Q2 2024 Orchid Island Capital Inc Earnings Call
Hello, good morning, and welcome to the second quarter 2024 earnings conference call of Orchid Island Capital. This call is being recorded today, July 26th, 2024.
Operator: This call is being recorded today, July 26th, 2021. At this time, the company would like to remind the listeners that statements made during today's conference call relating to matters that are not historical facts are forward-looking statements subject to the safe harbor provisions of the Private Security Litigation Reform Act of 1995. Listeners are cautioned that such forward-looking statements are based on information currently available on management's good faith belief with respect to future events and are subject to risk and uncertainty that could cause actual performance or results to differ materially from those expressed in such forward-looking statements.
Speaker Change: At this time, the company would like to remind the listeners that statements made during today's conference call relating to matters that are not historical facts are forward-looking statements subject to the safe harbor provisions of the Private Security Litigation Reform Act of 1995.
Speaker Change: Listeners are cautioned that such forward-looking statements are based on information currently available on the management's good faith belief with respect to future events and are subject to risk and uncertainties.
Speaker Change: that could cause actual performance or results to differ materially from those that expressed in such forward-looking statements.
Operator: Important factors that could cause such differences are described in the company's filings with the Securities and Exchange Commission, including the company's most recent annual report on Form 10-K. The company assumes no obligation to update such forward-looking statements to reflect actual results, changes in assumptions, or changes in other factors affecting forward-looking statements. Now, I would like to turn the conference over to the company's chairman and chief executive officer, Mr. Robert Cauley. Please go ahead.
Speaker Change: 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
Speaker Change: Such forward-looking statements to reflect actual results, changes in assumptions, or changes in other factors affecting forward-looking statements. Now I would like to turn the conference over to the company's Chairman and Chief Executive Officer, Mr. Robert Cauley. Please go ahead, sir.
Robert E. Cauley: Thank you, Operator, and good morning. Hopefully, everybody's had a chance to download our slide deck. As usual, I'll be using that for the presentation today. Turning over now just to slide three, just kind of the agenda, as usual. We'll go through our financial results, then we'll talk about market developments and how those impacted our results and how we see things going forward, and then we'll dive deeper into the portfolio hedging and funding positions and then a few comments on our outlook for the market and for the portfolio going forward. So on slide five, for the quarter, Orchid generated a net loss of $0.09 per share versus an income of $0.38 in the last quarter
Robert E. Cauley: Book value declined approximately 5.9% from $9.12 to $8.58. Book value as of last Friday, I know that most of our peers have mentioned that it is down about 0.9%, so a little under 1% that has to do primarily with just our hedges, which I'll get into later in the presentation. The total return for the quarter was slightly under negative 2%, and we declared and paid $0.36 in dividends. The average portfolio grew quite substantially from a little under $3.9 billion to $4.2 billion.
Robert E. Cauley: We have amazing capital in the ATM. The portfolio as we stand today is about $5.1 billion, and repo is about $4.9 billion. Leverage ratio was 7.1 at the end of the quarter, unchanged primarily from the beginning of the quarter. Today, it's a little higher in the mid-seventies.
Robert E. Cauley: Thank you, Operator, and good morning. Hopefully everybody's had a chance to download our slide deck. As usual, I'll be using that for the presentation today. Turning over now just to slide three, just kind of the agenda as usual. We'll go through our financial results.
Robert E. Cauley: Speeds in the portfolio did increase slightly. That's probably due to rates being a little lower and seasoning in the, especially the discount side of the portfolio. Equity remains strong, up slightly, and represents a little under 50% of equity. Slide seven just presents our financials. I won't spend time going through these.
Robert E. Cauley: Those are just for your review. The income statement and balance sheet as at the end of the second quarter. Slide eight, as we all know, all of our peers publish something they refer to as earnings available for distribution. This is commonly compared to the dividend. We don't publish such a number. This is kind of our proxy.
Robert E. Cauley: Then we'll talk about market developments and how those impacted our results and how we see things going forward.
Robert E. Cauley: And then we'll dive deeper into the portfolio hedging and funding positions and then a few comments on our outlook for the market and for the portfolio going forward. So on slide five.
Robert E. Cauley: This number is what we call our economic income. It's all derived from GAAP financials. We are taking all of these numbers from our GAAP numbers. However, the dividend is based on taxable income, not GAAP. There are some differences. I just want to walk you through this presentation and highlight where there could be differences between GAAP-derived numbers and tax. For instance, just walking down the income statement, the interest income number is slightly different for tax purposes, but I think this is a good proxy.
Robert E. Cauley: There are minor differences in the calculation of interest income on pass-through portfolios and derivatives, but this number should be reasonable. The amortization of the discounted premium, that number is the GAAP number here. That can deviate quite a bit from the taxable number. The main reason is simply the fact that we do this based on changes or paydowns from the market and how that impacted the market value at the beginning of the quarter, whereas for taxes, we take the purchase date.
Robert E. Cauley: And then with rebuild funding, of course, that's pretty much identical. And then with the hedges, we show the impact of the benefit of the hedges that we have in place, which is quite substantial. There is a slight difference between gap and tax in that with tax, you have to take into account hedge positions that are actually closed to the extent they cover the effect of the current period.
Robert E. Cauley: For the quarter, Orchid generated a net loss of $0.09 per share versus an income of $0.38 in the last quarter. Book value declined approximately 5.9% from $9.12 to $8.58.
Robert E. Cauley: Book value as of last Friday, I know that most of our peers
Robert E. Cauley: have mentioned that is down about 0.9%, so a little under 1%. That has to do primarily with just our hedges, which I'll get into later in the presentation.
Robert E. Cauley: Total return for the quarter was slightly under negative 2% and we declared and paid 36 cents in dividends.
Speaker Change: The portfolio, the average portfolio grew quite substantially from a little under 3.9 billion to 4.2 We have been raising capital in the ATM The portfolio as we stand today is about 5.1 billion and repo is about 4.9 billion
Speaker Change: Leverage ratio is 7.1 at the end of the quarter, unchanged primarily from the beginning of the quarter. Today it's a little higher in the mid-7s.
Speaker Change: Speeds in the portfolio did increase slightly. That's probably due to rates being a little lower and seasoning, especially the discount side of the portfolio. Liquidity remains strong, up slightly, and represents a little under 50% of equity.
Speaker Change: Slide 7 just presents our financials. I won't spend time going through these.
Speaker Change: Those are just for your review. The income statement and balance sheet as at the end of the second quarter.
Speaker Change: Slide 8, as we all know, all of our peers published something they referred to as earnings available for distribution.
Speaker Change: [inaudible]
Speaker Change: We are taking all of these numbers from our GAAP numbers, you know, dividend is based on taxable income, not GAAP.
Speaker Change: So there are some differences. I just want to walk you through just this presentation and kind of...
Speaker Change: highlight where there could be differences between gap derived numbers and tax. So for instance, you know, just walking down the income statement
Speaker Change: The interest income number is slightly different for tax, but I think this is a good proxy. There are minor differences in the calculation of interest income on pass-through portfolios and derivatives, but this number should be reasonable. The amortization of discounted premium, that number is the gap number here.
Speaker Change: That can deviate quite a bit from the taxable number. The main reason is simply the fact that we do this based on changes or paydowns.
Speaker Change: from the how that impacted the market value at the beginning of the quarter whereas for taxes from purchase date
Speaker Change: And then with repo funding, of course, that's pretty much identical. And then the hedges, we show the impact of the benefit of the hedges that we have in place.
Speaker Change: which is quite substantial. There is a slight difference between GAAP and tax in that with tax...
Speaker Change: You have to take into effect.
Robert E. Cauley: So, for instance, if you entered into a 10-year swap two years ago and closed it one year ago, the open equity at the time of closing would still impact your interest income for tax purposes over the remaining eight years of that swap. So that can be slightly different, and the expenses are basically the same. So we're showing this number, this economic income or adjusted income of 50 cents. It is a proxy for what our taxable income is. I just want to make sure you understand that they're not necessarily exactly the same.
Speaker Change: If you entered into a 10-year swap two years ago and closed it one year ago, the open equity at the time of closing would still impact your interest income for tax purposes over the remaining eight years of that swap.
Speaker Change: So that can be slightly different and the expenses are basically the same. So, you know, we're showing this number, this economic income or adjusted income of 50 cents.
Speaker Change: It is a proxy for what our tax will income, I just want to make sure you understand that they're not necessarily exactly the same.
Robert E. Cauley: And as you can see, it's been fairly stable for the last three quarters. So that's all I'll say about that for now. Moving on to market developments, just kind of go through these four slides. In a nutshell, what's happened in the economy. If you look back to the end of the first quarter, the inflation and economic data had been quite strong. In fact, we were talking about rates being higher for longer, even the potential that the Fed would have to hike again. In the second quarter, that all changed.
Speaker Change: [inaudible]
Speaker Change: In a nutshell, what's happened in the economy, if you look back to the end of the first quarter,
Speaker Change: The inflation and economic data had been quite strong, in fact we were talking about the rates being higher for longer, even the potential that the Fed would have to hike again. Second quarter, that all changed. All the mainstream, all the main key data, inflation, jobs, ISM.
Robert E. Cauley: All the mainstream, all the main key data, inflation, jobs, ISM, for April, May, and June were considerably softer, and especially the inflation data is back consistent with what we saw late last year, which is inflation trending down towards the Fed's 2% target. Now the market views the Fed is likely to be on the path to cutting rates later this year. And then just kind of fast forward to where we are now in July, and the big change has been the change in the slope of the curve as the market gets closer to pricing in, or pricing eases closer. So now, for instance, 2's, and 10's, as a proxy for the shape of the curve in late June, that was at minus 50 basis points. Earlier this week, it got as low as minus 13.
Speaker Change: for April , May, and June were considerably softer and especially the inflation data is back consistent with what we saw late last year, which is inflation trending down towards the Fed's 2% target.
Speaker Change: and now the market views that.
Speaker Change: Fed is likely to be on path to cutting rates later this year.
Speaker Change: And then just kind of fast forward to where we are now in July and the big change has been the change in the slope of the curve as the market gets closer to pricing in or pricing eases closer. So now, for instance,
Speaker Change: 2's, 10's as a proxy for the shape of the curve.
