Q2 2023 Orchid Island Capital Inc Earnings Call
[music].
Okay.
Please standby were about to begin.
Good morning, and welcome to the second quarter 2023 earnings conference call for Orchid Island capital. This call is being recorded today July 28 2023.
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 and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in such forward looking statements.
Important factors that could cause such differences are described in the company's filings with the Securities and Exchange Commission, including the company's most recent annual report on Form 10-K.
The company assumes no obligation to update such forward looking statements to reflect actual results changes in assumptions or changes in other factors affecting forward looking statements now.
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, hopefully everybody has had a chance to download our slide deck.
And I'll be going through that over the course of todays call as usually I'll be following the same format I'll start on slide three just the table of contents just to give you an outline of the agenda.
The first item, we'll just be as quick overview of our results of operations for the quarter.
And then I will talk about market developments and what we dealt with over the course of the quarter and then our financial results before finally, describing our current portfolio positioning with respect to the portfolio the hedges and so forth and let's say a few words about.
How do we see things going forward, so with that turning to slide four orchid island generated net income per share of <unk> 25 cents per share for the quarter net earnings excluding realized and unrealized gains and losses on RMB acid derivative instruments, including net interest income on interest rate swaps.
Was 34 cents negative for the per share.
Gain of 59 per share from net realized and unrealized gains on RMB acid derivative instruments again, including net interest income on interest rate swaps.
Book value per share at 630 was $11 16.
Versus $11 55 at March 31, 2023 in Q2 2023, the company declared and subsequently paid 48 cents per share in dividends.
So our initial public offering the company has declared $65 77 per share in dividends.
The dividend declared in July of 2023, total economic gain of <unk> <unk> per share for the quarter or 0.08% that is or not.
The annualized figure now going to market developments.
So we're basically four notable developments that occurred during the quarter.
The first which occurred in late May was the debt limit impasse between the administration and Congress.
And while that was resolved during that period, we did see very negative performance for risk assets generally, but more importantly mortgage backed securities in particular and I'll just talk about this more in a moment, but it was during that period that most measures of mortgage pricing in other words in terms of spread.
Some comparable duration treasury reached a cycle high in late May and that was significant of course and that did trigger some actions on our part of which again I'll get into in a few moments.
The second development was the recovery in mortgages in June obviously haven't recovered all the way back anywhere close to where we were pre pandemic.
But the mortgage sector had a very good recovery in June .
The third item, which.
Really has gone on for two plus months now as a re strengthening if you will of economic data are both inflation data a strong labor market data GDP yesterday, and the resulting a reaction on the part of not just the fact that central banks across the globe, which have become very.
Even more hawkish and we saw this week another hike.
With the potential at least potential maybe not.
Ultimately be realized but even more hikes to come and then the fourth item, which occurred in the second quarter.
Which were a result of the bank failures in March with the FDIC, taking over those banks, where the auctions of the assets are well over $100 billion, approximately 61 billion of pass through mortgages.
That started on April 18th and is still ongoing although it is growing much faster than initially anticipated and is also going quite well. So those are kind of the four major macro developments. We dealt with now just to go through the slides just to give you. Some of these things and pictures slide six. This is is look the same as <unk>.
<unk> for a year and a half and what we see the Red line. There is where we were at the end of last quarter and the lines above it or the more recent ones. The last of which is last Friday and as you can see that curve as the fed has continued to hide the front end has moved higher but the curve has remained very inverted that's meaningful for us and for any Levered <unk>.
Faster.
I'll say more about that in a minute.
It tells you through hedging and using say for instance, swap instruments you can lock in very attractive net interest margin levels using those types of instruments. So in any event. The curve has continued to steepen or invert rather.
That's true in both the treasury nominal curve is in the swap curve slide seven. These are just pictures of the 10 year note.
<unk> and cash nominal cash and then the tenures over swap over the course of the quarter rates were drifting higher.
And.
