'll say something about that in a moment, but obviously, it's been a very tough period for mortgages, particularly the third quarter slide.
Slide nine just gives you another perspective on the market.
Takeaway here is that the curve is obviously very inverted if you look at the bottom right you're just looking at the spread between the five and a 30 year treasuries and you can see were fairly negative here and also it's interesting to note that's occurring at the same time that both the yield on the five year and a 30 year are at basically the highest level they've.
Been in 10 years. So obviously these are not normal times versus what we've been accustomed to of late.
A couple of slides one last slide here, just really something to keep in mind up on slide 19. These are just holdings by the fed and by commercial banks. This is something to keep an eye on over time.
We entered quantitative tightening.
And reserves have drained from the system. Both of these lines will draw down. The question is how far and at what rate are really not much to say other than just to keep an eye on that now turning more specifically to the mortgage market on slide 11. The top left I think is very telling if you look at this what we're showing here are the price.
For representative coupons in the fixed income or in the mortgage universe Fannie.
Fannie 30 year threes fours fives and sixes in which you can see these are normalized so taking the price I'd be giving coupon as of 630 studying that to 100 and then looking at how it performed over the course, not just the quarter but into October .
Interesting when you look back to late July and early August that's when the market thought the fed was going to pivot in early 2023 and mortgages were doing very very well.
Especially lower coupon longer duration mortgages and they outperformed meaningfully in fact higher coupons were doing fairly poorly.
Simply because they're going to be subject to perhaps the prepays.
<unk> I.
I believe head.
The fed pivoted and now all of a sudden rates start going the other way than everything flip flops and you'll see that six as did very very well theyre short duration makes sense and the lower coupons did poorly and Theres also the specter of bank selling or bank of Japan, selling and so that performance.
Turned around very meaningfully, but I hope this is a very useful chart because at some point when the fed ultimately does pivot I think what you see on the left side of this page is what you're likely to see and so it's a very kind of a microcosm of how the mortgage market is going to perform over the course of the next year or so.
Rates are continuing to rise, which you see on the right side is likely to prevail and to the extent the fed pivot and we rallied what you see on the left side is what you're likely to see happen there.
The slides are bottom left I'll just go through these quickly Oh. These are the rules.
I would like to give you data on the current production coupons like five and five and a half since <unk> six and a half, but we just don't have enough data there just new because rates have slowed off so fast and even though these coupons are now the quote unquote current coupon they haven't been so for long enough that we have any data in fact, if you look at the top right what we see.
Pay ups for certain specified pools, we have added fives and sixes, but we only have a very little amount of data. So as we move through time that will come in.
In the meantime, just to note with most of the market trading at a discount.
The need for call protection that are offered by specified polls really just isn't there and as you would expect those pay ups are very subdued.
Now another story on slide 12, this is very important.
This is basically our proxy for volatility in the market and as you can see for instance on the left side back in March of 2020 volatility spiked up very very high.
But in fact, if you look at what's happened in the current year, it's even higher and more importantly, if you look really what happened starting early in the year when ball started to increase its just been a steady rise in its risen pretty much all year and it really hasn't abated that much and that really is just a it makes for a very challenging.
Market for mortgages as you know in the mall.
Rudimentary sense when you own a mortgage you are short of prepayment option or short volatility. So obviously, if you are short volatility and it's rising throughout the year, it's not a good thing.
Solely a agency mortgage investor.
We're just subject to that pain, and there's really nothing we can do.
Going through in the next few slides on the market slide 13.
Limited information here. These are just OIS numbers on bunch of coupons. Unfortunately again, the more recent production coupons fives higher interest isn't any data.
So we really can't show much there and the other one is just payoffs which of course are extremely depressed on the right side on slide 14. This just gives you an overview of basically how all the asset classes performed and I think the most important takeaway here is that when historically.
High risk sectors of the market like equities tend to be inversely correlated with extremely low risk sectors of the markets like treasuries and of course that has not been the case. This year as you can see whether you look at Q3 alone or the year to date numbers.
All the high risk sectors of the market, especially equities have negative returns, but soda treasuries and so all risk assets in this environment are suffering meaningfully.
Just on slide 15, this is new.
Basically this captures all basically the entirety of the domestic fixed income universe, so everything from investment grade corporates.
Down to double B rated CLO and CRT bonds and everything in between just point your attention that the one of the first column on the left is current so that's the current spread and this is as of 930.
If you look over to the right. There's one that shows the 2022 highs.