Speaker Change: In late June , that was at minus 50 basis points. Earlier this week, it got as low as minus 13, so a big move.
Robert E. Cauley: So a big move. It's really hard to discern from these charts if you're looking at the difference between the green and the blue line, but the two-year point of the swap curve has moved over 35 basis points.
Speaker Change: It's really hard to discern from these charts if you're looking at the difference between a green and a blue line.
Speaker Change: The two-year point of the swap curve has moved over 35 basis points, so a big move, the curve is much steeper.
Robert E. Cauley: The curve is much steeper, and in our view going forward, that will continue, and it's easy to have a fair amount of conviction in that because there are really two forces that can drive that. On the one hand, obviously, if the Fed eases, you can get the front end of the curve moving down. It's currently anchored.
Speaker Change: In our view going forward is that that will continue, and it's easy to have a fair amount of conviction in that because there's really two forces that could drive that. On the one hand, obviously, if the Fed eases, you can get the front end of the curve moving down that's currently anchored.
Robert E. Cauley: But also on the longer end of the curve, to the extent that we're going to continue to run, for instance, large deficits, somewhere in the $5 to $8 trillion of debt that has to be rolled over by the government in the next year and a half. And depending on the outcome of the election, say, for instance, if Trump were to win, he has talked at length about imposing more tariffs, which could be inflationary.
Speaker Change: But also on the longer end of the curve, to the extent that we're going to continue to run, for instance, large deficits, there's...
Speaker Change: Somewhere in the 5 to 8 trillion dollars of debt that has to be rolled over by the government in the next year and a half.
Speaker Change: And depending on the outcome of the election, say for instance, if Trump were to win, he has talked at length about imposing more tariffs, which could be inflationary. So there's a lot of reasons to think that the long end of the curve may not rally as much as the front end.
Robert E. Cauley: So there are a lot of reasons to think that the long end of the curve may not rally as much as the front end, and that could even go higher. So for these reasons, it's easy to gain a fair amount of conviction and a steepener, and that's kind of how we expect the market to unfold. That being said, to the extent that it doesn't, we are positioned to do quite well even with that outcome.
Speaker Change: In fact it could even go higher. So for these reasons it's easy to gain a fair amount of conviction and a steepener and that's kind of how we
Speaker Change: the market to unfold. That being said, to the extent that it doesn't, we are positioned to do quite well even with that outcome.
Robert E. Cauley: Moving on to the mortgage market, this chart on the top I like to talk about. This is just the spread of the 10-year treasury going back very far. It's a good perspective.
Speaker Change: Moving on to the mortgage market, this chart on the top that I talked about, this is just the spread of the 10-year treasury going back very far. It's a good perspective.
Robert E. Cauley: As you can see, we are still at a fairly elevated level. On this chart, we show the most current reading of 141 basis points spread to the 10-year. Today, that's closer to 135, 136.
Speaker Change: As you can see, we are still at a fairly elevated level. On this chart we show the most current reading of 141 basis points.
Speaker Change: Spread to the tenure today that's closer to the
Speaker Change: 135, 136.
Speaker Change: All of that being said, the current coupon mortgage has a duration that's much, much shorter than 10 years, so a more appropriate benchmark for today would probably be the five-year.
Robert E. Cauley: All of that being said, the current coupon mortgage has a duration that's much, much shorter than 10-year. A more appropriate benchmark for today would probably be the 5-year. That spread is a little under 150, and it hasn't moved as much of late, so it's not tightened as much.
Speaker Change: And that spreads a little under 150 and it hasn't moved as much of late, so it's not tightened as much. So mortgages are still attractive.
Robert E. Cauley: Mortgages are still attractive, and we expect going forward that there's room for tightening. The market expects that to the extent we do see Fed easing, we're likely to see banks become more involved. They have been modestly involved to date, but if they were to become more meaningfully involved, that could be the impetus or the catalyst for some more tightening. I don't know that we're going to go back to the levels we saw pre-pandemic, but it could certainly drive us fairly tighter.
Speaker Change: And we expect going forward that there's room for tightening. The market expects that to the extent we do see Fed easing, we're likely to see the banks become more involved. They have been modestly involved to date.
Speaker Change: But if they were to become more meaningfully so that that could be the impetus or the catalyst for some more tightening I don't know that we're going to go back to the levels we saw pre-pandemic, but it could certainly drive us fairly tighter
Robert E. Cauley: Again, the market's conventional thinking is that the banks would become more involved if we do get easing. Outside of that, money manager inflows have been substantial. I saw some data published by Nomura yesterday that showed something like 7 or 8 billion weekly average inflows so far this year, which is pretty strong.
Speaker Change: And again, it's, you know, that's the kind of market's conventional thinking is that the banks would become more involved if we do get easing.
Speaker Change: Outside of that, money manager inflows have been substantial. I saw some data published by Nomura yesterday.
Speaker Change: that showed something like 7 or 8 billion weekly average to date this year, which is pretty strong.
Robert E. Cauley: To the extent that those money managers continue to be overweight mortgages, those are pretty substantial inflows, so they've been supportive. Then of late, as we know, REITs have been raising capital, and those are on the margins for the market as well. Looking at the bottom left of the page, you can see the performance of select coupons of mortgages, and you can see early in the second quarter that quite a weak performance. April was a rough month. We were still looking at data from March, and it was very strong.
Speaker Change: And to the extent that those money managers continue to be overweight mortgages, those are pretty substantial inflows, so they've been supportive and in a flake.
Speaker Change: We know that REITs have been raising capital, and those are kind of on the margins, affordable market as well.
Speaker Change: Looking at the bottom left of the page, you can see the performance of select coupons of mortgages. And you can see early in the second quarter, quite weak performance. April was a rough month. We were still looking at data from March. It was very strong. The market was expecting the Fed to.
Robert E. Cauley: The market was expecting the Fed to keep REITs high for an extended period of time, so mortgages were looking less appealing. But then we had a nice recovery into the end of the quarter. We gave up most of that in the last week, which really ended up hurting returns for the entire quarter only to turn around in July and rebound, although of late, the last week or so, that's turned around again. We're probably close to unchanged if you look back at a 331 reference.
Speaker Change: people
Speaker Change: gave up most of that in the last week.
Speaker Change: which really ended up hurting returns for the entire quarter only to turn around in July and kind of rebound although of late the last week or so that's turned around again we're probably close to unchanged if you look back at a 331 reference point
Robert E. Cauley: On the next slide, we talked about volatility. Volatility is obviously a very big driver of mortgage performance. And as this chart on the top shows, if you go back to October of 2023, when we were at very high levels of rates and volatility, we've had a nice long rally since, although the light is starting to pick up. And in particular, this week, especially realized volatility has been quite high. And this is just something that we always have to keep an eye on because it is a very big driver of mortgage performance.
Speaker Change: The next slide, we talked about volatility. Volatility is obviously a very big driver of mortgage performance, and this chart on the top shows.
Speaker Change: If you go back to October of 2023, when we were at very high levels of rates and volatility, we've had a nice long rally since, although the light is starting to pick up, and in particular this week, especially realized volatility has been quite high.
Speaker Change: And this is just something that we always have to keep an eye on because it is a very big driver of mortgage performance. So, for now, we're at relatively low levels looking back just a year or so, but starting to go the other way.
Robert E. Cauley: So for now, we're at relatively low levels, looking back just a year or so, but starting to go the other way. Slide 13 is kind of our proxy for the housing market and refinancing, and as you can see, as we all know, it's been the same story for quite some time. Mortgage rates are high. That's the red line on the top left, and the blue line is the refinancing index, which is basically zero.
Speaker Change: Slide 13 is kind of our proxy for the housing market and refinancing. And as you can see, as we all know, it's been the same story for quite some time. Mortgage rates are high. That's the red line in the top left. And the blue line is the refinancing index, which is, you know, basically zero.
Robert E. Cauley: But just speaking more generally about the housing market, affordability is very, very low, near record lows, so that impacts a lot of things like turnover, rates, again, near a high level, prices are high, which, you know, these two combined drive affordability, and now what we're starting to see are inventory levels build. I know this week, for instance, new home sales were released.
Speaker Change: But just speaking more generally about the housing market, affordability is very, very low, near record lows, so that impacts a lot of things like turnover, rates, again, near the high level, prices are high, which, you know, these two combined drive.
Speaker Change: [inaudible]
Robert E. Cauley: The inventory of new homes is over nine months' supply, which is typically associated with recession levels. I'm not saying that we're going to get a recession, but those levels have moved a lot. In fact, I think the absolute level of new homes and inventory is similar to the levels we saw before the financial crisis, so the housing market is definitely weak. There's no question of that.
Speaker Change: The inventory of new homes is over nine months supply, which is typically associated with recession levels. I'm not saying that we're going to get a recession, but those levels have moved a lot.
Speaker Change: In fact, I think the absolute level of new homes and inventory is similar to the levels we saw before the financial crisis. So the housing market is definitely weak, there's no question of that.
Robert E. Cauley: Slide 14 is something I introduced last period. It's just kind of an interesting look at GDP and the money supply. I'm not really going to talk about it, but it paints an interesting picture.
Speaker Change: Slide 14 is something I introduced last period, it's just kind of an interesting look at GDP and the money supply. I'm not really going to talk about it, but it paints an interesting picture.
Robert E. Cauley: You can see that growth has been above the long-term trend for some time since the pandemic, and whether it's causal or not, the money supply would appear to be behind that, and that's kind of associated with the significant deficits that we've been seeing since the pandemic. That's about all I have to say about that. Now I'll turn to the portfolio. On slide 16, as I said, our outlook for rates is for the curve to steepen.
Speaker Change: Growth has been above long-term trend now for some time since the pandemic, and whether it's causational or not, the money supply would appear to be behind that, and that's, you know, kind of associated with the significant deficits that we've been seeing since the pandemic.
Speaker Change: That's about all I have to say for that. Now I'll turn to the portfolio.
Speaker Change: On slide 16, as I said, our outlook for rates is for the curve to steepen.
Speaker Change: As I said, there's two potential drivers of that. You could have the Fed lower short-term rates.
