Q3 2023 Orchid Island Capital Inc Earnings Call
[music].
Good morning, and welcome to the third quarter 'twenty twenty-three earnings conference call for Orchid Island capital. This call is being recorded today October 27th 2023.
At this time the company would like to remind the listeners that statements made today during today's conference call relating to the 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 total listeners are cautioned.
Such forward looking statements are based on information currently available on the managements. Good faith belief that 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.
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 I would now 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, and thank you for joining us today, hopefully everybody's had a chance to download our deck.
You probably noticed this.
It's all changes made to the deck hopefully you find it more useful.
We presented information and better format that we've been doing up until now and with that I will begin.
The outline of our talk today.
Follow the same pattern and go over our financial results for the quarter.
Briefly about our market developments and how those shaped our results in all these form our outlook going forward and then get into a discussion of the portfolio.
Some physicians and so forth so with that.
Turning to slide five here or there.
The high level numbers for the third quarter net income for the quarter was a loss of $1 68.
Versus income of <unk>, two five last year.
Book value.
The moves in the market. It was a very rough quarter for mortgage investors as you can see our book value was down just over 20%.
From 116 to 892. Unfortunately October has been equally as intense in our books down about 14 over 14% through yesterday.
So obviously it especially since September 1st it's been very challenging mortgage market environment.
Total return for the quarter was a very unsatisfactory negative 15 seven 7%.
And we pay dividends again at 48 since the last quarter.
The average MBS portfolio did increase over the course of the quarter.
We did use our ATM, we raised about $80 million and added to the portfolio.
But given what's happened since quarter end with the significant move in rates volatility and mortgage spreads.
We have sold assets to maintain our leverage and liquidity positions that are acceptable level and the portfolio was about 365 billion as of yesterday, that's down 18% from the average of Q3, but.
But as I said, that's the average at 930 number.
The economic leverage ratio did increase during the quarter as a result of the sell off and the decline in book value.
Not terribly so from eight one to $8 five.
But since then the steps we've taken this month, so far we've actually lowered our economic leverage ratio to about 744, so it's down quite a bit.
Our speeds given that the portfolios have easily skewed towards discounts, we do have a lot of seasoning, especially in our lower coupon securities. So the speeds are.
Barely acceptable 6% and.
The dollar price of the securities, we own thats, allowing us to increase a fair amount of discount and that helps with our earnings liquidity is right around the low end of our range and that was driven by the events of late September into early October currently its in that same range around the high 30, maybe 40%, but we are working to bring that up.
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The next page just shows you our summary balance sheet income statement I'll leave that for you to peruse I'm not going to spend any time talking about at the next slide is something we've been talking about more frequently lately. This is kind of where we show you the number.
Our proxy for our disposable income we don't use that term, we use fair value accounting, which makes it challenging for us to present those types of numbers, but what we do here as we've done in the past as we show you our interest income and repo Ameren as our interest expense, but then we also show you the dollar amount of discount accretion.
And then also the effective hedges that were in place during the quarter and as you can see.
There are substantial numbers Theyre finally, we backed out our expense and you can see the earnings for the last four quarters and on the bottom of the page. We just presented at <unk> per share and as you can see we're running around 10, a little more below the dividend we were doing so because we believe in the market would turn sooner rather than later and we did not want it.
Wholesale changes to the portfolio.
That has not proven to be the case and we've had to make some changes although as you also know.
We've always given you had this quarter. So now it's 12 cents, which means we have a 36%.
Run rate, which means we should probably have earnings right in line with the dividend.
Going out to market developments.
You can see a very meaningful change in the top left in top right.
For the last year and a half all we've seen in that movement of Kirby the swaps curve more than nominal curve is movement higher in the front end and that just kept getting higher and higher long end given what the curve was inverted always had that downward sloping look and was moving up slowly well that's changed dramatically in the third quarter.
You can see the front end of the curve is pretty much anchored and I think most market participants expect it to remain that way maybe go up slightly more if there is one more hike, but that's pretty much yet.
What we're seeing now is moving on the long end of the curve.
It's a steepening in the sense that it's less inverted, but it is a meaningful move and 100 basis points plus just from late July to where we are now.
Another proxy for that is one on the bottom of the pages just three months Treasury Bill versus the 10 year note again, you can see a significant look like.
Turning now to mortgages.
Two pictures here. The first one is the spread to the 10 year and as you can see that spread is very wide very close to the widest levels, we've seen since the financial crisis and.
And when you take into consideration the fact that as I mentioned long term rates have been up materially of late.
The spread again this is the current coupon, but it's a proxy for the mortgage universe that spread has been widening also which gives you an idea of what that the yield on mortgages are growing much faster than even treasuries. So as a result, if you look at the bottom left you can see this is normalized price change of several coupons. So basically just starting at 100.
For each coupon on June 30th and show you what that coupon is done.
The end.