And then where we are at 930 versus that in a zero basically tells you that we are at the high spread.
And as you can see pretty much the entire universe.
It's either at or very close to the wider spreads that we've seen over the course of the year and in fact, many years. So obviously all sectors of the fixed income market are suffering in this type of environment.
Finally, a few more one more page R&R market before I talked about our results.
If you look on the top left you can see the Red line. There is the mortgage rate and in fact did past, 7%. This week and the refi index every week that comes out of late it makes a fresh multi decade low.
And then if you look at the bottom you can see the percent of the universe. It's re financeable, which is the shaded area is effectively zero and the refi index as I said just keeps dropping the primary sector secondary spread has just been choppy that reflects the volatility in the market generally and really what originators are dealing.
Now as you know.
What to do with head count and capacity because obviously.
This market is very very bad for the housing market as a whole.
Now we can talk about our financial results I want to spend a fair amount of time.
On slide 18, we have this slide every quarter.
And if you look on the left hand side. This is very simple disaggregation of our income statement. So on the first column basically you see all of our components of interest income and expense and then the expenses, we incur for the quarter and then the middle column, there all of our realized and unrealized gains and losses.
Just to talk about the middle column for the moment as you can see we had a book value decline and it's all reflected in the fact that the realized and unrealized gains or losses on the mortgage portfolio far exceeded the gains on our hedges and that's what led to the book value decline.
So obviously that has the effect of.
Artifact of what we just discussed.
Now if you look at the first column I want to point out a couple of things. So first we show our interest income.
That is we use the fair value option of accounting. So basically what we do is we take the coupon times the par and that is the dollar amount of the interest expense is what we pay on our repo.
We do use hedge accounting for tax purposes, but not for GAAP. So we don't reflect that in this number and then of course, we have our expenses and then we have a net interest income a little over $9 million, which is 26 cents now that's 26.
We paid a dividend of <unk> 54, and a half since so I need to point out two things one.
As I said, we don't use hedge accounting, but we do hedge and we have a number of hedges will talk about that more in a moment, but those hedges are very much in the money.
Paying fixed arden, receiving floating in the case of swaps or futures in our swaption and so as those hedges have become very much in the money.
Net to US we are receiving cash flows and the cash flows attributable to the third quarter of 2022 was about 5.043 million to us So thats 14 three.
Again, it is not reflected in this table, because we don't use hedge accounting.
Also our portfolio, which we have paid down John has a weighted average price under 90, so significant discount and so as we do get Paydowns, we get paid back at par we have discount accretion and.
And even though prepayments are low the magnitude of the discount is extremely high so the accretion of discount for the quarter.
Was 4.647 million, which is $13 two.
So for the quarter the benefit of our hedges. If you look at the say in an economic sense not just a GAAP reporting.
The effect of the hedges was another $14 three.
The discount accretion was another 13.2 cents.
The two tunnel 27, and a half cents, which when you add that to the 26, we reflect here gets you to $53.05. So our economic income for the quarter was one penny less than the dividend. So I just wanted to bring that to everybody's attention. Because this is where the shortcomings with our <unk>.
GAAP accounting.
<unk> can lead to some confusing outcomes and it's always been the case that we presented this way it is.
Just has not been the case that the magnitude of these differences were anywhere close to this high premium amortization when the portfolio was at a premium or hedges whenever they were out of the money. These were much smaller numbers.
But today they are very large and it in fact more than doubles. The net interest income number. So the economic net interest income was very much in line with the dividend.
With respect to the right hand side just more of the same you can see the first column is the return of the pass through portfolio, obviously very negative with the widening that we've seen in this sector.
Moving on somewhat quicker than some of the subsequent slides on page 19. This is just a proxy for our net interest income over time.
One thing that's interesting takeaway is even though the redline or economic interest cost of funding has increased our net interest margin is two churn and by the way that's not reflective of everything we just discussed in terms of hedge accounting.
Or discount amortization, so it's actually understated if you will.
It's more like 260.
But even at 210, it's really more or less in line with where we've been in fact, the law was back in late 2019, when it was about 155 basis points. So the net interest margin.
This environment is not poor even with funding costs. So high and we will talk about this more in a moment, it's actually a very attractive environment to invest in but it's also an extremely volatile one and one where rates and volatility are working against us. So you have to weigh those factors and everything you do.
Going on forward slide 20 edges more historical information I do want to talk about slide 21. This is of course, a paramount importance our leverage obviously in this type of environment, we have to be very active in managing our leverage of course, if you have a book value decline that means your equities lower so you have to lower your liable.