Speaker Change: [inaudible]
Robert E. Cauley: As I said, there are two potential drivers of that. You could have the Fed lower short-term rates, and longer-term rates could stay the same or go higher if inflation and or deficits continue to stay high. So with that in mind, that's kind of the backdrop of how we view the world going forward. Now, in terms of what we did, well, the big driver was that we had a lot of money to put to work. We used the ATM quite exclusively in the second quarter.
Robert E. Cauley: We raised about $100 million, and actually, in July through the first third of the month or so, we raised another $55 million, so quite a bit of capital in relation to our size. As a result, we've been deploying that into the portfolio, and basically, almost exclusively or exclusively in higher coupons. As a result, our weighted average coupon went from 4.38 at the end of the first quarter to 4.72 at the end of the second, which is a pretty substantial move, but it's even higher now.
Speaker Change: We had a lot of money to put to work. We used the ATM quite exclusively in the second quarter. We raised about $100 million.
Speaker Change: And actually in July through the first, you know, third of the month or so, we raised another $55 million. So quite a bit of capital in relation to our size.
Speaker Change: As a result, we've been deploying that into the portfolio and basically almost exclusively or exclusively in higher coupons. As a result,
Speaker Change: Our weighted average coupon went from 4.38 at the end of the first quarter to 4.72 at the end of the second, which is a pretty substantial move, but it's even higher now. It's at 4.88, so a 50 basis point increase off of where we were at the end of March.
Robert E. Cauley: It's at 4.88, so a 50 basis point increase off of where we were at the end of March. Realized yields are higher. I don't have the current number, but it would be higher than what we reported here for the end of Q2.
Speaker Change: Realized yields are higher.
Speaker Change: I don't have the current number, but it would be higher than what we report here for the end of Q2.
Robert E. Cauley: And also, our net interest spread for the quarter went from 2.47 to 2.64 with the additions of the higher coupons and our slight changes to our hedging strategy, which I'll get into in a moment. You know, there's room for that to expand slightly more. And I will just point out, if you look back at our portfolio historically, say going back a year or so, especially in relation to our peers, we probably had one of the lowest weighted average coupons in the portfolio. And as we employ our barbell strategy and add higher coupons, that's been coming up quite a bit. So,
Speaker Change: And then also our net interest spread for the quarter went from 2.47 to 2.64, with the additions of the higher coupons in our...
Speaker Change: Slight changes to our hedging strategy, which I'll get into a moment. You know, there's room for that to expand slightly more
Speaker Change: And I will just point out, if you look back at our portfolio historically, say going back a year or so, especially in relation to our peers, we probably had one of the lowest weighted average coupons in the portfolio. And as we employ our barbell strategy and add higher coupons, that's been coming up quite a bit.
Robert E. Cauley: In terms of performance for the quarter, our net interest income for June, even though we were negative for the quarter, was actually slightly positive. I don't have any Q2 figures yet for you, but that's clearly the trend with respect to the portfolio itself. As you can see on slide 17, these charts are just bar graphs of our portfolio. If you look to the right, that's where we were at the end of last year.
Speaker Change: and so on.
Speaker Change: We were, in terms of performance for the quarter, our net interest income for June , even though we were negative for the quarter, was actually slightly positive.
Speaker Change: I don't have any YouTube figures yet for you, but that's clearly the trend.
Speaker Change: with respect to the portfolio itself, as you can see on slide 17.
Speaker Change: These charts are just the bar graphs of our portfolio. If you look at the right, that's where we were at the end of last year. And as you can see, moving to the left, the current position is at 630. We have, as I said, been adding to the higher coupons.
Robert E. Cauley: And as you can see, moving to the left, the current positions at 630, we have, as I said, been adding to the higher coupons. Just to give you some updates on what we've done since quarter end, 630-24, our allocation to sixes is now just under a billion dollars. So that's grown quite a bit. Six and a half, we're now over 800 million, and sevens are almost 400 million.
Speaker Change: Just to give you some updates of what we've done since quarter end, 6-30-24, our allocation to sixes now is just under a billion dollars, so that's grown quite a bit.
Speaker Change: Six and a half, we're now over 800 million.
Robert E. Cauley: So, you know, that's almost $600 million of ads, and all in those higher coupons. And the reason we prefer this barbell strategy is that we think it does well in either rate environment. So, for instance, if we were to have a rally on the long end in particular, our lower coupons would do quite well. Unknown Executive, Mikhail Goberman, George Haas, Matthew Erdner, George Haas, Unknown. Turning to slide 18 in our funding, the Fed hasn't done anything, so not surprisingly, our average repo rate for the quarter was unchanged.
Speaker Change: and Sevenths are almost 400 million, so that's almost $600 million of ads.
Speaker Change: and all of those higher coupons.
Speaker Change: The reason we prefer this barbell strategy is, you know, we think it does well in either rate environment. So, for instance, if we were to have a rally on the long end in particular, our lower coupons would do quite well.
Speaker Change: And to the extent the rates, long end rates in particular stay higher, these higher coupon securities generate lots of income and in absence of an substantial increase in longer term rates, don't have much extension risk.
Speaker Change: The belly of the coupon stack has more often than not been quite rich of late. That's another reason why we find these securities to be attractive.
Speaker Change: Turning to our slide 18 in our funding, well, the Fed hasn't done anything, so...
Robert E. Cauley: All that being said, with the market starting to price in eases, we have extended our average maturity, and we've continued to do that into July, so we can get some benefit from some slightly lower, not meaningfully small, but slightly lower rates further out. With respect to our economic cost of funds, it did improve a fair amount from 2.56 to 2.41, and that has a lot to do with changes in the strategy of how we're hedging.
Speaker Change: Not surprisingly, our average repo rate for the quarter was unchanged. All that being said, with the market starting to price in, eases, we have extended our average repo rate.
Speaker Change: [inaudible]
Speaker Change: With respect to our economic cost of funds, it did improve a fair amount from $2.56 to $2.41. And that has a lot to do with...
Robert E. Cauley: We've been using a lot more swaps versus treasuries or futures, and we've been moving those swaps up the curve, so a slightly lower notional balance, but with more DV01 further up the curve and with the curve very, very flat, in effect, our borrowing rate, our hedge borrowing rate,'s gone down slightly, and that's what's caused the NIM to improve. Now turning to our hedge positions, as I mentioned, we've been moving the swaps out, moving two swaps, and using longer tenor swaps, almost all 10, 7 and 10 years.
Speaker Change: Changes in the strategy of how we're hedging. We've been using a lot more swaps versus treasuries or futures
Speaker Change: And we've been moving those swaps up the curve, so slightly maybe lower notional balance.
Speaker Change: But with more DV01 further off the curve, and with the curve very, very flat, in effect our borrowing rate, hedge borrowing rate's gone down slightly, and that's what's caused the NIM to improve.
Speaker Change: Now turning to our hedge positions, as I mentioned, we've been moving the swaps out, moving two swaps and using longer tenor swaps almost all 10, 7 and 10 year. And the reason we're doing that is just we think the greatest potential pain
Robert E. Cauley: And the reason we're doing that is just that we think the greatest potential pain or risk to the portfolio would be a long end sell off, which would typically be accompanied by an increase in vol. And so therefore by using 7 and 10 year swaps, especially when we're hedging new purchases which are higher coupon, lower duration, if those mortgages were to extend, they're extending towards the long end, they're extending their duration, that's moving close to our hedges, we would dynamically hedge and potentially add to those positions, but it really I think is the most sound way to protect the portfolio because that, as I said, I think that would be the greatest source of pain would be a significant sell off in the long term.
Speaker Change: Or risk to the portfolio would be a long-term sell-off, which would typically be accompanied by an increase in vol.
Speaker Change: And so therefore, by using seven and 10-year swaths, especially when we're hedging new purchases, which are lower or higher coupon, lower duration, if those mortgages were to extend, they're extending towards.
Speaker Change: the long end, you know, they're extending their duration, that's moving close to our hedges. We would dynamically hedge and potentially add to those positions, but it really, I think, is the most sound way to protect the portfolio, because that, as I said, I think that would be the greatest source of pain, would be a significant sell-off in the long end.
Robert E. Cauley: Also, just more statistics on slide 19, we do cover 84% of our funding liabilities with our hedges, excluding TBAs. Swaps are now up to 72% of that, and our weighted average pay fixed rate is 2.71. If you look at the bottom of that page, you can see our swaps are now a little over $3.1 billion. The corresponding number at the end of Q2 was 2.53.
Speaker Change: Also, just more statistics on slide 19. We do cover 84% of our funding liabilities with our hedges, excluding TBAs.
Speaker Change: Swaps are now up to 72% of that.
Speaker Change: And our weighted average paid fixed rate is 2.71. If you look at the bottom of that page, you can see our swaps are now a little over 3.1 billion. Corresponding number at the end of Q2 was 2.53, so a significant move.
Robert E. Cauley: So a significant move. The futures were $842 million; now it's $521 million. So we've been, in addition to adding to our hedges, we've been moving some of them from futures to swaps and moving the swaps further out the curve. TBA shortage essentially unchanged, and same with the swaps, that's really just one position. Now if you look at slide 20, we provide a little more detail on our hedges, and I just want to say a few comments. In particular, on the top right are swaps.
Speaker Change: The futures, those were $842 million, now it's $521 million. So we've been, in addition to adding to our hedges, we've been moving some of them from futures to swaps, and moving the swaps further out the curve. TBA shortage essentially unchanged, and same with the swaps. That's really just one position.
Speaker Change: Now, if you look at slide 20, we provide a little more detail on our hedges and I just want to say a few comments.
Robert E. Cauley: As you can see, if you compare where we were at the end of the first quarter versus now, the shorter maturity swaps are the same. So we've been adding to the longer kind of swaps, as I mentioned. With respect to the performance of the portfolio through last Friday, it really was just driven by the fact that we do have a fair number of swaps in that five, six, and seven-year part of the curve.
Speaker Change: In particular, on the top right are swaps. As you can see, if you compare where we were at the end of the first quarter versus now, the shorter maturity swaps are the same. So we've been adding to the longer kind of swaps, as I mentioned.
Speaker Change: with respect to the performance of the portfolio through last Friday.