End of the second quarter, and obviously those are very big negative numbers its been a very challenging market for mortgage investors to say the least.
Another thing Thats been.
A challenge for US has been volatility as you know mortgages are very much impacted by volatility because whenever you're long mortgage or shorting vol, and if it's going up then it's hurting you and that's what we see.
These are two different measures of volatility.
Zinc picture three months by 10 year normal ball and then swaption implied vol from the move index at.
At elevated levels and continue to remain there.
Speak.
One last page on the market. If you look at the top right. This is the primary secondary spreads and the mortgage originator community is trying to maintain their ability to generate mortgages and so that's why you tend to see a slight downward trend in that spread so as rates go up there trying to accept.
Margins in order to get rates to borrowers that they can live with.
They only have so much capacity to do that because originators typically will sell all of their origination and to the extent that the prices at which they can sell their production or going down that.
That limits how much they can cut the primary secondary spreads so I would not expect to see that come down much more.
Otherwise with respect to this page as you all know with rates as high as they are in 30 year mortgage rates approaching 8% refinancing activity.
To me low level and in fact, we are approaching the late year early 2024 period, which will be the seasonal slowdown so speeds will do they will go down from here.
Moving onto the portfolio slide 15 is it.
The highlights for the quarter as I mentioned, we raised about $80 billion and our ATM.
But 30 year six six <unk> coupon securities to increase the income of the portfolio in light of the higher rates for longer and the apparent case, so we're going to be higher for longer.
Effective those was to raise our average coupon from 383% to 4.05 and the realized yield increase even more from $3 eight 1% to 451 that was affected somewhat by speeds being a little higher coupling increased accretion.
Discount and then with respect to our economic interest spread this is just where we apply our swaps.
The GAAP spread.
It increased slightly from 128 basis points to 133 basis points.
Slide 16 shows with pictures, what I was referencing if you look at the right hand side of this page you can see at the end of last year, we had a very.
Very very low coupon bias and we had no exposure to higher coupons, but given the fact that rates are as high as they are apparently going to stay here for a while our goal now is to try to even out the distribution across the stack.
To give you a for instance.
In September when rates started to move higher we saw the lowest coupons really suffer a presumably a lot of money manager will vote against the index, we're reducing over weights and the lower coupons. It makes up a significant portion of the index and so that salaries caused lower coupons to suffer.
Tober, it's been more of the belly coupons, so 3544 and a half five that have suffered so the takeaway for us is that we need to have greater diversification across the coupons that we own.
And that's what we're in the process of doing I've mentioned that we had sold some assets since quarter end, it's all.
If you look at the far left you see our holdings as of 930, we reduced our exposure to the 3% coupon by about 40%. So it's down to about $1 2 billion that will have the effect of raising our average coupon in our yield somewhat.
But we still expect to maintain ups.
It's there.
Because of the outstanding a few moments we star outlook is we still think eventually that will be.
A softening of the economy and the best you have fed pivot and we think that those securities are the best Securities we can to maximize our potential outcome in that scenario.
Now going to slide 17, this is where we've talked about hedging obviously in this environment. This has been critical with borrowing costs rising interest rates selling off.
Our hedge positions exceed our repo liability I'll get to that point in a moment, but I wanted to show you here is the effect of the hedges we have in place and you can see on this chart on the right that Blue line is our economic interest expense in other words, our just our economic expense adjusted for the effective hedges and it's well below.
Our actual funding costs or one month's sulfur. It did go up slightly this quarter from $2 five 3% to $3 one eight.
Given.
Yes, we get more hikes, we expected thats pretty much where it should plateau and that gives us fairly comfortable NIM.
And obviously those hedges in the strategy as you know very critical in that regard. The next slide just lays out all of the hedge positions we have in place.
Bottom, we have a table with the notional amount of the duration of each we have interest rate swaps futures.
Two options and rate derivatives, which are sometimes floors or caps or other types of structured derivative bets that are designed to give us protection in the event of certain outcome say for instance, the curve stays flatter for longer or that sort of thing and then we also short TBA and we show you the duration of that all told.
All of these hedges the notional balance is about 115% of our repo funding liabilities. All of these hedges worked in two ways Theyre, both asset hedges and funding edges TBA is more on the asset side.
So very much both because he does cap your floating rate cost.
Extended the notional balance of those swaps, but they also work as an asset hedge at least as long as the points on the curve that are moving higher or the state tenders or swaps and our swaps. We do have a large allocation to longer maturity swaps. So that's been very beneficial and he is going to be critical going forward.
Slide 19, we just lay out all of the different positions I'm just going to make a couple of points. The top left you can see that the treasury futures went down in swaps went up.
Just more effective hedge in this environment.
Is more capital intensive.
Tens of two on swaps versus futures.
But we can lock in pretty low funding and as much as rates have sold off as of late in the last few months, we put a lot of these on prior to a meaningful move so some of our longer dated swaps you can see the pay fixed rates.