And in spite of that as I said mortgages, it actually had a decent quarter, even with the rise in rates.
Moving onto slide eight.
I will just focus on the bottom of this page. This is the spread of a current coupon mortgage to the 10 year Treasury.
Many such measures that people look at you can look at the 510 blend or just to the curve.
And they're all pretty much all the same picture and I think if you look at the bottom. This just goes back to 2010 and this gives you some very good perspective, and you can see from say 2013 through the pandemic. The spread was fairly stable we had a spike in March but more meaningfully if you look to the most.
More recent history last fall in October that spread got as high as 190, but in late May we reached 200, so as I said well when we had the.
The debt limit in past swallow it didn't appear to be something that you would consider mortgage market related it was during that period that mortgage spreads hit their widest level and cycle high.
Through this current episode and so that was meaningful and that was something that caused us to take several actions, which I'll describe in a few moments moving on slide nine.
Just shows you the 530 curve there are many many other <unk>.
On the curve you can pick most common would be twos tens or the spread between fed funds and tans Theyre all inverted index.
In the case of tunes tens.
This cycle high so far is negative 110.
We were as high as 105 this week, although this week in the last few days in particular that has steepened steepen as in less negative, but still very much inverted.
Moving on to slide 10.
It shows you the size of the fed balance sheets and bank holdings and we describe the details of what we mean when we refer to bank holdings in the note below but the takeaway is that youre seeing a normalization as the fed likes to refer to it on their balance sheet in other words, they expanded their balance sheet in response to developments that occurred in 2020 and Theyre now through.
Quantitative tightening letting that balance sheet runoff or normalize and bank balance sheets, just fall out because after all when the fed is reducing their balance sheet, they're reducing reserves in the system and banks tend to mimic what they do both on the way up and down.
Now turning to slide 11, this is more than mortgage market specific as you can see in the top left and remember these are absolute price change not necessarily total return or total return versus some benchmark, but just price change with oil prices normalized to 100 at the end of the last quarter and as you can see all coupons are down in price.
<unk>, which makes sense given the moving rates.
The performance.
It was not uniform and as I've mentioned in late May and spread Scott quite wide and have since recovered somewhat. So so you could argue that these price movements are exaggerated to the downside reflective of that spread widening on the bottom left you see roles on the dollar roll market, often a source of income and the Levered mortgage space.
<unk> and otherwise and you can see that all of these rules are essentially non economics.
The only rule that has any positive.
The drop is six five coupon as of this morning, the rest are all negative.
And the alternative to TBA as is usually the specified pool market. So if you looked in the top right you get a picture of that and keep in mind that as I said on April 18th the FDIC liquidation started so we've had substantial selling of mortgages by the FDIC and almost every bond that they sell is of some form.
Some of our specified pool, even if it's just seasoned so they all have a pay up so you've got tremendous supply.
Initial reaction the FDIC liquidations, where TBA has widened as you would expect and so the payouts.
Initially it didn't look so bad and that's just really because of the benchmark was lower but stabilized and as I said those liquidations are going very well.
Probably 80 plus percent through probably be done comfortably before this quarter is over and it'll be interesting to see how those markets behave once we're don't have three or $4 billion of supply every week, but again that market has held up quite well considering the size of those liquidations again over <unk>.
$1 billion of supply just in the <unk>.
Passenger market.
Turning to slide 12. This is measure evolve three month by tenure.
Obviously mortgages or an asset that is very much impacted by levels of volatility that short takeaway here. As you can see is that vol is nominal normalize or not normalize I guess, it's moderated somewhat since late March or late may.
But keep in mind that this level is still over 100 and for reference during the last decades up until the pandemic occurred the average level for that period was about 72, so we're well above that so volatility is still elevated just.
We're kind of at a local low as opposed to a local peak.
Turning to slide 13, as I talked about mortgages earlier, you can see on the left hand side. These LIBOR slash sulfur OAS levels and as you can see they're extremely elevated as of late and they appeared to peak in late May and then recover in June consistent with what I said earlier keep in mind that prior to the pandemic. These levels were.