Speaker Change: It really was just driven by the fact that we do have a fair number of swaps in that five, six, seven-year part of the curve, and that's where the markets really rallied. And so it's the reason that we're down slightly is just because of that, the rally in the swap positions that shot the...
Robert E. Cauley: And that's where the markets really rallied. And so the reason that we're down slightly is just because of that, the rally in the swap positions that shot the market to a slightly negative position. Now, with that being said...
Speaker Change: Mark to market to a slightly negative position. Now, with that being said...
Robert E. Cauley: I don't know that we're going to change that. I think we expect the curve to be steep, and we do expect the Fed will ultimately ease, but current pricing is for quite a few eases by the end of the cycle, you know, 200 basis points or so. And I don't think we're ready to take the over on that.
Speaker Change: I don't know that we're going to change that, but I think we expect the curve to steep and we do expect the Fed will ultimately ease.
Speaker Change: Current pricing is for quite a few eases by the end of the cycle, you know, 200 basis points or so.
Robert E. Cauley: I don't think we see the economy as on top of the world in the recession, and so I wouldn't be surprised if we actually realize less than that. So the fact that there's no real reason in our minds to unwind any of those hedges because we think the market's maybe a little ahead of itself. Also, with respect to the swaps, I want to point out that none of our swaps mature before March of 2026.
Speaker Change: I don't think we're ready to take the over on that. I don't think we see the economies without the role in the recession. So I wouldn't be surprised if we actually realized less than that. So the fact there's no real reason in our minds to...
Speaker Change: [inaudible]
Robert E. Cauley: 85% of our swaps are in place through or mature in Feb. 29 or longer, and 65% in May of 2030 or longer. So, these hedge positions are going to be in place for quite a while. The one swap that does mature in March 26 represents less than 10% of our notional balance. So, our hedges are here. We're not going to have them roll off.
Speaker Change: 85% of our swaps are in place through or mature in Feb of 29 or longer.
Speaker Change: and 65% in May of 2030 or longer. So these hedge positions are going to be in place for quite a while. The one swap that does mature in March of 26 represents less than 10% of our notional balance.
Robert E. Cauley: We don't have to refinance those, so to speak, anytime soon. And then, secondly, with respect to our balance sheet, as you know, we have no preferred, we have no floating rate preferred, so our balance sheet, in that regard, is very clean, and we don't have that risk to our net interest margin posed by either a floating rate preferred or swaps that have to be refinanced in the near future. Slide 21 just gives you a look at the portfolio. I would point your attention to the column entitled effective duration.
Speaker Change: So our hedges are here. We're not going to have them blow up. We don't have to refinance those, so to speak, anytime soon.
Speaker Change: And then secondly, with respect to our balance sheet, as you know, we have no preferred, we have no floating rate preferred, so our balance sheet in that regard is very clean and we don't have that risk to our net interest margin posed by either a floating rate preferred or swaps that have to be refinanced in the near term.
Robert E. Cauley: And you can see across the various coupons those numbers. And on the bottom or on the far right is just our allocation. So basically, if you look at the effective duration column starting from the top down to the bottom, that's basically the curve where we're positioned along the curve.
Speaker Change: Slide 21 just gives you a look at the portfolio. I would point your attention to the column entitled Effective Duration.
Speaker Change: And you can see across the various coupons, those numbers, and in the bottom or the far right is just our allocation. So basically, if you look at the effective duration column, starting from the top.
Robert E. Cauley: So the shortest part of the curve, which would be 1.27 years, our current allocation at the end of June was 7%. Those are higher. But basically, this just gives you a sense of how we've positioned the portfolio across the curve. Granted, these are static numbers.
Speaker Change: Down to the bottom. That's basically the curve where we're positioned along the curve. So the shortest part of the curve, which would be 1.27 year.
Speaker Change: Our current allocation at the end of June was seven percent. Those are higher, but basically this just gives you a sense of
Speaker Change: how we position the portfolio across the curve. Granted, these are static numbers. If rates were to move materially, these duration numbers can change. But as you can see on the far right column, how we're positioning, just note in the bottom right, the allocations to those higher coupons have gone up.
Robert E. Cauley: If rates were to move materially, these duration numbers could change. But as you can see in the far right column, how we're positioned. And just note in the bottom right, the allocations to those higher coupons have gone up. Slide 22 just kind of gives you a sensitivity of our net duration gap or the sensitivity of the portfolio. As you can see, we do a little better in a backup, and that's just because we've added longer tenor swaps. Lastly, slide 23, our speed experience.
Speaker Change: Slide 22 just kind of gives you a sensitivity of our net duration gap or the sensitivity of the portfolio. As you can see, we do a little better in a backup, and that's just because we've added longer tenor swaps primarily.
Speaker Change: Finally, slide 23, our speed experience.
Robert E. Cauley: The one thing that we've benefited from of late, as I mentioned earlier, is that most of our deep discounts, bonds with 95 handles or below, fours, four and a half, and so forth, they're quite seasoned. And as a result, our speeds, if you look in the very far right column, they're not bad for deep discount bonds, so that's been beneficial for us. And with respect to our newer, higher coupons, they've been maintained at just basically moderate speeds, and we haven't had any issues there. That's pretty much it.
Speaker Change: The one thing that we benefited from, of late, as I mentioned earlier, is that most of our deep disks calcite.
Speaker Change: Bonds with 95 handles are below 4s, 4 1?2s and so forth, so quite seasoned, and as a result, our speeds, if you look in the very far right column, they're not bad for deep discount bonds, so that's been beneficial for us.
Speaker Change: And with respect to our newer, higher coupons, they've been maintained at just basically moderate speeds. We haven't had any issues there.
Robert E. Cauley: Now just kind of turning to our outlook. As I mentioned earlier, lots have changed since the end of the first quarter. We were looking at higher for longer, maybe the Fed hiking, the data changed pretty abruptly, and now the market really thinks that we're on the verge of an easing cycle. We've been here before.
Speaker Change: So that's pretty much it. Now I'll just kind of turn it to an outlook.
Speaker Change: As I mentioned earlier, you know, a lot's changed since the end of the first quarter. We were looking at higher for longer, maybe the Fed hiking, the data changed pretty abruptly, and now the market really thinks that we're on the verge of an easing cycle.
Robert E. Cauley: We certainly have if you go back to December of last year, we thought we were on the verge of a big easing cycle, but that didn't turn out to be the case. So we are mindful of that, but that being said, to the extent we do get an easing cycle, there are obvious benefits to that as our funding costs decline and our position in the portfolio, which I think is well-suited to that outcome.
Speaker Change: We've been here before. We've certainly, if you go back to December of last year, we thought we were on the verge of a big easing cycle and it didn't turn out to be the case.
Speaker Change: So we are mindful of that, but that being said, to the extent we do get an easing cycle, you know, there's obvious benefits to that, as our funding costs decline, and our position in the portfolio, which I think is well-suited for that outcome.
Robert E. Cauley: But all that being said, if nothing happens and the data turns around again and we don't get any tightening or easing, we just have a status quo, the portfolio is very well-positioned, the income and net of our hedges is very attractive, and we think that our hedges are such that we can maintain a pretty stable value throughout. So we're very comfortable positioning the way we are. And that's it.
Speaker Change: But all that being said, if nothing happens and the data turns around again, and we don't get any tightening or easing or easing rather We just have a status quo. The portfolio is very well positioned. The income and net of our hedges is very attractive
Speaker Change: And we think that our hedges are such that we can maintain pretty stable book value throughout. So we're very comfortable positioning the way we are. And that's it. Operator, I will now turn the call over to questions.
Operator: Operator, I will now turn the call over to questions. All right, thank you. The floor is now open to questions. If you would like to ask a question, please press star followed by the number one on your telephone keypad.
Speaker Change: All right, thank you. The floor is now open for questions. If you would like to ask a question, please press star followed by the number one on your telephone keypad. The number again is star followed by the number one.
Operator: The number again is a star followed by the number one. Alright, our first question comes from the line of Jason Lieber from Jones Trading. Please go ahead. Hi, good morning.
Speaker Change: All right, our first question comes from the line of Jason Lieber from Jones Trading. Please go ahead.
Jason Lieber: Appreciate that market commentary. It's very helpful. I was wondering, can you comment on the pace of deployment over the quarter of the ATM issuance? And if that represents any sort of meaningful cash drag, or were you able to get that invested relatively simultaneously? I'll give you my first comments and then turn it over to Hunter.
Speaker Change: Hi, good morning. I appreciate that market commentary. It's very helpful. I was wondering, can you comment on the pace of deployment over the quarter of the ATM issuance and if that represents any sort of meaningful cash drag, or were you able to get that invested relatively simultaneously?
Speaker Change: I'll give you my first comments and turn it over to Hunter.
Robert E. Cauley: We did wait a little bit in June. We raised a lot of money in the ATM in June, and with the market, especially the mortgage market, under-performers late in the month, we did wait. So we didn't deploy most of that until July. So that would cause a slight drag for the first month because we just had less income on more shares. But we then did deploy it.
Hunter: We did wait a little bit in June . We raised a lot of money in the ATM in June and with the market
Hunter: Especially the mortgage market under performance late in the month. We did wait So we didn't deploy most of that until July so that would cause slight drag for the first month because we just have less income
Robert E. Cauley: We're, I would say, fully deployed. Yes, we're fully deployed at this point, although our numbers in June and July would not reflect being fully invested. So with this most recent slug of capital that we've raised, the money will be fully put to work starting in the month of August. So we'll get full months' worth of interest accruals on all those. We raised some capital in the beginning of May, put that money to work relatively quickly, and then also did some more fundraising in the latter part of May and early June.
Hunter: on more shares. But we then did deploy it. We're, I would say, fully deployed.
Hunter: [inaudible]
Hunter: with this most recent slug of capital that we've raised.
Hunter: You know, the money will be fully put to work starting in the month of August . So we'll get full, you know, sort of full month's worth of interest accruals on all those.
Hunter: We
Hunter: raise some capital in the beginning of May.
Hunter: put that money to work relatively quickly, and then
Hunter: Also did some more fundraising in the later part of May and early June . We really waited until towards the end of the quarter to put that money to work.