Our only 284% on our swaps with a maturity of greater than five years. So our blended rate is only 246 am very effective and fortunate that we were able to get all those on and we expect we will have to maintain those for some time.
The next slide is kind of a new we haven't done anything like this before and I need to explain to you. What you are looking at so basically what we have here.
All of the 30 year fixed rate conventional mortgages, starting with a 3% coupon up to six and a half and.
And we took the price as of 930, we use citibank's Youll book to run the metrics on a generic coupon of each one so you can see for each one of you see the OAS.
Active duration and convexity.
And as you can see convexity, which is very important for mortgage investors because that kind of <unk>.
Drives how you do when rates are moving.
Got a lot of that lately, the lower coupons out by far the best Convexity. If you look at how those securities perform in these different scenarios again. These are just generic youll book scenarios.
50 basis points higher lower shock and then a bowl steepen on a bare flattening and there is no question that the fed may hikes or more from the inflation data could stay stronger for a little longer and we may get a bit more of a bare flattening, but we think if that happens more likely not just increases the chance of you ultimately get the bolus steepen when the fed does succeed in.
Breaking the economy and you can see on the returns of these coupons the lower coupons definitely standout with the best return potential and since we still have a bias towards that outcome, although little less than we did a few months ago, we still view that as the more likely than not outcome.
And that explains why we would probably maintain an overweight to those coupons on the far right column. We just show the allocation as of 930 that as I mentioned has changed slightly when we report fourth quarter those numbers will look somewhat different.
Slide 21, just shows you our interest rate sensitivity of the portfolio not going to say much about this this should be pretty self explanatory.
Slide 22, our speeds.
Included in the slide here for each coupon that we own as the wallet of those securities and you can see.
The deepest discounts that we own the threes three apps have very high quality and as a result of prepay fairly well in fact for the third quarter, our <unk> paid six CPR and our three in house at six three those aren't very high speeds, but when you consider the dollar price of these securities in the case of three sometimes they've been under $80.
Any dollar level that means a lot in terms of discount accretion. So that has been a very beneficial effect for us.
And really.
The next slide is just kind of a wrap on what we've experienced and what we're going through obviously.
The market is very challenging and we expect it to be challenging going forward. So our focus now is to just diversify the portfolio across coupons try to avoid excessive concentration and equally on the curve.
We're going to maintain our hedge levels as high as we get out in the recent past just because of where funding costs are okay.
To keep our leverage ratio at the low end of the range I mentioned it is down from $8, 5% to seven four and we're going to have to keep our liquidity as high as we can just to get through the balance of this episode.
We don't really know when this period will end, but we know these are the steps that we take theyre going to give us a high high level of confidence that we're going to get through this period, Okay and at the same time allow us to be positioned in such a way that we can do very well when the market turns assuming we do get the outcome, we perceived if we don't.
Portfolio positioning is at a point now where we're covering the dividend we think and we can get along just fine here, but we think that we do get the outcome of a bear bolstered.
Bolstering printer that we could be poised to do quite well, so thats, a rundown of our positioning in our portfolio and all the market developments and with that operator, I will turn the call over to questions.
Thank you to ask a question. Please press star one on your telephone keypad.
Your first question is from Matthew <unk> of Jones trading. Please go ahead. Your line is open.
Hey, good morning, Thanks for taking the question. So you mentioned the diversification.
Within the coupon stack are you looking to kind of spread out evenly across coupons or are you going to favor the belly more so than current production obviously the reduction in the 3% is coming but what part of the curve are you really looking to diversify into.
Well, we're still have a slight down in coupon bias just won't be as pronounced.
Just because we all we just we like the characteristics of those assets. The convexity the return potential in the event, we do get a a bowl steeply, which we may not the problem with the higher coupons.
Well in times like this at least most of the time and they carry well, but they have a lot of risk a lot of extension potential in a meaningful sell off and in a rally they will not.
<unk> performed well and one thing that we didn't really dwell on but if you look at new production current coupon mortgages the gross wax on.
Typically 95 to 105 basis points above the coupons. So Fannie seven has a gross WAC and 795 eight and loan balances are very high and what that means I would predict is when we do get a rally if we do get a rally that those are going to be prepaying very very fast Hunter you want to throw in a few extra words.
On that.
Sure I think that the.
There will be a little bit of a focus on higher coupons.
Maybe not as quite as extreme as sevens, but.
Just like we did a continuation of what we did in the third quarter $6 and $6 a haves are quite attractive from a carry perspective.
<unk>.
Fits that part of our portfolio.
Where are you.
If we are at a higher for longer environment, but not necessarily higher rates and higher for longer.
Yes, there is some extension risk on on the upper coupons, but if we are kind of topping out somewhere.
And let's say five 6%.
Ballpark for 10 year rates.