All negative.
Even after this.
The pandemic when the fed was in the midst of QE. These numbers were negative. So we've moved a long way and as a result, the mortgage market, while it's been painful at times of late over the last year and a half performance wise.
Asset class is very attractive.
Turning to slide 14. These are just returns across our markets and other components of the aggregate index and even the S&P and of course, you know it was mortgage investors.
Certainly ones that are focused exclusively on mortgages a number of investors are invested across multiple asset classes and so therefore, the returns across these things matter to them and therefore us because they are large players in our market as you can see in the second quarter. The best returns, where the riskiest assets high yield emerging market high yield on the S&P 500.
All the other components of the fixed income markets were either very modestly positive indication on emerging market investment grade debt or negative.
But not materially so and looking at the.
Year to date numbers again, the riskiest assets have had the best returns, but otherwise everything is fairly uniform the spread between the best and the worst is quite small the best returns year to date, our investment grade corporates and while that has not been.
Unfortunately, not mortgages.
Going forward because of investment grade corporates doing as well.
Mortgages look fairly attractive versus that asset class.
As a perfect segue to go to the next slide where we show spread levels across the same large investment grade and.
In sub investment grade fixed income market and I'm, just going to focus at the top of the page. If you looked at the agency MBS in corporates and the reason I am focusing here is that to the extent money managers are active in the market and they are the largest most active at the margin players today because the bank.
Our community and the fed are largely absent some money managers irrelevant for us so as if youll get spread products in other words.
Assets that trade was spread to treasuries.
The two largest buckets are the agency mortgage market and the investment grade corporate market and so relative attractiveness is important. So just look at a few points of columns and this slide if you look at.
Column labeled 2021 year and you can see the corporates were quite a bit wider than mortgages. If you look a little to the right you can see that we had a very.
Stressful 2022, and those spreads were much wider but they converged.
Look to the left December of 2022, you can see again that those levels, while they are off the tight or the wides. They tightened there's still very much in line with one another but if you look at the current level you can see that mortgages are quite a bit wider and so thats not been so good for performance year to date, but going forward.
The asset class that mortgage asset class does look relatively attractive and that should bode well for this sector going forward and is the reason for that we are very constructive on the market over the balance of 2023 and beyond.
Slide 16, just shows you the refinancing picture so to speak on the bottom of the page you can see the percent of the market. That's in the money, which is essentially zero, it's about 2% not surprisingly given where mortgage rates are but I would call your attention to the top side on the right. That's what we call the primary secondary spread.
The spread between the newly originated mortgage and a benchmark treasury or swap and you can see it's been volatile of late but it's also a fairly heightened wide levels and to the extent that the market turns and we see the fed moving from a tightening bias to an easing bias.
That would of course be a beneficial development for the mortgage banking universe, because they would be in a position to start doing refinancing, which as you can see has been negligible and the fact that those spreads are wide means they have room to tighten and we've said throughout our last few earnings calls that we are have a very negative view on.
<unk> current coupon recent originated recently originated mortgages and this is just another reason, where we would think the convexity could prove to be a real challenge, especially in this case the ability of this primary secondary spreads tightened and allow mortgage rates available to borrowers that come in and just make that set.
Some of the universe that much more refinance of both cell and that's just an aside but I just wanted to point that out.
Now turning to our financial results on Slide 18, I'm of course going to focus on the left hand side and this is the same slide we've had for <unk>.
Several years and as I'm sure. Most of you are keenly focused on the left side. The net income excluding realized and unrealized gains and losses as you can see that number as a negative 34, and we're paying a <unk> 48 in dividends. So the question in your mind is how can that be the case and I'm just going to walk you through it.
Starting with the net portfolio income was negative $8 7 million Thats roughly <unk> 22 cents negative added in the expenses of 4.8 hundred $9 million Thats. Another 12 that gets you to your negative 34.