Robert E. Cauley: We really waited until towards the end of the quarter to put that money to work. I think it was a wise decision as that last week of June spreads really backed up quite a bit. So we put some money to work in late June and early July that was pretty attractive. Got it. Thank you.
Hunter: I think it was a wise decision as that last week of June spreads really backed up quite a bit. So we put some money to work in.
Robert E. Cauley: And then just on the macro front, as far as the book looks today, you know, where do you think benchmark mortgage rates or spreads, for that matter, have to come in for you to begin to get really concerned about your convexity exposure? Do all spreads have to come in? Sorry, what rates have to move for it before you start worrying about accelerated prepayment exposure? Oh, I would say, right now, the current coupon is about $5.58 or $5.60. We have a lot of sixes and six-and-a-halves. I think you guys mentioned a little under $400 million in sevens. So the sixes and six-and-a-half are not...
Hunter: Late June and early July at pretty attractive levels.
Speaker Change: Got it. Thank you. And then just on the macro front, as far as the book looks today, you know, where do you think benchmark mortgage rates or spreads for that matter have to come in for you to begin to get really concerned about your convexity exposure?
Speaker Change: Where do all the spreads have to come in? Sorry, where do rates have to move before you start worrying about accelerated prepayment exposure?
Speaker Change: Oh, um...
Speaker Change: I would say right now the current coupon is about $5.58 or $5.60. We have a lot of sixes and six-and-a-halves. I just mentioned a little under $400 million of sevens. So the sixes and six-and-a-halves are not...
Robert E. Cauley: Significant premiums, and we also have a lot of those in New York. They're all specs, a mixture of low pay-up and some higher pay-up bonds. They would have to be quite a rally, I think, for those to become meaningfully in the money and become a concern. An exact number, you're probably looking at, I don't know, 25 basis points or more. And the other thing is that mortgage spreads primary secondary spread, I didn't mention that on the thing that they called earlier, but they've been kind of sticking to the high side. So I don't know that we would necessarily see them bundled up with rates basis point for basis. Yeah, the strategy has been, especially in the sixth.
Speaker Change: Significant premiums and we also have a lot of those are New York's.
Speaker Change: They're almost, they're all specs.
Speaker Change: a mixture of low pay up and some higher pay up bonds. They would have to be quite a rally, I think, for those to become meaningfully in the money and become a concern.
Speaker Change: [inaudible]
Speaker Change: They've been kind of sticky to the high side, so I don't know that we would necessarily see them cake up with rates, basis point for basis point.
Speaker Change: Yeah, the strategy has been...
Robert E. Cauley: Six and a half and seven, even more so as you go up in rate, has been to stay sort of close to TBA. So we're trying not to, we recognize that convexity risk, you know, and we monitor our hedge ratios as they, they, they change, you know, from day to day on that front. So we're trying to stay on top of the convexity into a rally. We did mention that our barbell strategy, the other side of that is we have a lot of really high quality specified pools that are lower coupon.
Speaker Change: especially in the sixth
Speaker Change: six-and-a-half and seven movies.
Speaker Change: Even more so as you go up in rate has been to stay sort of close to TBA So we're trying not we recognize that with that convexity risk You know and we monitor our hedge ratios as they as they as they change, you know from day to day on that front, so
Speaker Change: We're trying to stay on top of the convexity and to a rally. We did mention that our barbell strategy, the other side of that is we have a lot of really high quality.
Robert E. Cauley: And so because they're so far out of the money at this point, their payouts aren't all that high, but we would expect those payouts to accelerate at an increasing rate if we were to have a really big rally. So on the opposite side, the high coupon portfolio, because it's, relatively low payout. If we were to have that big sell-off, I think, as Bob alluded to in his comments, we would expect those assets to do quite well.
Speaker Change: And so, because they're so far out of the money, at this point, they're, you know,
Speaker Change: Payups aren't all that high, but we would expect those payups to accelerate at an increasing rate if we were to have a really big rally. So, on the opposite side, the high coupon portfolio, because it's...
Speaker Change: you know, relatively low pay up. If we were to have that big sell off, I think as Bob alluded to in his comments, we would expect those assets to do quite well. And we've really seen that as we've bounced around the rate range, you know, if we have a big sell off.
Robert E. Cauley: And we've really seen that as we've bounced around the rate range. If we have a big sell-off, we'll see 6.5 and 7 TBAs do relatively well, with lackluster performance down lower in coupon. That market's a lot more technical, less predictable as rates rise and fall, but production coupons tend to do well into a sell-off, and tighten up. So we like the way we're positioned for that. Got it. Well, thank you for that cover.
Bob: We'll see six and a half and seven TBAs do relatively well, you know.
Speaker Change: lackluster performance down lower in coupon. That market's a lot more technical, less predictable as rates rise and fall, but the production coupons tend to do well into a sell-off and tighten up. So we like the way we're positioned for that reason.
Speaker Change: Got it. Well, thank you for that cover. Very, very helpful. Yep. Thank you.
Robert E. Cauley: Very, very helpful. Yes. Thank you. Our next question comes from Jason Stewart from JANI. Please go ahead. Hey, good morning.
Speaker Change: Our next question comes from Jason Stewart from JANI. Please go ahead.
Jason Stewart: Thank you. Hey Bob. Maybe start with the current cash ROE of the portfolio and what you're seeing in terms of incremental capital deployment on current cash ROEs. Well, we've seen, we were at 150 for quite a while. Now we're getting closer to 200 over, especially as we've been using more of the longer-dated swaps. I don't need to publish the numbers, but yields on the new acquisitions that Hunter just alluded to were in the very, very high fives on average, using a combination of 7 and 10-year swaps. They're in, you know, depending on when we put them in either the low 4s or even the high 3s.
Jason Stewart: Hey, good morning. Thank you. Hey, Bob. Let me start with the current cash ROE of the portfolio and what you're seeing in terms of incremental capital deployment on current cash ROEs.
Speaker Change: Well we've seen we were at 150 for quite a while now we're getting closer to 200 over especially as we've been using more the longer dated swaps.
Hunter: I don't need to publish the numbers, but yields on the new acquisitions that Hunter just alluded to were in the very, very high fives on average.
Hunter: and using a combination of seven and 10-year swaps.
Robert E. Cauley: So, you know, I don't know if we're 200 over, but they're quite high. And with 7x leverage, 7.5, you know, those are pretty decent ROEs. And I don't think that's being very aggressive with respect to leverage. So they're very, very attractive.
Speaker Change: They're in, you know, depending on when we put them in either the low 4s or even high 3s. So, you know, I don't know if we're 200 over, but they're quite high.
Speaker Change: And with 7x leverage, 7 1?2, you know, that's pretty decent ROEs.
Speaker Change: and I don't think that's...
Speaker Change: being very aggressive with respect to leverage, so they're very, very attractive.
Robert E. Cauley: I think the one thing we do think about is, you know, what's going to be the big driver if you're going to get the big tightening? We haven't seen that yet, obviously, and I don't know that we're going to see it in the immediate term unless you really start to see the banks come in. And I would just add just a comment. One thing we've seen since you don't have the Fed doing QE, you don't have banks buying, is that the mortgage market has become very relative value-driven.
Speaker Change: I think the one thing we do think about is, you know, what's going to be the big driver if you're going to get the big tightening.
Speaker Change: We haven't seen that yet, obviously, and I don't know that we're going to see it.
Speaker Change: in the immediate term unless you really start to see the banks come in. And I would just add up just a comment. One thing we've seen, since you don't have the Fed doing QE, you don't have banks buying.
Robert E. Cauley: No coupon outperforms for more than a day or so. It's, you know, if the belly outperforms today, then you know it's going to outperform tomorrow kind of thing. Unknown Executive, Mikhail Goberman, Orchid Island Capital Inc. As alluded to earlier, some of the early May settles were done at slightly tighter spreads from both an OAS and yield perspective, but yeah, it's 180 to 200 over. Positive cash flow versus funding today's repo funding levels, just in terms of carry, and then room for, one of the benefits of hedging these a little bit farther out Yeah, so, Yeah, no, it does.
Speaker Change: is the mortgage market has become very relative value driven. No coupon outperforms for more than a day or so. It's, you know, if the belly outperforms today, then you know it's going to outperform tomorrow kind of thing.
Speaker Change: And so, performance has been very volatile in that regard on a relative, you know, just
Speaker Change: [inaudible]
Speaker Change: You know, as alluded to earlier, some of the
Speaker Change: Some of the early May settles were done at slightly tighter spreads from both an OAS and yield perspective. But, yeah, it's $180 to $200 over positive cash flow versus
Speaker Change: Funding today's repo funding levels just in terms of carry and then room for one of the benefits of hedging these a little bit
Speaker Change: Further out the curve is if and when we do get those FETIs is we have immediate room for NEM expansion on sort of the unhedged portion of the assets, so
Robert E. Cauley: Thanks for that. So, like mid to high teens, and all cash carry with room for improvement is sort of the bottom line there, right? Yeah, yeah. Okay. And then just a technical question on the payups. You know, when you look at hedging, sort of that spread duration of the payup, does that change your hedging strategy at all? Just given, you know. I mean, we've seen some pretty aggressive refi programs out there.
Speaker Change: Yeah.
Speaker Change: Yeah, so...
Speaker Change: Yeah, no, it does. Thanks. It's like mid to high teens and all cash carry with room for improvement. It's sort of the bottom line there, right? Yeah. Yep
Speaker Change: Okay, and then just a technical question on the payouts, you know, when you look at hedging sort of that spread duration of the payout.
Speaker Change: Does that change your hedging strategy at all, just given, you know, I mean we've seen some pretty aggressive refi programs out there. You know, it seems like, you know, a lot of the mortgage market is very
Robert E. Cauley: You know, it seems like, you know, a lot of the mortgage market is going to be very quick to refi some of the new production. I mean, just maybe talk a little bit about how you're looking at that spread duration and hedging that risk on the payup. Well, we've seen that be very painful in the past.
Speaker Change: is going to be very quick to refine some of the new production. I mean, just maybe talk a little bit about how you're looking at that spread duration and hedging that risk on the pay ups.