<unk> to keep your leverage ratio in mind, you don't want it to get excessively high that means you have to sell assets or short mortgages and one other former another.
As you can see the leverage ratio was $8 two at the end of the quarter.
As we sit here today.
Our economic leverage ratio, which would be liabilities divided by our equity adjusted for any longer short TBA positions. We might have that number is actually seven three as of Wednesday's close of business. So seven three today $8 two at the end of the quarter other right.
Hand chart, just shows us for our peers, but because we don't have all the information on our peers for Q3. This is scale data as of Q2, So we really don't need to say much about that.
Turning now to slide 22.
One thing of note here, we had talked late last year early this year about increasing our exposure to iOS, because we thought that passengers would widen and rates would increase.
That work the Io portion of that worked out well the iOS did very well so much so that they are at a point, where they really can't do any better speeds have slowed so much you basically extract at all of the value out of those assets that are no longer effective from a hedging perspective, and so as you can see on the left hand slide side.
Slide 22.
We talked or the right, we took that position from about $175 million down to 50 and actually subsequent to quarter end, we've strengthened even more we sold another 28 odd million in market value of iOS. So we only have about 22 million iOS left there just not a much used towards anymore.
And so the capital weighting has been shifting more towards pass throughs.
When we dealt with.
The rate volatility so more on the rate hedges versus just using iOS.
Now turning to slide 24, just update you on the portfolio as I said, we had to deal with decreasing equity and increasing leverage. So we had to reduce the portfolio. What did we do I've mentioned that we sold Iowa that was one way with respect to the pass through as you can see our largest holding there isn't.
3% coupon about $2 3 billion, that's actually about a $1 billion less than where it was at the end of the second quarter, but we didn't just sell those we actually added to the higher coupons for five five which at the time, we're a lot closer to par than they are today.
But so net of that is about four so we reduced our exposure to threes by $1 billion added to the higher coupons buy for the net of that is a net decline of $600 million, which is what we in fact had for the quarter and.
And then on the bottom of the page we have our hedges I just want to point out before we move on two points. If you look at the market value of the mortgage assets about $3 2 billion. The notional on the hedges is now higher at 107% of that balance at 345 billion at the end of the SEC.
Quarterly equivalent number was 93% so we've upped our hedge exposures I mentioned, reducing the io exposure and picking up the hedges and other products and that's how we've done that and then just one final point.
Weakness trend. This is model based on the right hand side, you show our exposure to interest rate shocks and its very balanced which is obviously something desirable for us to maintain.
The next slides we go through speeds. Obviously this is not a big story since everything is at a discount.
Slide 26. This is again kind of very intuitive as you look at interest rates here on the right hand side. The tenure, that's actually stale as I've mentioned that 10 years north of four and paid out and again, what we're doing here is we're normalizing our pay downs because of the size of the portfolio changes over time. So we just take the dollar.
The amount of Paydowns and divided by the principal balance of the portfolio and as you would expect with rates high it's lower those dotted lines represent one standard deviation above and below average going back to our inception March of 13 and were approximately one standard deviation below average.
Back in 13, we actually got fairly far below that.
We're benefiting from the fact that most of the passengers that we do on while they are discounts are season. So they do pay a little faster and Thats why this number hasnt decreased more than it has.
Slide 27 is a snapshot of our funding you can see all of our Counterparties on the left if you look on the right. There are several lines. There's a red line is actually a light gray language you can barely see that just basically represents average one month silver which is the benchmark that is used for our funding and then of course, our cost of <unk>.
And as you can see at quarter end. It was round around 250 or hedges are in the money so that gap between the Red line and the Blue line has been growing obviously these numbers are as of 930.
Likelihood by the time, we get into early 2023. These numbers are all going to be north of four simply because the fed has a lot more hygiene can do.
One last slide before we conclude the discussion of the portfolio just our hedges on slide 28.
As you can see on the top left as we shrank the portfolio our futures positions have been reduced slightly we show $750 million approximately short of five years.
Contract that was down from about $1 2 billion and the ultra as we were down we were about 275, so we reduce that.
We have added to tpa's.
We're at $475 million, that's versus 175 at the end of the previous quarter I do want to point out on the top right I talked about our hedges. This is where it becomes very explicit if you look at our swap positions the average fixed pay rate, 139% today, 1090% at the end of <unk>.