However, we use fair value accounting, which means that we do not capture premium amortization or discount accretion and our income figures.
But thats still very much relevant because we do only securities generally at a discount in the current environment.
The accretion to par of our discount securities was approximately $4 9 million in the current quarter. So thats a positive 12.
But much more materially our hedges again, we don't use hedge accounting, even though we do actively hedged we use hedge accounting for tax purposes only.
Our hedges are very much in the money and that added about $23 5 million of income are offset to interest expense, which is about 59.
So when you factor in those two items that gets you to a positive 37.
Again versus up 48% dividend, so theres still a shortfall I will note that during the quarter, we did issue a little under $50 million of equity through our ATM program to.
To increase our leverage by approximately one turn and we used the proceeds to buy a combination of 30 year five five and six securities and we were able to hedge those positions using.
Interest rate swaps predominantly in as I mentioned earlier with the curve inverted.
We could lock in basically funding through those hedges such that we had a blended net interest margin on those newly acquired assets of just over 100 basis points. So that will add about two 5% to three so that is going to close that gap some.
And I'll speak more to this in a few moments but.
Just want to point out that the gap is obviously 34 cents negative were much much less than that and we did do this add here in the very very late stages of the quarter. So it is not reflected in these numbers at all so going forward all else equal we would be at around 40 versus the negative 34 or even the <unk>.
37, since we had this quarter so.
So that's just.
One thing I want to point out to you will be able to do at the end of the quarter and then I'll speak more about our current positioning and how we see things going forward in a moment.
Through the balance of the slide Slide 19. This is just a picture of our net interest margin, obviously with the curve inverted.
And the fed rise raising rates.
Local trough and actually a long term trough in that regard.
Slides 20 is more or less the same slide 21 is our leverage ratio I want to speak to this and we've spoken in the past that.
The Blue line represents our what we call adjusted leverage that's basically just our repo balance divided by our shareholders equity and as you can see it was $8 six at the end of the most recent quarter, but we also use TBA or in our case hedges of TVA. So short term ppas to adjust that figure.
And late last year and earlier this year, we were short a substantial amount of TBA, so and our economics that are at risk leverage was much lower and we had said that if we saw the market opportunities as being extremely attractive which they have been of late that we could reduce our TBA short and affect <unk>.
Kris our leverage which is what we did in this quarter.
By simply just buying back.
These TBA shorts and the most recent AD that I mentioned, we were able to take our leverage higher which we did and it's obviously to take advantage of these extremely attractive levels in the mortgage market.
Do have some small more additional room to do so, but we did take a substantial step this quarter.
Moving on to slide 22, our positioning on the left side, there's really nothing to say here, it's basically unchanged.
With rates as high as they are there is not much value in iOS. Other then sheri very little ability to offer a hedge component of their performance and so as a result, we have a heavy heavy skewed towards pass throughs.
And now I'll talk about our portfolio characteristics. So on slide 24, we show our portfolio on the top half of the page.
As has been the case for some time as heavy skew towards fixed rate 30 year mortgages.
Approximately 97% almost 5%.
But as you can see we've added five fives and sixes all other coupon buckets.
Basically unchanged from last quarter other than pay off so the change in the outstanding balance there just reflects pay downs over the course of the quarter, but we did add substantially to the five five and six bucket and we took our weighted average coupon from about 356% to 383%. So we.
<unk>.
Taking that higher.
And as I said, we may do so more in the future, but I want to table that conversation just for a moment otherwise with respect to the portfolio. There has been no changes in the post quarter end. So we haven't done anything in Q3 yet.
Slide 25 shows our speeds, obviously at a substantial discount environment. These levels are quite low if you look at the most recent quarter, which is the bottom left that's June .
This.
Reasonable speeds, our securities we're paying around six CPR in the 3% coupon and a little higher than the $3 five bucket.
That may be the cycle high since we're kind of at the peak seasonal.
So turnover and the like.