Think that those.
Those higher coupons can do quite well they have a lot of current carry so thats the portion of our portfolio, that's going to carry a little bit better, but not necessarily do well on the wings big rally or big Selloff.
Got you that's helpful and then from a tactical perspective, it seems like when money managers, one overweight they've kind of sold off.
In the recent months, what do you think.
<unk> tightened spreads from here and who do you think is going to be the purchasers of this MBS.
Well, that's that's the million dollar question.
The reason that mortgages are done so poorly as that you really have no.
Sponsorship from any large investor base, obviously, the fed's long gone banks are not money managers are very overweight.
It may be having redemptions and thats really whats keeps mortgages from tightening anytime soon.
It just isn't you really probably need the curve to uninsured and banks to come in in a meaningful way or something like that because it's just not out there and thats why we expect that will probably be positioned the way. We are for some time, because you can get some tightening, but I don't see a meaningful tightening but with the market.
It is it's something that's going to have to change and probably it's going to be the shape of the curve.
Yes, it's pretty it was very disappointing third quarter.
We were we landed we leaned into the basis, a little bit at the end of the stack towards the end of the second quarter when spreads were sort of at the Wides.
Unknown Executive: 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 10K.
During the second quarter in the wake of the regional Bank crisis.
Those lists went off so incredibly well, it's so much faster than we expected.
Unknown Executive: The company assumes no obligation to update such forward-looking statements to reflect the actual results, changes in assumptions, or changes in other factors affecting forward-looking statements.
Definitely.
More positive farmer town, but as you alluded to the money managers can now quickly got overweight.
Robert Cauley: I would now 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. We thank you for joining us today. Hopefully everybody's had a chance to download our deck. You probably will notice there's some substantial changes made to the deck. Hopefully you find it more useful. I think we presented the information in a better format that we've been doing up until now.
And.
The.
Quantitative tightening continued and as rates just grinded higher.
Was it really that lack of <unk>.
Marginal buyer so.
Optimistic I guess.
<unk> seen some signs of life from the banking sector I don't think they are quite ready to come in in full force but.
There was a couple of reports out.
And the last couple of weeks about.
Being able to.
Robert Cauley: And with that, I will begin. The outline of our talk today will follow the same pattern. We'll go over our financial results for the quarter, talk briefly about market developments and how those shape our results and how they form our outlook going forward, and then get into a discussion of the portfolio and our hedging positions and so forth. So with that, turning to slide five. Here are the high level numbers for the third quarter.
Unload some of their lower coupon asset in and supplement their income with.
Some better earning potential and higher coupon mortgage space.
It's not anywhere near them becoming of the.
The marginal buyer, but it's certainly starting to see some signs of life.
It will probably be driving for the next.
A couple of quarters.
And we will be volatile.
Robert Cauley: Net income for the quarter was a loss of $1.68 versus income of $1.25 last year. Book value. I'm giving the moves in the market. It was a very rough quarter for mortgage investors. As you can see, our book value was down just over 20% from 11.16 to 8.92. Unfortunately, October has been equally as intense and our books down about 14 over 14% through yesterday. So obviously, especially since September 1st, it's been very challenging the mortgage market environment.
But we're also having those days when we see.
Just the slightest glimmer of hope in mortgage spreads space really brings in an influx of participants and so the basis is incredibly volatile but on those days when it's green, it's very green so.
That's been a little bit of a welcome change over the past.
Four to five weeks.
We've really just seeing show up in the last handful of days.
That's helpful. Thanks for the color guys.
Robert Cauley: Total return for the quarter was a very unsatisfactory negative 15.77%. And we pay dividends, again, of 48 cents. Same as the last quarter. The average MBS portfolio did increase over the course of the quarter. We did use our ATM. We raised about $80 million and added to the portfolio. But given what happened since quarter end with the significant moving rates of volatility and mortgage spreads, we have sold assets to maintain our leverage of liquidity positions that are acceptable level.
Right.
Yes.
Your next question is from Chris Nolan of Ladenburg Thalmann. Please go ahead. Your line is open.
Hey, guys.
Okay have you guys received any margin calls on your repo funding this quarter.
This morning.
Well, we got them every day.
A margin call activity is very robust.
We.
We get calls both on the hedges and on the assets every day.
We've internalized that we used to outsource that to ABM, we hired Pat Doyle from AVM and we brought in our own systems and so now we can manage that whole process entirely on our own.
Robert Cauley: And the portfolio is about $3.65 billion as of yesterday. That's down 18% from the average of Q3. But as I said, that's the average. That's not the 930 number. The economic leverage ratio did increase during the quarter. As a result of the sell-off into the clienty book value, not terribly so from 8.1 to 8.5. But since then, the steps we've taken this month so far, we've actually lowered our economic leverage ratio to about 7.4.
And yes, I mean, the margin call activity keeps Pat busy several hours a day in and out so absolutely.