Last quarter, but the receive rate as you can see has moved materially in our favor.
It means the net estimated fair value has gone up so that will continue to be the case as the fed continues to raise rates with respect to the bottom right. These are our swaption. So I just want to point out one thing you can look at the fixed pay rate you see at rate went up that just because we are basically delta hedging with these positions. So as the market moved and has moved a lot of that.
We've just continued to adjust these hedges so that they're kind of at an optimal position in terms of the the rates on these instruments and so thats pretty much it for the portfolio and what I said I wanted to do is spend some time basically just going over our kind of a very current update on our financial condition. So first of all in terms of liquidity.
Obviously very important to us as of 930, our cash and unencumbered assets represented 53, 5% of our equity.
<unk> healthy cash balances, we maintain that number between 40% and 60% basically since our inception and we've done so since the end of the quarter. So we have very ample liquidity, we don't have any problem meeting margin calls and the like.
In fact with respect to repo, we have very ample access to repo, we have borrowing capacity in excess of our needs.
Our haircuts have been stable with one exception there was one counterparty that did raise their haircut by 1%. We were told it was more of a <unk>.
<unk> rhythmic thing basically capturing the fact that volatility in the market was higher their models their risk models told them. They had the raise haircuts slightly they did so by 1%.
Had other counterparties just to be fair, who have talked about raising haircuts over the last month or two.
But really haven't seen it just that one party and by the way our portfolio remains 100% agency MBS pools don't even have much iOS left so with respect to the ability to fund. These are instruments that are quite easy to fund.
And I talked about our leverage ratio, obviously, we've been maintaining that.
Lovely, we're comfortable with and that has really driven a lot of our portfolio decision, making at a high level and just wanted to point out that our TBA position. What I mentioned was 475 million at the end of the quarter were actually shortly sold forward $675 million now and that is.
Very very useful for us because that allows us and remember we sold these forward. So that one it's a very effective hedge against basis widening but also it allows us a lot of flexibility in terms of maintaining our leverage ratio. So to the extent that rates move against us and we want to lower our leverage ratio.
Because it's moved against US we can fill as many as.
By selling assets into the TBA short as much as we need to do so and where we can sell none if conditions warrant. So it's been very effective in terms of allowing us to one hedge but also.
Tremendous flexibility and maintaining our leverage ratio and.
It's just a very effective way of dealing with the issues and mentioned the iOS and so forth before.
Not so useful a few more points with respect to funding most of our funding is done at a spread to sulfur. It has been trending higher which basically reflects two things one that you just have.
Conditions tightening generally and then two I think there's a lot more uncertainty in the marketplace over the path of rate hikes, and that's just reflected in a wider spread so we have seen some widening in the spreads so far over the course of the year, we actually did put in some.
Basically floating rate funding earlier in the year.
Thereby we pay a spread over sofa that was fixed at initiation that was actually had a very tight levels. So that's been nice now I'll just final one final point just talking about our view on the markets. Obviously, we view the market is attractive in terms of assets in terms of returns that are available and so forth, but as we learned in Q3.
When the same situation was the case.
We had a lot of volatility to show up in August late August September and in October and so.
Caution is definitely warranted that and we do have to maintain a leverage ratio at a safe level. So while the market is extremely attractive.
We do have to.
Be somewhat cautious so we do have an ATM, we have the ability to raise capital when we think it's prudent to do so.
And we May do so if that's the case.
But that being said with the sector gets weak again as it's done in the past.
We can buy back shares and over the course of the most recent.
90, plus days, we in fact did not sell any shares on our ATM and instead bought back a little over 5% of our outstanding shares at a substantial discount.
To book value. So so far we have opted to just buy back shares and capture that discount as opposed to try to issue shares because we really are.
It's hard to have a lot of conviction and thinking that this.
Period of rising rates and high volatility is over at the end of the day. It seems that inflation is driving that.
The fed is very keen on containing inflation and the data just keeps being strong. So these data keeps being strong and the fed has to react to it we're going to continue to see more of the same eventually I would assume that's going to end, but we don't know with any conviction when that will occur. So we will continue to operate as we have.
So that's pretty much it and with that I will turn the call over to questions.
If you would like to ask a question simply press Star then the number one on your telephone keypad.
Once again to ask a question. Please press star one at this time.
Your first question comes from the line of Jason Stewart with Jones trading. Please go ahead.
Hey, Bob Thanks for the update.