And you get decent yields or the assets with those speeds, but I would not expect those to change meaningfully in the near term.
Going through Slide 26. This is just more of the same mortgage rates are very very high the orange line, there and our turnover our paydowns expressed as a percentage of the outstanding principal balance.
There are quite low and you would expect that to remain the case until rates.
I'll turn it around 1 billion other ways.
Slide 27. This is a picture of our repo borrowings by counterparty and as you can see we have.
White.
What I call effective.
Spreading of the exposure across many many counterparties.
Diversity no no single counterparty is over 8%.
We've continued to do that for a number of years and try to avoid concentrations while at the same time, maintaining access to more than adequate funding and a large number of counterparties on the right hand side, we see our funding cost.
One month's sofa, which is kind of hard to make Alger. That's the light grey line. The Red line is basically our cost of funds and as you can see it.
<unk> quite steeply and continued to rise as we move through 2023, although at a slower rate, but importantly, if you look at our economic cost of funds and this is where the impact of our hedges come into play you can see it's basically peaked and has stabilized and unless we were to grow the portfolio substantially.
That number would be expected to stay there and I have spoken at length on prior calls about the dollar amount of hedges that we have that are being closed out but for federal income tax purposes will still impact our taxable income this year and next and actually years after and we have substantial gains from those.
Hedges are available to offset increased interest expense and so this number.
Has the ability to stay that way for quite some time.
Now turning to our hedges. This is an important slide as we mentioned that in late may when mortgages got very very wide.
<unk>.
The cycle wise and I said that we have taken some steps I mentioned, the fact that we bought some assets, but the other thing. We did was on the hedge side and what we did was really moved a lot of our hedges from mortgages TBA shorts, which you see in the bottom left we were at negative $875 million minus $3 50, and we moved those.
Two rates.
Thinking that mortgages could not get meaningfully wider so we wanted our hedges to be more rate driven than mortgage driven.
Also we moved more out the curve and so.
What we've seen over the last couple of months whenever you get some softer data lake. So we had a softer CPI number last month, our non farm payroll as is typically the case the most reactionary point on the curve as the five year of the five year point of the curve is typically the most sensitive to changes in the direction of rates and we think that eventually when and if the.
Fed does pivot and starts to ease that youll see a steepening of the curve, which will be led by the five year and so we would not want to be using the five year is a hedge we would much rather use longer dated treasuries less of them because they have more duration, but we wanted to move the hedges further out the curve and so if you look at the top left for instance, you see in our <unk>.
<unk> positioned our allocation to the five year Treasury note future was reduced substantially and when we moved our TBA hedges, we move them into either 10 year note futures are all truss or swaps. So if you look at the top right side of the page you can see our swap position went from $1 $67 4 billion.
215, approximately a 40% increase so we've moved our hedges again. This was in late may away from mortgages into rates and further out the curve and we think that is very ideal positioning for an eventual pivot and reversing of the direction of rates and <unk>.
Again, given the nature of the curve is inverted as it is you can lock in very attractive funding even in this high fed funds environment.
And north well north of a 100 basis points is available so.
It's not as bad of a market as it appears on the face of it with respect to post Q and we've done very little there was some slight changes to our swaption.
Positions, we basically converted one of our forward vault payers into a forward starting 10 year swap again consistent with what I just described above and so that's basically it.
I would just say in summary that our portfolio positioning as I said, we still have a very low or low coupon bias. We did add opportunistically to some higher coupons may do so again at the margin in the future if conditions are favorable although we don't view those assets as long term coal core holdings because.
We think that they will do very poorly.
Mark the March toward a turnaround and rates were to rally.
And we are very very comfortable with our current hedge positioning.
The fact that we've moved mostly from mortgages to rates and where we are in the curve.
And that we.
We have a very constructive view on the market certainly over the long term.
We think mortgages have the opportunity to do extremely well over the balance of this year and next it may not occur in the very short term, but we have a very constructive long term view on the sector with our positioning and with our hedges and with that I'll turn the call over to the operator and.