Thank you and then also a follow up what sort of flexibility do you have on the dividend because I know you need to.
Distributing taxable income.
Given all the moving pieces here.
It's more flexibility going from Q <unk>.
Just wanted to do that.
Robert Cauley: So it's down quite a bit. Our speeds, given that the portfolio is heavy, slowly skewed towards discounts, we do have a lot of seasoning, especially in our lower coupon securities. So the speeds are fairly acceptable, 6%. And with the deep dollar price of the securities we own, that's allowing us to create a fair amount of discount, and that helps with our earnings. With Quintany, it's right around the low end of our range, then that was driven by the event of late September into early October.
We brought it down into kind of line with what we were earning we were under earning over distributing thinking that the market was getting a target we didn't want to take the steps to reposition the portfolio.
But we had to adjust some and we did but that 12% seems fairly reasonable.
Reasonable I mean, the big picture view on the dividend philosophy, we've spent hours discussing this.
If the market does tend to punish you if you change it too often.
Robert Cauley: Currently, it's in that same range around the high 30, maybe 40%, but we are working to bring that up. The next page just shows you our summary balance sheet income statement. I'll leave that for you to peruse. I'm not going to spend any time talking about it. The next slide is something we've been talking about more frequently lately. This is kind of where we show you. We were doing so because we were believing the market would turn sooner rather than later and we did not want to make wholesale changes to the portfolio.
And they also policy pupae over distribute too much in the <unk>.
<unk> laws keep you from under distributed so we track our taxable earnings.
We have a pretty good sense generally as we go throughout the year, where we are in terms of our distribution.
There is some latitude, but it's not boundless.
Great.
Your next question is from Macau Kopelman of JMP Securities. Please go ahead. Your line is open.
Hey, guys. Good morning, Hope everybody's doing well could you guys give an update on where book value stands right now and also I believe you mentioned economic leverage is down to seven four now from eight five is that right.
Yes.
Yes, It is and book I'd imagine, it's we're down about little over 14% through yesterday.
Okay. Thank you sorry, if I missed that and all my other questions were kind of touched on.
By the other two question yourself. Good luck going forward guys. Thank you. Thank you. Thank you. Thanks.
Robert Cauley: But that is not proven to be the case. And we've had to make some changes, although you also know we lowered the dividend in this quarter. So now it's 12 cents, which means we have a 36 cent run rate, which means we should probably have earnings right in line with the dividend. Going out to market developments page 10, you can see a very meaningful change in the top left and top right.
There are no further questions at this time I will now turn the call over to Robert Cauley for closing remarks.
Thank you operator, and thank you for taking the time to listen to the call do you have any further questions that come to mind. After the call's over feel free to call us or if you listen to the replay have a question you can always reaches in the office. The number is 770 22311400, otherwise we look forward to speaking with you at the end of the <unk>.
Robert Cauley: For the last year and a half, all we've seen in that movement of a curve, either a swaps curve or the nominal curve, is movement higher in the front end, which is kept getting higher and higher in the long end, given that the curve was inverted. It always had that downward sloping look and was moving up slowly. Well, that's changed dramatically. The third quarter, as you can see, the front end of the curve is pretty much anchored.
Fourth quarter. Thank you everybody.
This concludes today's conference call. Thank you for your participation you may now disconnect.
[music].
Robert Cauley: And I think most market participants expected to remain that way. Maybe go up slightly more if there's one more hike. That's pretty much it. What we're seeing now is moving on the longer to the curve. It's a steeping in the sense that it's less inverted, but it is a meaningful move and 100 basis points plus just from late July to where we are now. Another proxy for that is one on the bottom of the pages.
Yeah.
Robert Cauley: It's just a three month treasury bill versus the 10 year note. Again, you can see a significant move of late. Turning now to mortgages. This two pictures here. The first one is the spread to the 10 year. And as you can see, that spread is very wide, very close to the widest levels we've seen since the financial crisis. And when you take the consideration, the fact that, you know, as I mentioned, long term rates have been up materially of late.
[music].
Yes.
[music].
Robert Cauley: And the spread, again, this is the current coupon, but it's a proxy for the mortgage universe. That spread has been widening also, which gives you an idea with that the yield on mortgages are going up much faster and even treasuries. Those who are solid, if you look at the bottom left, you can see this is the normalized price change of several coupons, so basically just starting at 100 reach coupon on June 30th and showing you what that coupon has done since the end of the second quarter.
Robert Cauley: And obviously those are very big negative numbers. It's been a very challenging market for mortgages and measures to say the least. Another thing that's been a challenge for us has been volatility is, you know, mortgages are very much impacted by volatility, because whenever you're long the mortgage, you're shorting ball. And if it's going up, then it's hurting you. And that's what we see. These are two different measures of volatility. They paint the same picture three month by 10 year normal ball.