I wanted to ask you about your thoughts on the forward curve and whether you think there's going to be a fed pivot and how you position the portfolio for that.
Sure.
I really don't put a lot of another 100 and speak to this too I don't put a lot of stake in it.
As you know last Friday.
When this whole pivot things came back into the market. There were a couple of things. So it's a timber OS article, saying that the fed might consider winding down their hikes are decelerating daily the fed governors in San Francisco said, the same thing and then the bank of Canada didn't quite hike as much as they thought the market thought they would and ECB with somewhat dovish yesterday.
Hey by the way apparently Tim Ross had a tweet today, saying the market the fed might we consider what they do in the $7 75 at the end of the day. The data is going to drive it and I don't care, what the forward curve says or what tomorrow says or anybody says if next whatever it is in two weeks from today when we get the next CPI number if it's meaningfully higher than <unk>.
Census estimates they can't pit, so and from what I've been reading, there's a lot of evidence that inflation is fairly well ingrained. So if you wanted to make the argument that inflation could stay high for a while.
It's easy to do.
As an economist so I can't really do so with any great conviction, but I do know that until inflation really slows I don't see how the fed can do anything other than continue to try to get ahead of it yeah, I think thats exactly right from a portfolio perspective and hedging perspective.
You know we have a limited number of tools given that amount of uncertainty. So the things that we can do is that we've noticed of course to the extent that inflation comes in hotter mortgages, obviously have to.
To respond negatively to that versus other risk assets. So we've been continuing to increase.
Our hedge allocation towards.
Towards mortgage basis sensitive hedges like Ppas and the other thing that we've been looking at and have.
I have not.
Done much on this front.
Being long Vega loans.
Net long volatility so to the extent that there's upside surprises we benefit from a from an updraft in volatility and then we have been looking on the front end of the curve to do some things and conditional space, but just so that it's higher for.
For longer plays out and proves to be sort of a mantra that we can.
Benefit from that without being locked into it in a more symmetric fashion. So that if we're in other words, if we're wrong and we lose some premium on <unk>.
Auctions, but if we're right then we can benefit from the fact that we're going to see higher funding costs for maybe another year or two or however, long this plays out.
Yeah. Okay. That's that's helpful color and then how does the TBA short fit into that thought process.
The basis.
As I tried to stress it in the slide deck can be mortgage basis has been widening we have a lot of disclosure to threes.
That used to be the desirable place to be earlier in the year, because nobody would've gone production coupons because of potential speed increases nor did they wanted to own the deep discount so that what they referred to as belly coupons were fairly desirable that's changed of late they become less so but.
There's no better way to hedged in shorting the underlying.
In this case the Fannie three so.
That's about as effective as the hedges you can use.
Just because it obviously changes with your portfolio.
<unk> phase III rolls in particular are very very low. So there is not a high explicit cost of doing so.
Not trading special at least.
And for Us.
It can be costly hedge in this manner, but.
Also we like the flexibility of being able to lay off our pools most of the specified pool universe. At this point has relatively low pay ups. So.
We were able to mitigate our risks with respect to Boris.
Boras basis by Shorting us those two years.
Yeah, No I understand the down in coupon strategy I guess I was trying to just last question then I'll jump out of the queue.
Understand what your thought on the basis.
Does over the next kind of call it three six months.
Well it saw.
I tried to say at the end of the second quarter I can see getting much wider and then all of that.
It still could widen.
We've got to be close to the end.
<unk>, just gotten bludgeoned to death.
What would it take to get them materially wider if the fed started more certainly implying that we're going to absolutely sell mortgages or the bank of Japan had to intervene and sell mortgages.
Net front the bank of Japan has intervened in the currency markets and did not sell mortgages. So that's good to see.
Yeah.
It could get a little wider than just what's going to get tighter and it's really not until that pivot occurs when that pivot becomes clear theyre going to snap tighter meaningfully so so going back to that little slide in the deck, where you see how mortgage instead in late July and early August .
Youre going to get a lot of that so it's hard to guess when that point is and whether it's three months or five months, but once we pivot mortgages are going to do well because what's likely to happen is the fed is going to have to tighten a lot get the economy to get rates and restrictive territory and then we're going to have a recession and when we have a recession mortgages.
Well, we have no risk component of our asset class rates are going to be the curve will be inverted.
Mark will be expecting longer term rates, the rally and mortgages can get back a lot of this widening so when that happens I'm very happy to be positioned the way we are.
Wholeheartedly agree with that and you can look back to the cross asset.