I will take any questions.
Thank you Mr colleagues, ladies and gentlemen at this time to do you have any questions simply press star one and if you do find your question has already been addressed you can remove yourself from the queue by pressing star one again, we'll take our first question. This morning from Matthew <unk> of Jones trading.
Hey, good morning, Bob.
Could I get your thoughts on the supply demand and spread dynamic after the FDI sales are complete given that the banks are kind of out of that market at this point.
Yes, it's going to be that's a hardware the guests I mean, the market as I said, it's gone well the auctions have gone well.
From what I, we don't have direct access to the information, but from what we can gather from those that do it seems that the money manager community, which I kind of alluded to on the call is kind of a critical marginal buyer of mortgages.
With banks and the fed on the sidelines and they appear to be a pretty extreme overweight.
But that being said the sector is still attractive on a relative basis versus leased investment grade corporates, if not other sectors and so.
I don't think you get.
Whipsaw tightening, but I don't know that.
You would probably get some gradual tightening I just don't think it'll be a lot in the near term.
No.
Totally agree with that.
Okay.
No matter what measure you look at just nominal spreads like our current coupon too.
Yield to the 10 year treasury yield slide or if we're looking at on an OAS basis or a relative to other spread product suites mortgages are obviously are still wide.
I think that once some of this uncertainty around the FDA goes away as it has gone away over the last.
Monitor so that.
We would expect to see a gradual tightening, but I think you are.
To your point, there banks have yet to reemerge.
Some players and so.
But I don't think we're going to see anything dramatic but we.
We still really like mortgages here, we don't think they have had the opportunity to perform particularly on our spread duration basis.
So that's why we've kept our focus on lower coupon longer duration assets.
Can benefit from.
Spreads driving tighter over time.
Thank you that's helpful. And then sorry, if I missed this but did you provide a book value update quarter to date.
No it did not I'm sorry.
It is very close to unchanged as of Wednesday, we were probably slightly positive yesterday, we had a widening especially in the afternoons. We gave back some probably took us to slightly negative on the quarter.
And before I came in here it looked like we were green and so I would say plus or minus 1%, where we've been for about the last week.
Yep.
Yeah.
Thank you. We'll go next now to the Macau government at JMP Securities.
Hey, good morning, guys hope everybody's well just wanted to get.
Thoughts on.
How are you guys seeing the specified pool market going forward merchandise.
Enrolls.
Well, it's it's certainly been under duress, so to speak as I said with the FDIC liquidations.
Everything that's being auctions essentially a specified pool and in addition to that pad, while they're smaller than we've seen in the past, but we still are seeing cash window lifts from Fannie and Freddie so.
St amounts of supply and levels of held in and you also all of that occurring while rates are very very high so.
It all bodes well.
We don't have the technical squeeze that we had when the fed was through an <unk> to keep the TBA market Hot and Thats, probably not coming back. So we're kind of left with the specified pool market again.
Those went into the indices last year and so all of the money managers out there that run against the index have to own them and I think thats bode well that's definitely been a benefit during this most recent period without bank participation.
So I would say that given the weather quite a storm I would say I'm reasonably optimistic I don't think youre going to see a material move but I just don't think that it's going to be more of a slow gradual.
On a positive performance I guess I would say yes.
I agree with that and I think that.
Related.
Mhm.
There's a large bifurcation in the specified pool market between some of the lower coupon universe that was produced over the course of the last <unk>.
10 years, or so that has been popping up on these liquidations and.
More recently produced current coupon.
Assets.
I don't have a high degree of confidence that what's been produced in the last year and a half or so is in specified pool form is going to.
B, particularly great and term.
<unk>.
Of convexity.
Convexity protect protection both in AR.
Rally or a sell off.
On the other side of that coin is.
The older stuff is I think.