Robert Cauley: And then swapsion implied ball from the move index at elevated levels and continue to remain there. One last page on the market. It feels at the top right. This is the primary secondary spread. And the mortgage originator community is trying to maintain their ability to generate mortgages. And so that's why you try to see a slight downward trend in that spread. So those rates go up. They're trying to accept less margin in order to get rates to borrowers that they can live with.
Robert Cauley: They only have so much capacity to do that because originally there's typically will sell all of their origination. And so the expense at the prices at which they can sell their production are going down. That limits how much that they can cut the primary secondary spread. So I would not expect to see that condone much more. Otherwise, with respect to this page, as you all know, with rates as high as they are.
Robert Cauley: And 30 year mortgage rates approaching 8% refinancing activity as an extremely low level. And in fact, we're approaching the late year early 2024 period, which will be the next season will slow down. So speech will go down from here. Moving on to the portfolio in slides 15. This is just the highlights for the quarter that mentioned we raised about $80 million in our ATM. We bought 30 year six and six and a half coupon securities to increase the income of the portfolio in light of the higher rates for longer in the apparent case.
Robert Cauley: So we're going to be higher for longer. The effect of those was to raise our average coupon from 3.83 to 4.05 and realize the yield increased even more from 3.81 to 4.51. That was affected somewhat by the speeds being a little higher, tough with increased accretion of discount. And then with respect to our economic interest spread, this is just where we apply our swaps. So that's the gap spread and you can see it increased slightly from 128 basis points to 133 basis points.
Robert Cauley: Slide 15 shows when pictures, what I just was referencing, if you look at the right hand side of this page, you can see at the end of last year, we had a very, very low coupon bias and we had no exposure to higher coupons. But given the fact that rates are as high as they are and apparently going to stay here for a while, our goal now is to try to even out the distribution across the stack.
Robert Cauley: Just to give you, for instance, in September, when rates started to move high, we saw the lowest coupons really suffer presumably a lot of money management. You're right against the index. We're reducing overweights and the lower coupons make up a significant portion of the index. And so that's selling cause lower coupons to suffer in October. It's been more the belly coupons. So three and a half, four or four and a half, five that are suffered.
Robert Cauley: So the takeaway for us is that we need to have greater diversification across the coupons that we own. And that's what we're in the process of doing. I mentioned that we had sold some assets since quarter end. It's, if you look at the far left, you see our holdings as of 930. We reduced our exposure to the 3% coupon by about 40%. So it's down to about 1.2 billion. That will have the effect of raising our average coupon and our yield somewhat.
Robert Cauley: But we still expect to maintain a bias there because of staying a few moments. Our outlook is we still think eventually that will be a softening of economy and the best she has said pivot. And we think that those securities are the best securities we can own to maximize our potential outcome in that scenario. Now, going to slide 17, this is where we talk about hedging. Obviously, in this environment, this has been critical with borrowing costs, rising and dangerous rates selling off.
Robert Cauley: Our hedge positions exceed our repo liability. I'll get to that point in a moment. What I want to show you here is the effect of the hedges we have in place. And you can see in this turn on the right that blue line is our economic interest expense. It's not where it's just our economic expense adjusted for the effective hedges. And it's well below our actual funding cost or one month. So for it did go up slightly this quarter from 2.53% to 3.18.
Robert Cauley: But given, unless we get more heights, we expect that that's pretty much where it should plateau. And that gives us fairly comfortable. And obviously this hedges and the strategies in a very critical net regard. The next slide just lays out all of the hedge positions we have in place. On the bottom, we have a table with the nocial amount in the duration of each. We have interest rates swaps, features, swapsions and rate derivatives, which are sometimes floors or caps or other types of structured derivative bets that are designed to give us protection in the event of certain outcomes.
Robert Cauley: For instance, the curve stays flatter for longer or that could have been. And then we also short TBAs. And we show you the duration of that. All told all of these hedges, the nocial balance is about 115% of our repo funding liabilities. All of these hedges work in two ways. They're both asset hedges and funding hedges. TBAs, more on the asset side, swaps are very much both because you does cap your floating make cost.
Robert Cauley: The extent of the nocial balance of those swaps that they also work as an asset hedge, at least as long as the points on the curve that are moving higher are the same tenders or swaps. In our swaps, we do have a large allocation to longer maturity swaps. So that's been very beneficial and it's going to be critical going forward. By 19, we just lay out all of the different positions. I'm just going to make a couple of points.
Robert Cauley: The top left you can see that the treasury futures went down and swaps went up just more effective hedge in this environment. It is more capital inclusive, attentive to own swaps versus futures, but we can lock in pretty low funding and as much as rates of sold off as of late the last few months, we put a lot of these on prior to a meaningful move. So some of our longer dated swaps, you can see the pay fixed rates are only 2.84% on our swaps with a maturity greater than five years.