Yeah spread matrix that we.
We put in the deck.
Agency mortgages in particular or particularly wide you know some other things that are.
Very well insulated from.
From credit risk like the agency MBS.
<unk> are also very wise, our AAA CLO those are extraordinarily wide.
From the standpoint of agency MBS were.
Approaching levels that we haven't seen since the financial crisis really and.
Somebody I think Morgan Stanley was talking about this the other day that whats.
Unique about this environment versus the global financial crisis was there was some little bit of uncertainty as to whether or not agency MBS were actually going to be credit not have credit risk back then because there was a lot of uncertainty around the gse's, we've certainly seen that firm up.
There's no indication that the GSE is not going to stand behind their there Gary or have the ability to stand behind their guarantee obligations at this point and Theyre just really wide. So.
We're going to trade Directionally like we just said with inflation and the economic data and to the extent that rates go higher than inflation is hotter than expected I would expect the basis to remain weak and to the extent that they start with it really starts feeling more comfortable in this concept of pivoting and and.
And.
And that situation I think that the basis could tighten firmly but theres a lot of liquidity issues still working your way through the market and not a lot of the traditional buyers.
Of agency MBS in particular are just not there yet and of course, the fed has made their exit this year. So I think the market is still kind of digesting all of that.
Yeah, we haven't talked about that that liquidity.
Is not a non issue there is definitely liquidity issues, even in the treasury market.
And.
That gets to this whole idea about Q T and how much the fed can drain liquidity from the system as of now I don't think it's acute.
But I wouldn't be surprised one of the stories of 2023 is likely going to be when it or if the fed has to stop Qt because liquidity conditions are getting too tight I mean, theres still whatever two one trillion in the RFP. So it is not an issue now.
But it could become one.
We continue to tighten financial conditions and the other thing is that you're starting to see a little bit of it in the earnings for Q3, but you're likely to see more of it going forward, but you're going to see earnings are going to be weak and then youre going to see margin pressure and then eventually you're going to see layoffs and jobs are going to go from positive to negative and that just brings more and more pressure on them.
Fed when conditions are tight the economy's contracting and people are losing their jobs.
<unk>.
That's all it is going to play out and eventually they're going to either contained inflation or theyre not going to contain inflation, but theyre going to.
Essentially back onto the pressure to ease because everything else is so nasty.
Who knows how that plays out if they don't have inflation under control, but anyway next year, it's going to be equally interesting.
Good points and thank you as always for the color I appreciate it guys Yep Yep. Thanks, Jamie.
Your next question is from the line of <unk> Doberman with JMP Securities. Please go ahead.
Hi, Good morning, gentlemen, hope everybody is doing well in these difficult times.
Good morning.
I Wonder if you could provide perhaps a book value update for the months of October up to now and also <unk>.
Kind of a question on capital management going forward, how you guys are thinking about the dividend.
With the stock run up there, they're really strong stock run up these past few two weeks I guess, how you guys are thinking about those share buybacks with the stock trading.
I guess above book value at this point thanks.
Our book, we've put in the press release that was out there was between $10 50, intense 60 or 60 and 70.
Between $10 60 intent 70 as of Wednesday's close.
So.
We benefited from the activity the last few days I know for instance.
Agency reported on Monday, and Friday was kind of.
Rough day, but the mortgage market has done very well. These last few days. So we're at $10 68 tenths any range. So I don't know where the stock's trading at is burning moment, but when I came in here it was below that.
And when it's below that we will consider buying back shares although I don't know that the discounts quite that large when we were buying back shares earlier. This month. It was 20 plus percent discount and if we get back there we will do so again, so so thats book value, that's our approach to the buyback as far as capital.
Really if the stock trades, well and theirs.
Benefits and raising liquidity, if nothing else and raising capital.
But it's really.
I think warrants caution like I said in this market. It's just hard to say when that pivot point is.
And I know the market wants to do so very badly everybody wants to but at the end of the day. The inflation data is driving the fed and the fed's driving the market.
I don't I haven't seen much that's convinced me that we're about to see inflation rollover. It's more the opposite you keep seeing more and more evidence that are becoming more engrained.
Even today in the <unk> numbers.
Public sector employee wage gains, which typically lag prior.
We get this right public sector wage gains lag private sector wage gains, but they tend to be more sticky once they go up and they were higher.
More than double the highest quarterly increase in two decades.
That's not a good sign for the fed and the fed will pay attention to that so that's probably why timber else had as all tweet out today about the fed's Reconsidering December that's what's driving everything.