Very attractive from a convexity viewpoint, there's not a lot of pay up in that universe, because it's at such a discount huge upside into a big rally and not a meaningful amount of extension into continued sell offer an inflation scare something so.
I think that those comments.
Can be seen in our positioning as well I would just add to that is they are easier to hedge.
We talked about the ability to use the inversion of the curve to lock in longer term funding, but when you're earning something with an eight one income and 186 or $84 price. It really can't extend a lot. So you can use longer tenor treasuries to hedge but also with respect to the more recent production current coupon if you look at the.
The collateral that's being produced the gross wax are extremely high now theyre running 95 to 105 basis points over the net coupon.
If you're buying a six or low 7% or very high six gross WAC.
As I mentioned primary secondary spreads are very wide and they may be for a while but if the market ever turns it goes the other way in mortgage banker industry cash to Reengage.
There's a lot of low hanging fruit out there to go after.
That stuff is going to exhibit poor convexity is in a rally, it's mark and a tightened materially speeds are going to be fast as they move into a bigger premium position and that's just going to really inhibit their upside, especially relative to its knees Hunter just mentioned the lower coupons.
Which have very favorable convexity. So it's somewhat painful in this environment to continue to have such a bias and we have mitigated that some.
But we just think net net long term, that's where you want to be in.
Obviously always a challenge to try to time the market.
You can't just say well I'll just sell out of all of those high coupon mortgages when the market turns out you don't.
You don't get an email the day before it happens and say now it's kind of a.
Hard to do.
Kind of with that in mind I'm just.
Thinking about leverage and seeing.
Youre correct.
Eight eight turns right now kind of in between historical range of $6 10.
Yes.
You guys see the opportunities that you hope to see going forward. How you can ratchet that leverage up a bit could we potentially see a sort of drift towards the nine and 10 range.
And if we get.
Good amount of spread spread tightening.
And you can.
10, they may not but we've been in the mid nines before we could do that and we have two ways of getting there.
One big step, we already took which is where we got rid of a lot of the TBA shorts when mortgages got very wide levels and then we.
Raise some equity, but also added to our balance sheet.
Just through purchases. So yes, we could go higher I mean, its I don't think its meaningfully higher but we cut it.
A wide level now so it doesn't mean, it's arguably is the time to do that so yes, we could go a little wider but I don't think meaningfully.
Our higher leverage I should say.
Alright, Thanks, a lot guys I appreciate it.
And just a reminder, star one please for questions. We go next now to Christopher Nolan at Ladenburg Thalmann.
Hey, guys.
On your comment.
You mentioned 40.
Per quarter going forward or was that including the discount accretion in hedge income than you were discussion, yes. So basically I kind of walk you through from a negative 34.
Added back accretion I think was 12 <unk> added back the hedge which was 59 that got you to a 37 and that was for that quarter I mean, obviously this quarter.
It's all going to be a mirror image of that but and with the additional assets. We added that got you to about 40. So there.
There is still a slight gap there at least for GAAP purposes, No pun intended as I said for hedge purposes or for tax purposes. We have a lot of legacy hedges that were closed years ago that.
Still cover this period just to kind of refresh your mind, how that works a say you entered into a 10 year swap today.
Designated as a hedge for tax purposes, and a year from now you close out that position and let's say that the open interest at the time you close it out was $10 million for.
For GAAP purposes, you ordered recorded that $10 million mark to market gain and that would be the end of it for tax purposes that $10 million is applied to the balance of the hedge period that period being the day you close it until the end of the maturity date of that swap so if I closed out at.
10 year swap one year from today I would apply that $10 million as an offset to interest income for the period, beginning one year from today and ending 10 years from today. So we have a lot of those hedges that have been closed.
And we had open interest positive open interest in those hedge positions and so they are available to offset interest expense in the periods of those hedge period. So I don't have the numbers in front of me I think we provided them at year end, but those numbers are in the low hundreds of millions of dollars.
For the balance of all of those hedges and so.