Robert Cauley: So our blended rate is only 2.46. Very effective and fortunate that we were able to get all is on and we certainly will have to maintain those for some time. The next slide is kind of new. We haven't done anything like this before and what I need to explain to you what you're looking at. So basically what we have here are all the 30 year fixed rate conventional mortgages starting with a 3% coupon up to 6.5.
Robert Cauley: And we took the price as of 9.30 and we used city banks yield book to run the metrics on a generic coupon of each one. So you can see for each one you see the OAS effective duration and convexity. And as you can see, convexity which is very important for mortgage investors because that kind of drives how you do when rates are moving, and we've had a lot of that lately. The lower coupons have, by far, the best convexity.
Robert Cauley: If you look at how those securities perform in these different scenarios, again, these are just generic yield book scenarios, a 50 basis point higher, lower shock, and then a both steeper and a bear flattener. There's no question that the Fed may hike some more from the inflation data could stay stronger for a little longer and we may get a bit more of a bear flattener, but we think if that happens, more likely not, that just increases the chance that you ultimately get.
Robert Cauley: But the both steeper and when the Fed does succeed in breaking the economy, and you can see on the returns of these coupons, the lower coupons definitely stand out with the best return potential. And since we still have a bias towards that outcome, although little less than we did a few months ago, we still view that as likely the not outcome. And that explains why we'll probably maintain an overweight to those coupons.
Robert Cauley: On the far right column, we just show the allocation as a 930 that, as I mentioned, has changed slightly when we report fourth quarter, those numbers will look somewhat different. 521 just shows you are interested to be the portfolio, not going to say much about this, this should be pretty self explanatory. Slide 22 are speeds. And what we've included in the slide here for each coupon that we own is the wall up of those securities.
Robert Cauley: And you can see the deepest discounts that we own the threes, the three and a half. That very high wall up to this result, they pre-paid fairly well. In fact, for the third quarter, our threes paid at 60 PR and our three and a half said 6.3. Those aren't very high speeds, but we consider the dollar price of these securities in the case of threes. Sometimes they've been under $80. The $80 level, that means a lot in terms of discount accretion.
Robert Cauley: So that has been a very beneficial fact for us. And really that kind of the next slide is just kind of a wrap on what we've experienced and what we're going through. Obviously, the market is very challenging. And we expect it to be challenging going forward. So our focus now is to just diversify the portfolio across coupons, try to avoid excessive concentration in the point on the turf. We're going to maintain our hedge levels as high as we have in the recent past, just because of where funding costs are.
Robert Cauley: We're going to keep our leverage ratio at the low end of the range. I mentioned it's down from 8.5 to 7.4. And we're going to have to keep our liquidity as high as we can just to get through the balance of this episode. We don't really know when this period will end, but we know these are the steps that we take. They're going to give us a high high level of confidence that we're going to get through this period.
Robert Cauley: And at the same time, allow us to be positioned in such a way that we can do very well when the market turns, assuming we do get the outcome we perceive. If we don't, the portfolio positioning is at a point now where we're covering the dividend we think and we can get along just fine here. But we think that we do get the outcome of a bearable steeper that we could be poised to do quite well. So that's a rundown of our positioning and our portfolio and all the market developments.
Unknown Executive: And with that operator, I will turn the call over to questions.
Unknown Executive: Thank you. To ask a question, please press star one on your telephone keypad.
Matthew Erdner: Your first question is from Matthew Erdner of Jones Training. Please go ahead. Your line is open. Hey, good morning. Thanks for taking the question. So you mentioned the diversification within the coupon stack. Are you looking to kind of spread out evenly across coupons, or are you going to favor the belly more so than current production? Obviously, the reduction in the 3% is coming, but, you know, what part of the curve are you really looking to diversify into?
Matthew Erdner: We'll still have a slight down in coupon bias just won't be as pronounced, just because we all, we just, we like the characteristics of those assets, the convexity, the return potential in the event we do get a, a bolsteping, which we may not, the problem with the higher coupons, they do well in times like this, at least most of the time, and they carry well, but they have a lot of risk, a lot of extension, potential in a meaningful sell-off, and in a rally, they will, you know, be not before and well. And one thing that we need really to go on, but if you look at new production current coupon mortgages, the gross wax on the emerging, typically 95 to 105 basis points above the coupon.
Matthew Erdner: So a Fannie 7 has a gross wax of 7, 95, 8, and loan bounces are very high. And what that means, or predicts is when we do get a rally, if we do get a rally, that those are going to be pre-paying very, very fast. Hunter, you want to throw in a few extra words on that? Sure. I think that the, there will be a little bit of a focus on higher coupons, maybe not as to put it as extreme as sevens, but it's like we did a continuation of what we did in the third quarter, sixes and six and a half are quite attractive from a carry perspective.