Robert E. Cauley: I mean, we all know, you know, this been gut-wrenching episodes early in 23, where those payoffs can move a lot, and you experience that spread duration. What we've done is basically just basically stick to more slow payoffs stuff. As I mentioned, we own some New Yorks, but those are in sixes. So the payoffs aren't that high. Generally, it's been, you know, higher loan balance or FICO or, you know, Texas or Florida or LTV. So try to avoid that.
Speaker Change: Well, we've seen that be very painful in the past. I mean, as we all know, you know, there's been some...
Speaker Change: gut-wrenching episodes early in 20...
Speaker Change: where those payouts can move a lot and you.
Speaker Change: experience that spread duration. What we've done is basically just basically stick to more slow pay up stuff. As I did mention, we own some New York's, but those are in sixes. So the payouts aren't that high. Generally, it's been, you know, higher loan balance or FICO or, you know, Texas or Florida or LTV. So try to avoid that.
Robert E. Cauley: We have not been buying or holding on balance seven. And those payoffs are... a little bit different than the traditional payoff stories where you might say like a low loan balance or something where you're really paying up for this superior convexity. A lot of times, the payoff that is embedded in some of those less expensive stories is really kind of a months to break even sort of play, right? So are they going to outperform generic TBA deliverable type collateral by a handful of ticks per month? And the market kind of works. The break even is for that. They do have, in all cases, better than the cheapest to deliver convexity or S-curves.
Speaker Change: of the United States.
Speaker Change: And those payouts are...
Speaker Change: a little bit different than the traditional pay-up stories where you might say like a low loan balance or something where you're really paying up for this superior convexity. A lot of times the pay-up that is embedded in some of those less expensive stories is really kind of a...
Speaker Change: months to break even sort of play, right? So are they going to outperform generic TBA deliverable type collateral by a handful of ticks per month? And you know, the market kind of works out what the break even is for that. They do have
Speaker Change: In all cases, you know, better than cheapest to deliver convexity or S-curves, but, you know, a lot of times what you're really paying for is just
Robert E. Cauley: But, you know, a lot of times, what you're really paying for is just, you know, a month to break even. And so we think, you know, in a volatile market, they can do well. And that's also part of the barbell strategy because we still have a lot of threes. So if we do get a lot, we don't expect a huge rally on the long end, but if we do, they're going to do very, very well, you know, even in spite of the fact that some of these higher coupons may not do as well. And they're fully extended at this point, so they have a very low convexity for the opposite.
Speaker Change: you know, a month to break even type of thing.
Speaker Change: approach. And it's been a good strategy. They do carry a little bit better than worse to deliver. We don't expect them to defy gravity into a huge rally. That's why we're focused on the lower pay-ups and they have relatively low negative convexity.
Speaker Change: And so we think, you know, into
Speaker Change: [inaudible]
Speaker Change: So we do get a lot, we don't expect a huge rally on the long end, but if we do...
Speaker Change: They're going to do very, very well, you know, even in spite of the fact that some of these higher coupons may not do as well. And they're fully extended at this point, so they have very low convexity for the opposite reason, you know.
Robert E. Cauley: Yeah, yeah, absolutely. Okay, that's helpful for that last question for me on slide eight. Hunter, maybe this one's for you.
Speaker Change: Yeah, yeah, absolutely. Okay, that's helpful on that. Last question from me. On slide 8,
Robert E. Cauley: If I look at the 2224 number, say 29.5 million of gains on funding hedges attributed to the current period, how much of that is coming from closed swaps? Really, what I'm trying to get at is none, none of it is. These are all from existing.
Hunter: Hunter, maybe this one's for you. If I look at the 2Q24 number, say $29.5 million of gains on funding hedges attributed to the current period, how much of that is coming from closed swaps? Thank you. Thank you. Thank you.
Hunter: I'm really trying to get at is none none of it is these are all from currently existing edges
Robert E. Cauley: Okay, so when we look at these numbers relative to the dividend and book value, you know, we're having a market impact, obviously, that's been realized in book, and it's going to change as rates move around. And some of this is going to come out of book value. So it will be a return of capital and a dividend. Okay. Okay. Okay, I got it. I'm thinking about it the right way.
Speaker Change: Okay, so when we look at these numbers relative to the dividend and book value...
Eric Hagen: Okay. Thanks a lot. Yeah. Our next question comes from Eric Hagen from BTIG. Please go ahead. Hey, thanks. Good morning.
Speaker Change: Our next question comes from Eric Hagen from BTIG. Please go ahead.
Eric Hagen: Hope you guys are well. How are we thinking about the range for your leverage right now? Can you remind us kind of the historic range that it's been and what you think might get you to take it up to kind of the higher end of the range versus, you know, raising more capital? Thank you guys. Yeah, the range is seven to eight. It may be a little less than seven.
Eric Hagen: Hey thanks, good morning, hope you guys are well.
Eric Hagen: How are we thinking about the range for your leverage right now? Can you remind us kind of the historic range that it's been, and what you think might get you to take it up to kind of the higher end of the range versus raising more capital? Thank you guys.
Robert E. Cauley: We're about seven and a half now. We were right around seven or seven one at the end of the last two quarters. I would say, at the moment, I don't see a reason to take it immediately higher. I would say I'd be quite comfortable at seven and a half.
Speaker Change: Yeah, the range I
Speaker Change: I guess seven to eight would be the range, maybe a little less than seven. We're about seven and a half now. We were right around seven or seven and one at the end of the last two quarters.
Speaker Change: I would say, at the moment, I don't see a reason to take it immediately higher. I would say I'd be quite comfortable at 7 and 1?2. Yeah, you know, I think that.
Robert E. Cauley: Yeah, I, you know, I think that this fall could be very volatile. I don't, we're not really in a position where we're thinking about hiding and taking cover. But we're also, I think, there are a lot of black swans flying around right now. So we're content to sit at this level for the time being. Yeah, all right. That's helpful.
Speaker Change: This fall could be very volatile. I don't, we're not really in a position where we're thinking about...
Speaker Change: You know, hiding and taking cover, but we're also, I think, there's a lot of.
Speaker Change: Black swans flying around right now so we're content to sit at this level for the time being.
Robert E. Cauley: So how are we also thinking about, you know, repo rates in light of, you know, higher volatility? I think you guys mentioned a lot of government debt coming to the market pretty soon. Should we expect a repo rate? I was just reading this morning about, and we have, you know, our in-house repo trade has been in the industry for 30 years; we spent a lot of time talking about this. So if you look at software today, I think it said it's 34, it's above Fed funds.
Speaker Change: Yeah, all right, that's helpful. So how are we also thinking about, you know, repo rates in light of, you know, higher volatility? I think you guys mentioned a lot of government debt.
Speaker Change: Coming to the market pretty soon
Speaker Change: Should we expect repo rates?
Speaker Change: Yeah, when you started to see that, I was just reading this morning about, uh...
Speaker Change: And we have, you know, our in-house repo trade has been in the industry for 30 years. We've spent a lot of time talking about this. So, if you look at software,
Speaker Change: Today, I think it said it's 34, it's above fed funds.
Robert E. Cauley: I don't want to get over my skis, but my understanding is that software is set on the, it's the weighted average of the tripartite repo, GC repo, and then I don't even remember what the third component is.
Speaker Change: I don't want to get over my skis, but my understanding is that software is set on the, it's the average of, weighted average of tripartite repo, GC repo, and then I don't even remember what the third component is.
Robert E. Cauley: But what we've been seeing is that the banks and the Wall Street firms have been using sponsored repo more for balance street constraints reasons. As a result, the blended rate has been driven higher, so less tripartite, more sponsored repo, which is at a higher rate. And so you're seeing that drift higher. It's actually quite a bit higher now than the RRP, which is why RRP usage has been coming down money markets and moving funds into there, but that's been higher.
Speaker Change: But what we've been seeing is that the banks, the wallstreet firms have been using Sponsored Repo more for balance sheet constraint reasons. As a result, the blended rate has been driven higher, so less tri-party, more...
Speaker Change: Sponsored repo, which is at a higher rate.
Speaker Change: And so you're seeing that drift higher. It's actually quite a bit higher now than the RRP, which is why the RRP usage has been coming down. Money markets are moving funds into there.
Robert E. Cauley: I don't know that, you know, that's not a function of deficits. That's just, you know, funding levels and QT and things like that. Our focus on the deficits and things like that is more of a long-term story. With so much debt to be refinanced over the balance of the next two years, obviously at much higher rates, we think that's going to pressure longer-term rates. [inaudible] There is pressure on London, I think.
Speaker Change: But that's been higher. I don't know that, you know, that's not a function of deficits.
Speaker Change: That's just, you know, funding levels and QT and things like that.
Speaker Change: Our focus on...
Speaker Change: deficits and things like that is more of a long-end story with so much debt to be refinanced over the balance of the next two years.
Speaker Change: Obviously at much higher rates, we think that's going to pressure longer-term rates. And that's why, you know, in spite of the fact we're playing for a steepener, we think it's going to be more front-end driven than long-end.
Speaker Change: And then, you know, depending on the outcome of the election, you know, as I mentioned, you know, Trump talks a lot about sanctions and the like, and he's not known as a deficit hawk, so I don't think you're going to see inflation come roaring back down to the low ones. So all those things are going to get.
Robert E. Cauley: Yeah, in spite of all the volatility and like The Bill's Markets and everything that's rolling off there and the index rates bouncing around, and there's a lot of noise there. Our repo rates have been remarkably stable, and we're now finally just starting to roll into that period where if we're taking longer terms, putting on some longer term repos, two, three months, we're going to, every day that passes, start incorporating more of that September rate cut that's baked into the market.
Speaker Change: heat pressure on Long Island I think. Yeah in spite of all the volatility and like the...
Speaker Change: The bills markets and what everything that's rolling off there and
Speaker Change: the index rates bouncing around and
Speaker Change: There's a lot of noise there. Our repo rates have been remarkably stable, and we're now finally just starting to roll into that period where if we're taking longer-term
Speaker Change: putting on, you know, some longer term repos, two, three months, we, you know, we're going to every day that passes, start incorporating more of that September rate cut that's baked into the market. So, spreads may widen out a little bit, but I think we'll see.
Speaker Change: The you know nominal level of repo rates come down
Speaker Change: Good perspective, I appreciate you guys very much. Yep, thanks Eric.