Love to raise capital because assets are cheap, but we're gonna get slammed again I don't want to get an idea that is.
Well, thank you for that.
Also just one more for me how.
How are you guys thinking about operating expenses going forward. Thanks.
Well, obviously, they are coming under pressure because as we've shrunk.
And we've had elevated hedging costs, although in our income statement as Youll see in our Q1 line item for operating cost which is inflated.
As a kind of a quirk in our accounting system, where a lot of the costs associated with putting our hedges on our expense in the quarter incurred versus spread over the life of the hedge.
Might have to revisit that with the auditors.
I think thats, a little penile and its causing our expenses look worse than they are the other main line item. Obviously is the management fee as our capital has decreased its coming down but it does so with a lag so it does stick out for sure.
Hopefully at some point here in the near future our capital stabilizes and maybe even goes up and it will come into line, but for now it does seem to stick out a little bit otherwise.
We've had some inflation in our costs I know our audit fee did go up just same reason everybody else's raising fees, but.
And the shrinking the portfolio goes.
It makes that challenging but.
We just do everything we can to contain cost as much as we can with respect to the operating costs.
The fee schedule that we have just for a little bit of background I guess, there's a backup.
The both the futures hedges as well as cleared swaps are.
Flow through.
SCM.
And we have to we have two of those so those schedules on R. R.
Her contract costs or are on our cost for cleared swaps those are unchanged. The activities kicked up so you can see for the.
For the nine months ended Sept September 30th.
We are.
You know over doubled.
On that particular line item and that's attributable to that and.
Our operating costs with respect to management and overhead allocation will trend lower as the portfolio turns turns over and we do have some.
It's sticky there in a way that the management contract works, but it shouldn't be trimming down a little bit over time as well so.
And if need be the dividend just has reduced what you've done for now.
Went through hopefully great detail in enough detail, it's earning right at that number but.
No.
Hopefully that we stabilize here I think we've done enough to do so, but we'll see how it goes going forward.
Alright, Thank you I appreciate it and best.
Best of luck going forward in this tough environment and best wishes in the holiday season.
Thank you you too as well.
Thanks.
Your next question is from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.
Yes.
Chris Bob the discount accretion income is that going to be recurring deal do you think or what sort of run rate can we call.
Well it looks like it is for the time being and since 90, 999% of the market to disc op. Yes, that's a big number as I said speeds aren't that fast.
But the magnitude of the discount our weighted average current prices at the end of the quarter is at 89 handle so it's well over 10 points of discount.
So theres a lot of discount accretion.
Back in the day, where everything was always at a premium in.
We always had a lot of specified pools, so even though we had a lot of premium we had slow speeds well now we've got even more discounts and so that number is quite large.
About $4 6 million, which is in pennies.
13, I think it was <unk> seven I don't remember the exact number off top my head.
There are $13 <unk>, so it's big.
Especially in light of the fact that our dividend now is smaller than it used to be so.
It's a meaningful number.
Chris that numbers on slide 22 by the way I'm sure you've seen it but just to anybody who didn't catch that it's up it's.
It's on the right hand side of page 22 in the presentation materials, we put out it actually says premium loss due to pay downs, but that's <unk>.
Positive number so its discount accretion.
Okay. Good thanks Hunter and the income from the hedge I mean, that's just I don't think you've detailed it in the past, but is that sort of just an ongoing deal.
Well, it's just so important now I mean, you know.
Especially the last two years and frankly up until 2018 and 19 when rates were so low.
The hedge cost was kind of a.
Non material number I mean, the curve was fairly steep.
It was a stable number the dividend of course was higher than so the impact was much smaller but now the.
The dividends smaller and with rates. This high end going higher those hedges are very very far in the money. They are more in the money than they ever were out of the money if that makes sense.
Actually if you look at.
On slide 19 is the economic cost of funds you can see that.
It got a little high.
Towards the end of the last decade, but prior to that had been very very low.
It's going back up but not nearly as fast as sulfur sulfur.
<unk> is going to be.
North of 4% very soon and our hedges right.
The swaps, where our pay fixed rates like 139 bps, it's a meaningful number and when the dividend is smaller so the combination of the two makes the impact very significant.
And just confirm you hired you guys have not received any margin calls in the third quarter or the fourth quarter to date is that correct. So no no no. We get we get margin calls every day and we haven't missed we get margin calls every day I mean, there's we have margining activity on both the hedges in the assets.