Matthew Erdner: They, you know, fit that part of our portfolio, where, you know, we're in a higher for longer environment, but not necessarily higher rates and higher for longer. You know, there's some extension risk on the upper coupons, but if we are kind of popping out somewhere in this say five to six percent ballpark for 10 year rates, I think that those, those higher coupons can do quite well. They have a lot of current carry.
Matthew Erdner: So that's the portion of our portfolio that's going to carry a little bit better, but not necessarily do well on the wing's big rally or big sell off. Gotcha. That's helpful. And then from a technical perspective, it seems like when money managers went overweight, they've kind of sold off in the recent months. What do you think will tighten spreads from here and who do you think is going to be the purchasers of this MBS?
Matthew Erdner: Well, that's, that's the million dollar question. You know, the reason that mortgages have done so poorly is that you really have no sponsorship from any large investor base, you know, obviously the Fed long gone, banks are not money managers are very overweight and maybe having redemptions. And that's really what keeps mortgages from tightening anytime soon that just isn't. You really probably need the curve to uninverte and banks to come in in a meaningful way or something like that because it's just not out there.
Matthew Erdner: And that's why we expect it will probably be positioned the way we are for some time because you can get some tightening, but I don't see a meaningful tightening with the market the way it is. It's going to something it's going to have to change and probably it's going to be the shape of the curve. It was very disappointing, third quarter. We leaned into the basis a little bit at the end of the second quarter, when spreads were sort of out their wides.
Matthew Erdner: During the second quarter, the wake of the regional bank crisis. Those lists went off so incredibly well and so much faster than we expected. There was definitely a more positive farmer tone that as you alluded to, the money managers quickly got overweight. And the quantitative tightening continued and as rates just grinded higher, there was really that lack of marginal buyer. So optimistic, I guess, that you've seen some signs of life from the banking sector.
Matthew Erdner: I don't think they're quite ready to come in in full force. But there was a couple of reports out in the last couple of weeks about banks being able to unload some of their lower coupon assets and supplement their income with some better earning potential and higher coupon mortgage space. So, you know, it's not anywhere near them becoming the, you know, it's called the marginal buyer, but you know, it's certainly a tendency some signs of life.
Matthew Erdner: So it'll probably be grind for the next couple of quarters and will be volatile. But we're also having those days when we see, you know, just the slightest glimmer of hope in mortgage spread space really brings in an influx of participants. And so the basis is incredibly volatile, but on those days when it's green, it's very green. So that's been a little bit of a welcome change over the past, you know, four to five weeks, you know, that we've really just seen show up in the last handful of days. That's helpful.
Unknown Executive: Thanks for all your guys. But you're welcome.
Chris Nolan: Your next question is from Chris Nolan of Gladdenburg, Feldman, please go ahead. Your line is open. Hey guys. Have you guys received any margin calls on the repo file? This morning, but we get them every day. Yeah, I mean, we margin call activities very robust. Yeah, we we get calls both on the hedges and on the assets every day. You know, we've internalized that we use outsource that to AVM. We hired Pat Doyle from AVM and we brought in our own systems. And so now we can manage that whole process entirely on our own. And yeah, I mean, the margin call activity keeps Pat busy several hours a day in and out. So absolutely.
Unknown Executive: Thank you. And then also follow up. What's our flexibility do you have on the dividend? Because I know you need to distribute a certain amount of your taxable income. But given all the moving teachers here. What's our flexibility to think you might see how you read that. We brought it down into kind of line with what we were earning. We were under earning over distributing, thinking that the market was going to turn.
Unknown Executive: And we didn't want to take the steps to reposition the portfolio. We had it just some and we did. But I think of that 12% seems fairly well reasonable. I mean, the big picture view on the dividend trust me. We've spent hours discussing this. The market does tend to punish you if you change it too often. And they also punish you if you over distribute too much. And the tax laws keep you from under this.
Unknown Executive: So we track our tax of learnings. We have a pretty good sense generally as we go throughout the year where we are in terms of our distribution. There is some latitude but it's not boundless. Could you guys give an update on where book value stands right now and also believe you mentioned economic leverage is down to 7.4 now from 8.5 is that right? Yes. If it is in bulk, I did mention it's we're down about little over 14% through yesterday. Okay.
Unknown Executive: Thank you. Sorry if I missed that and all my other questions were kind of touched on by the other two question yourself. Good luck going forward guys. Thank you. Thanks.
Unknown Executive: There are no further questions at this time.
Robert Cauley: I will now turn the call over to Robert Cauley for closing remarks. Thank you operator and thank you for taking the time to listen to the call. You have any further questions that come to mind after the calls over. Feel free to call us or if you listen to the replay. Have a question. You can always reach us in the office. The number is 772-231-140.
Unknown Executive: Otherwise, we look forward to speaking with you at the end of the fourth quarter. Thank you, everybody.
Unknown Executive: This concludes today's conference call. Thank you for your participation. You may now disconnect.