Robert E. Cauley: So, spreads may widen out a little bit, but I think we'll see the nominal level of repo rates. Good perspective. I appreciate you guys very much. Yes, thank you, sir. Our next question comes from Mikhail Goberman from Citizens. Please go ahead. Hey, good morning, guys. Hope everybody's doing well.
Mikhail Goberman: Our next question comes from Mikhail Goberman from Citizens. Please go ahead.
Mikhail Goberman: If I could just jump in with a question, if you could flesh out perhaps a little bit further your ideas about book value and the swap portfolio. Given we're probably going to get some Fed loosening here in the next couple of months and quarters, are you guys thinking about book value? Transcripts provided by Transcription Outsourcing, LLC.
Mikhail Goberman: Hey, good morning guys. Hope everybody's doing well. If I could just jump in with a question, if you could flesh out perhaps a little bit further your ideas about book value and the swap portfolio.
Speaker Change: Given we're going to probably get some Fed loosening here in the next couple of months and quarters, are you guys thinking about book value stability or book value growth in a lower rate environment?
Robert E. Cauley: Billion Versus Growth. I don't know that we have that ironclad outlook. I think, as I said, I think you're going to see the curve steeped on the front end, so obviously the swaps are going to suffer there. But if you look on the asset side, especially with our large allocation to threes, I think a lot of that can be offset. So I guess... without thinking about it too much, it would be stability, but there is certainly room for growth.
Speaker Change: Civility Versus Growth?
Speaker Change: I don't know that we have that ironclad outlook. I think, as I said, I think you're going to see the curve steeped on the front end, so obviously the swaps are going to suffer there. But if you look on the asset side, especially with our large allocation to threes, I think a lot of that can be offset. So I guess...
Speaker Change: Without thinking about it too much, it would be stability, but there is certainly room for growth.
Robert E. Cauley: That would be more mortgage tightening. Like I said, you know, we're trading, depending on your benchmark, between 135 and 150. If we do get a meaningful easing cycle, which I don't think it's going to be that meaningful, but if we do and the banks come back in, and they're more of a buyer of the space, you can get spreads tightened 10 or 15, that's probably where the book value would come from.
Speaker Change: That would be more mortgage tightening.
Speaker Change: Like I said, you know, we're trading, depending on your benchmark, between $135 and $150 off. If we do get a meaningful easing cycle, which I don't think it's going to be that meaningful, but if we do and the banks come back in and they're more of a buyer of the space,
Speaker Change: You know, you can get spreads tight in 10 or 15, that's probably where the book value would come from.
Robert E. Cauley: I'd add that we have, From a tax perspective, we had a little bit of an over distribution earlier in the year. You know, so as the NIM expands, you know, we have some latitude to think about preserving a little bit of book that's a very short term, just really kind of through the end of this year, and then 2025 will have will be more tax-driven in terms, distribute, whether or not we can distribute or retain some, some, some excess profit. Thank you guys. Good luck going forward. Thanks, Mikhail. Our next question comes from the line of Christopher Nolan from Lautenberg-Thalmann. Please go ahead. Hey, guys. Hey, Chris.
Speaker Change: I'd add that we have...
Speaker Change: from
Speaker Change: A tax perspective, a little bit of an overdistribution earlier in the year.
Speaker Change: Thank you.
Speaker Change: You know, so as the NIM expands, you know, we have some latitude to think about preserving a little bit of book. That's a very short term, just really kind of through the end of this year. And then 2025 will have to be, you know, will be more tax driven in terms of.
Speaker Change: stuff.
Speaker Change: distribute whether or not we can distribute or retain some some some excess profit.
Speaker Change: Got it. Thank you guys. Good luck going forward.
Miguel: Thanks, Miguel.
Speaker Change: Our next question comes from the line of Christopher Nolan from Lautenberg-Thalmann. Please go ahead.
Christopher Whitbread Patrick Nolan: Bob, your comments on the banks getting out of the MBS market. Is this any sort of anything related to the fallout from the Silicon Valley bank? [inaudible] That was more of a story from last year, maybe earlier this year. No, it's not that they're not present; they're just not in a big way.
Chris: Hey guys. Hey Chris.
Christopher Whitbread Patrick Nolan: Bob, your comments on the bank staying out of the MBS market.
Christopher Whitbread Patrick Nolan: Is this any sort of anything related to the fallout from the Silicon Valley Bank etc seizure where suddenly the feds are
Speaker Change: That was more of a last year story, maybe earlier this year. That's why they're not present, they're just not in a big way. The conventional wisdom is that they're waiting for the Fed to ease.
Robert E. Cauley: You know, the conventional wisdom is that they're waiting for the Fed. And once they do that, they'll become meaningful buyers. And that's what I was trying to get at earlier, the comment in the one question I was answering. [inaudible] They're pretty much both gone.
Speaker Change: And once they do, they'll become meaningful buyers. And that's what I was trying to get at earlier, the comment in the one question I was answering.
Speaker Change: is that, you know, we had QE back in the day, you know, the Fed was just an indiscriminate buyer.
Speaker Change: Thank you.
Robert E. Cauley: I mean, the banks buy some, as I just said, but so you don't really have this huge indiscriminate buyer. Now the money managers buy, but they're very much relative value driven. So they'll buy mortgages if they think they're cheap versus, say, corporates or versus, you know, treasuries, whatever. But so, mortgage trading now is all relative value driven, so nothing stays rich for long or cheap for long. And so, you know, you haven't seen the mortgage gap wider or tighter much, and there's no real potential for that.
Speaker Change: They're pretty much both gone. I mean, the banks buy some, as I just said, but...
Speaker Change: So you don't really have this huge indiscriminate buyer, so now money managers buy, but they're very much relative value driven, so they'll buy mortgages if they think they're cheap versus say corporates or versus treasuries, whatever.
Speaker Change: But so there's, you know, mortgage trading now is all relative value driven, so nothing stays rich for long or cheap for long. And so, you know, you haven't seen mortgages gap wider or tighter much.
Robert E. Cauley: But that could change if we get banks back in. So, you know, we'll see. But, you know, the regional banks, I think, were the biggest culprits when it came to, you know, the underwater health and maturity accounts. You know, the Wells Fargos and J.P. Morgans of the world, I don't think, are in that position as much. Not at all.
Speaker Change: [inaudible]
Speaker Change: Culprits when it came to, you know, the underwater health and maturity accounts, you know, the Wells Fargo's and J.P. Morgan's of the world, I don't think are in that position as much or it, it,
Robert E. Cauley: They still have legacy portfolio issues to work off. The [inaudible] arm of the business and then using the gains from that to offset selling lower coupon mortgages at a loss and then redeploying in higher coupons. So Fed cuts will definitely accelerate the amount of time that they're sort of in the penalty box from having to work off those losses before they can redeploy into more profitable strategies. So I think they'll be present at an increasing rate, but I don't really expect a monumental shift anytime soon.
Speaker Change: They still have legacy portfolio issues to work off.
Speaker Change: you know, the accounting classifications that they use limit how much they can sell at a loss and redeploy at wider spreads. And so it's just going to be a matter of time or in the case of there have been some large bank
Speaker Change: you know, portfolio movements, and those have been sort of one off in nature that related to, you know, selling some profitable
Speaker Change: arm of the business and then using the
Speaker Change: The gains from that to offset.
Speaker Change: Selling lower coupon mortgages at a loss and then redeploying in higher coupons, so
Speaker Change: Fed cuts will definitely accelerate the amount of time that they're sort of in the penalty box from having to work off those losses before they can redeploy into more profitable strategies. So, you know, I think they'll be
Speaker Change: Present at an increasing rate, but I don't really expect a monumental shift anytime soon.
Christopher Whitbread Patrick Nolan: Okay, and then turning to capital management, what was the average share issuance price for the ATM in the quarter? I don't have that in front of me, but it did vary quite a bit. I would say in the second quarter.
Speaker Change: Okay, and then turning to capital management, what was the average share issuance price for the ATM in the quarter?
Speaker Change: I don't have that in front of me. It did vary quite a bit.
Robert E. Cauley: We were probably around 97% of books. On average, what we were selling in a book was fluctuating around, obviously, that number is higher. We weren't selling for long in July, but it was at a much higher percentage of books. But you know, I think the last sales we did were even in the 60s. Gross.
Speaker Change: I would say in the second quarter.
Speaker Change: We were probably around 97% of book
Speaker Change: On average, what we were selling in a book was moving around. Obviously, that number is higher when we weren't selling for long in July , but it was a much higher percentage of book.
Speaker Change: But, you know, I think the last sales we did were even in the eight-sixties.
Robert E. Cauley: But, you know, the stock has since fallen back, so, you know... We traded in quite a range, probably $825 to $875 throughout the second quarter. And the selling price tracked bulk more. So, like I said, it was kind of 97% of a book gross, maybe $97.5. And so it just depended on the day where those prices were. Unfortunately, I don't have that in front of me.
Speaker Change: got gross, but you know the stock has since fallen back so, you know...
Speaker Change: It's really, we traded in quite a range, probably $825 to $875 throughout the second quarter. And the selling price tracked bulk more, so it's, like I said, it was kind of 97% a book gross, maybe 97.5.
Robert E. Cauley: Yes, so given that you're raising equity capital, which is dilutive to book value, how much of the swing in book value this quarter was due to this capital, about nine cents. And here's how you get to that number.
Speaker Change: And so just depending on the day, where those prices were. I don't have that in front of me, unfortunately. Yeah, so given that you're raising equity capital, which is dilutive to book value, how much of the swing in book value this quarter, in the second quarter, was due to these capital raises?
Robert E. Cauley: We had gap earnings of negative nine cents, and we paid dividends of $0.36. So if you don't issue any shares, the change in your book value is just going to be earnings less the dividend, right? So minus $0.09, minus $0.36 gets you to minus $0.45, but we did issue shares, and our book value was down $0.54. So that difference is, that delta is $0.09, that was attributable to Cher. And the final question, given that, should we expect further book value dilution from Capital Raises? You've done a quarter.
Speaker Change: It's about nine cents, and here's how you get to that number. We had gap earnings of negative nine cents.
Speaker Change: and we pay dividends of $0.36. So, if you don't issue any shares...