Every day that's with.
With volatility in the market youre going to get margin calls.
That's a daily part of life for us.
We are constantly squaring up with the Counterparties that we learned that we borrow from and for versus the value of our collateral and how much money they have given us, but we've not ever failed.
We've never failed to meet a margin call.
Our entire operating history and.
Yeah.
We are not in breach.
Breach of anything right now so okay no. Thank you for the clarification. Okay. Thank you guys.
Thanks, Chris.
There is a follow up question from the line of Jason Stewart with Jones trading. Please go ahead.
Hey, Thanks for taking the follow up just wanted to go back to the concept of discount and your view of housing turnover and with the natural rate. There is given where mortgage rates are and you know.
And when we look at discount accretion.
You know that becomes a big factor in that equation, but I'm wondering here your view.
Yeah. It's.
It seems like it's going to continue to sell now of course right now is the seasonal slowdown so over the next three or four months, it's going to be slow. The question is how does it come out of the seasonal slowdown and of course, that's going to be a function of.
Where we are in terms of the marketed rates certainly if rates stay at 7%, it's going to be low.
The other thing that's going to affect turnover is gonna be job growth or loss.
The chances that the net change in jobs is going to be south of where it is today as high as in other words I think it's it.
It doesn't bode well for housing turnover in the next year now that being said we own a lot of.
Season discounts they pay at mid to high single digits.
And so there is still some discount amortization, but I think that's what's really driving it are two things one is the magnitude of the discount so even those speeds are slow you're picking up a fair amount of discount amortization and to the dividend is just a lot lower than it used to be so.
More relevant when the dividend was not 16, but I think if you look at that one chart at one point was as high as 70.
$5 million of discount.
<unk> is a much bigger percentage and so it's.
It means more for US now is to the hedges.
But as we come out of this at some point in recovery Steepens and hopefully the dividend can recover and those two factors will go back to being not as significant.
We have a lot of collateral thats coming up the curve too just in terms of wala ramp I don't know how long that will continue to how long this.
Borrowers will continue to be active in either some type of home equity takeout or just turnover in general we sort of are you expecting to see I think speeds.
The mid single digits.
Some vintages, maybe a little bit higher we've seen kind of a resilient.
Amount of turnover activity and some of the 234 year old.
Loans I suspect some of that will will taper off with time, just because mortgage rates are so high now, but again a lot of our portfolio is.
And very low pay ups and threes, we can at any point in time dump a lot of that into TBA bid or grab a few ticks of pay up we don't have really a lot of exposure for underperformance of that coupon.
As it relates to specified pools versus TBA. So we can always reload and go back into something that's.
A little yield year to the extent that those that discount accretion starts to slow down.
To your point I mean, it's we couldnt retest the lows of turnover you know it used to be.
Not that long ago, when turnover was running even north of 10, sometimes 11 CPR.
It could be pushing five or lower it's going to be pretty damn low Ah.
Theres no unless something changes, it's going to be we're going to retest, the lows, probably the lowest ever turnover rate.
It's going to happen in the next year would be my guess and those really deep discount coupons, we don't know what any 2022 production.
And have a fair amount of 2020, one production, which still has.
Ample amount of home price appreciation baked into it.
See if that holds but.
They have.
They were surprised to the SaaS side for me personally I think the street is kind of pretty dialed in but.
So I don't see valuations really being whipping around much.
As a byproduct of speeds coming down but.
Just from my own point of view, I think that with mortgage rates as high as they've been in and locked in as pronounced as it's been.
I'm kind of surprised it was continuing to see.
Double digit speeds on some for schools churches, Yeah, we still see production like two to two 5 billion a day, that's surprising to me I don't really see how it staying as high as it is.
But it is I mean, it's very consistent persistent.
We'll see.
Okay. Thanks for taking the follow up I appreciate it.
Absolutely.
Once again, if you would like to ask a question simply press star one on your telephone keypad.
And at this time there are no further questions I will now turn the call back to Mr. Mccarthy for any closing remarks.
Thank you operator, and thank everybody for taking the time anybody comes out with a follow up question or are you just happen to not make the call and listening to the replay and you want to ask a question feel free to call. The office. The number is 770 2231140 and zero otherwise we look forward to speaking to you at the end of the fourth quarter.
Got it all right. Thank you.
This does conclude the orchid Island capital third quarter 2022 earnings Conference call. Thank you for your participation you may now disconnect.
[music].
Sure.
[music].