Oh, so much per year for the next few years, so from a tax perspective, it's a lot different from GAAP.
It's just whatever you're realizing that particular period. There is no application of that position or any future period. It's all captured in the current period and so we're showing.
Approximately a 40 said positive net interest margin for this second quarter only.
But.
Our tax it's a lot different I think you can think about it a little bit too, but if you look at our hedge positions.
All of those we have about $1 billion worth of Av.
Gina futures shorts on and.
It's been a consistent part of our portfolio mix forever, but the thing about those instruments as they don't play out quite like a swap doesn't mean, we have swaps that we put on and it's sort of at the cycle lows as well that are around 100 basis points.
Fix and we're receiving so far.
Well into the fives now right. So if you think about the dynamics that took place that made those swaps going the money by so much where we're realizing that positive income value as the life of the swap plays out and that's we've had those same types of gains in those Tina futures as well, but the nature of the Beast.
You don't have an income component to those where youre, where youre paying a fixed rate and receiving float. So you are just rolling them and every time you roll them you have a capital gain that you took away that you are going to use to.
Offset your interest expense for tax purposes.
Over the life of the underlying instrument, which is a five year note are attempting or something like that so for.
For tax it's a little.
Year to get your head around where.
How those different industry.
Types of hedge instruments.
Mimic one another for offsetting interest expense for federal income tax purposes, So given all of that.
Where do we stand with the dividend.
Should we view the dividend sustainability to be somewhat detached from core EPS or GAAP EPS, yes, we are.
Haven't said anything I don't want you to read any too much but yes, I mean, we.
No not that I can never change our dividend has certainly changed in the past, but given.
Where we are at the moment in terms of our positioning the portfolio as we've mentioned, we're kind of comfortable with this lower coupon bias.
We may add at the margin some higher coupon securities to close that gap some.
The opportunity to do so.
But we think that the modest shortcoming on in that regard is offset by the much greater price appreciation potential of those assets versus the higher coupon securities, which offer greater current income, but in our minds much lower long term total return opportunity.
<unk>.
And so if you look over the next year total return the lower coupon Securities May give you a little less income, but we think they offer much higher price.
Potential price return and therefore higher total rate of return over that horizon.
I think we will you can think about it also advances around <expletive>.
Sentiment for what the fed's going to do next bounces around I mean, it wasn't all that many weeks ago when we had.
Cuts baked into 'twenty two this year and then the third and the fourth or third quarter, but definitely the fourth quarter and so.
Now.
The market is kind of taking the view that we're going to have more of a soft landing I think and maybe rates can stay higher for longer so.
The point of all of that is just in terms of the dividend.
We definitely don't want to.
Put our shareholders there any unnecessary pain. So if there is if we're looking at fed cuts in the next six to 12 months then.
We don't.
Under earning dividend is not as much of a problem for us.
Versus if it's going to be if we think it's going to be higher for a long period of time, and we will perpetually be under earning so I think theres a little bit of latitude for us in terms of.
The way that we think about cuts it doesn't always have to be.
We can pull forward some of the fed expectations.
And kind of continue to think that way alright.
Alright, thanks for the words, that's it for me.
Chris.
Thank you and just a final reminder, ladies and gentlemen, any further questions. This morning. Please press star one at this time.
Okay.
Yes.
And Mr. Calling it appears we have no further questions. This morning, I'd like to turn the conference back to you Sir for any closing comments.
Thank you operator, and thank everybody for taking the time to listen in to the extent. Another question comes to mind later that you didn't have a chance to ask today feel free to call our office or if you happen to listen to the replay and you have questions, we'll be glad to take any and all questions of a number of the office is 772 231.
400.
Look forward to your questions and if not we look forward to talking to you at the end of the next quarter. Thank you everybody.
Thank you Mr colleagues, ladies and gentlemen that will conclude the orchid Island capital second quarter earnings Conference I'd like to thank you all so much for joining us and wish you all a great day Goodbye.
[music].
Okay.