Speaker Change: The change in your book value is just going to be earnings less the dividend, right? So minus 9 cents, minus 36 cents gets you to minus 45 cents, but we did issue shares and book was down 54 cents. So that difference is, that delta is 9 cents.
Speaker Change: that was attributable to cherished ones.
Speaker Change: And final question, given that, should we expect further book value dilution from the capital raises you've done quarter to date?
Robert E. Cauley: Well, we did those at much higher percentages of book. My rough estimate is about a penny, a quarter to date. And that's because, as I said, the last sales we did were almost an ad book, essentially an ad book. Um, and so there's very little dilution in those. It may be worth noting also that something that makes this a little bit tough to wrap your hands around your mind around is that some of the, as I alluded to earlier, some of the capital that we raised.
Speaker Change: Well, we did those at much higher percentages of book. My rough estimate is about a penny.
Speaker Change: quarter to date.
Speaker Change: And that's because, as I said, the last sales we did were almost ad book, essentially ad book.
Speaker Change: And so there's very little dilution in those.
Speaker Change: May be worth noting also that something that makes this a little bit
Speaker Change: Tough to get your hands around your mind around is that some of the, as I alluded to earlier, some of the capital that we raised.
Robert E. Cauley: So, when book was higher, and then put the money to work when book was lower, so not to confuse the matter too much, but we did it. We did save some capital and put it to work when spreads were sort of at their quarter to quarterly wide. Thanks, Hunter.
Speaker Change: We did so when book was higher and then put the money to work when book was lower, so, you know, not to confuse the matter too much, but we did it. We did save some capital and put it to work when spreads were sort of at their quarter to quarterly wise.
Christopher Whitbread Patrick Nolan: Okay, thanks guys. All right, Chris, thank you. And as a reminder, if you would like to ask a question, please press star and the number one. Our next question comes from the line of Jim Fowler from Kingsburn Capital. Please go ahead. Hello, Bob and Hunter. Good morning. Hey, Jim.
Speaker Change: Okay, thanks Hunter. Okay, thanks guys. All right Chris, thank you.
Speaker Change: And as a reminder, if you would like to ask a question, please press star and the number one. Our next question comes from the line of Jim Fowler from Kingsburn Capital. Please go ahead.
Jim Fowler: Hey, guys, thanks for taking the question. I just wanted to ask, refer to a couple of tables, one in the press release and one in the deck, tie a few things together, see if I'm looking at this properly, and then ask a question. Sure.
Jim Fowler: Hello Bob and Hunter, good morning. Hey Jim. Hey guys, thanks for taking the question. I just wanted to ask, refer to a couple of tables, one in the press release, one in the deck, tie a few things together, see if I'm looking at this properly and then ask a question.
Jim Fowler: I've noted that the last two quarters, wrong economic income relative to the dividend distribution. If you look on page 8, and which you also provided detail on, the largest contributor of that has been the hedges in the current period, of which about 60% is related to the net swap benefit. And those swaps, you have a very enviable position of not having any maturities until 2026, and then they're much longer. So when I look at the economic income for the quarter of $29 million, and I look at that as a return on the average capital allocation for the quarter of $405 million from the press release.
Speaker Change: I've noted that the last two quarters, you know, economic income relative to the dividend distribution.
Speaker Change: If you note, on page 8
Speaker Change: and which you also provide a detail on the largest contributor of that has been the the hedges in the current period of which about 60 percent
Speaker Change: is related to the net swap benefit, and those swaps, you have a very enviable position of not having any maturities until 2026, and then they're much longer.
Speaker Change: So, when I look at the economic income for the quarter of $29 million, and I look at that as a return on the average capital allocation of the quarter of $405 million from the press release.
Jim Fowler: I get an economic income return on average invested and economic capital of about 28% for the quarter. And, as you articulated earlier, I think the marginal cash ROE is in the 19 to 19.5% range, leveraged seven and a half times. So if all of that seems reasonable to you and is accurate, I guess the question that I have or the observation that I'm making is that this is now a convergence situation where how long will it take for the portfolio economic return of 28% on average invested capital to converge on to the marginal investment return on the cash ROE of approximately 19%.
Speaker Change #101: I get an economic income return on average invested and economic capital of about 28 percent.
Speaker Change #102: for the quarter. And as you articulated earlier, I think the marginal cash ROE is in the 19% to 19.5% range leveraged seven and a half times. So if all of that
Speaker Change: Seems reasonable to you and and is accurate. I guess the question that I have or the observation I'm making is that this is now a Convergence
Speaker Change #100: situation where, you know, how long will it take
Speaker Change #100: or the portfolio economic return of 28% on average invested capital to converge on to the marginal investment return on cash ROE of approximately 19%.
Robert E. Cauley: That would seem to be a very long convergence cycle unless a significant amount of capital was being raised and invested at that marginal cash ROE that would cause that economic return to converge pretty more rapidly. And here we are in the second quarter and on into July, raising lots of capital. I think share issuance in the quarter was up, quarter over quarter, by about 22%. So I'm wondering how you think about that vis-a-vis the relationship of economic income versus the current distribution and if that economic income on the margin begins to decline closer to the distribution rate because of capital raises, does that obviate any opportunity to adjust the dividend upward and could potentially pressure the dividend? Let me take a crack at that.
Speaker Change #100: That would seem to be a very long convergence cycle, unless...
Speaker Change #100: The significant amount of capital was was being raised.
Sherish: and invested at that margin with that marginal cash ROE that would cause that that economic return to converge pretty more rapidly and here we are in the second quarter and on into July raising lots of capital. I think Sherish once in the quarter was up.
Sherish: quarter-over-quarter about 22 percent. So I'm wondering...
Speaker Change #105: how you think about that vis-a-vis...
Sherish: the relationship of economic income versus the current distribution and if that economic income on the margin begins to decline closer to distribution, the distribution rate
Speaker Change #104: Because of Apple raises, does that obviate any opportunity to adjust the dividend upward and could potentially, you know, pressure the dividend?
Robert E. Cauley: So the convergence, if we were to get an easing cycle. Let's not talk about easing at this point. I'm just talking about marginal capital raised and invested at 19% when you have a balance sheet and a hedge structure right now. It's obviously above market, mostly driven by the swap rate, but I don't want to introduce anything with the Fed at this point. I'm just looking at a static balance sheet and, you know, the raising of capital on the market at a cash ROE that is diluted to the economic ROE. Show, follow me correctly.
Speaker Change #106: Let me take a crack at that. So the convergence, if we were to get an easing cycle,
Speaker Change #107: Well, let's not talk about easing at this point. I'm just talking about, you know, marginal capital raised, you're invested at 19% when you have a balance sheet in the hedge structure right now. That's right now, it's obviously above market.
Speaker Change #107: Mostly driven by the swap benefit, but but I don't want to introduce anything with the Fed at this point I'm just looking at static balance sheet and Interest, you know the raising of capital on the mark That and a cash ROE that is diluted to the economic ROE
Robert E. Cauley: So if you're saying it's diluted because the Legacy ROE is higher than the marginal ROE, right? Absolutely right. The rationality for doing so is that if you look at it purely from the perspective of a NIM in your framework, it doesn't make sense.
Speaker Change #107: So...
Speaker Change #108: If I'm following you correctly, so if you're saying it's diluted because the...
Speaker Change #109: Legacy ROE is higher than the marginal ROE, right? Absolutely right, yes.
Speaker Change #110: And the rationality for doing so is that if you look at it purely from the perspective of a NIM in your framework, it doesn't make sense.
Robert E. Cauley: But the way that we would look at it is not just from the perspective of NIM but the valuation of the asset. So we think that the 19.5%, that is, if you think of total return as the sum of price appreciation and income, that's purely income, right? So that's assuming no price delta. And the rationale for us in doing so is the expectation that there is the potential for a fairly meaningful price return because we're putting the money to work on assets that we view as historically cheap. That may not come soon.
Speaker Change #111: But the way that we would look at it is not just from the perspective of NIM, but the valuation of the assets. So we think that the...
Speaker Change #112: The NIM that you allude to, the 19.5%, that is, if you think of total return as the sum of price appreciation and income, that's purely income, right? So that's assuming no price delta.
Speaker Change #112: And the rationale for us in doing so is the expectation that there's the potential for fairly meaningful price return, because we're putting the money to work at assets that we view as historically cheap.
Robert E. Cauley: So let's say that mortgages don't tighten at all for the next two years. In that case, you're right. As we raise capital, we will continuously dilute the return, the NIM. That being said, there is potential for price returns, and that would cause the marginal return to be higher. And I guess that would be our justification for continuing to do so. We view ourselves as putting money to work.
Speaker Change #112: That may not come. So let's say that mortgages don't tighten at all for the next two years.
Speaker Change #112: In which case, you're right, as we raise capital, we will continuously dilute the return, the NIM.
Speaker Change #112: That being said, there is potential for price return and that would cause the marginal return to be higher.
Speaker Change #112: And I guess that would be our justification for continuing.
Robert E. Cauley: And that's really the reason, getting back to the last question, why would you issue stock slightly below book? And the reason is that you think that you have the potential to generate capital, you know, price returns that will more than offset any potential dilution from issuing stock. I just add that there is one oversimplification here, and that is that these gains and losses attributable to the swaps, for example, as you alluded to, the swaps have already been marked to market.
Speaker Change #112: [inaudible]
Speaker Change #113: And that's why, is that you think that you have the potential to generate capital price returns that will more than offset any potential dilution from issuing stock.
Speaker Change #114: I'd just add, I think there's one oversimplification here, and that's that these gains and losses attributable to the swaps, for example, as you alluded to, the swaps have already been marked to market. So
Robert E. Cauley: So, in those markets, the mark to market on the swaps that are in the money is going to go from whatever it is now to zero over the life of that swap, right? So it's going to accrete or it's going to amortize back out of book value. That's I think one of the missing pieces to the 28% just on a total return basis. Right, they're going to they're going to accrete to zero, the market value impact will accrete to zero as they reach, as they approach maturity.
Speaker Change #115: Mark to market on the swaps that are in the money is going to go from whatever it is now to zero over the life of that swap, right?
Speaker Change #115: It's going to amortize back out of book value. That's, I think, one of the missing pieces to the 28% number.
Speaker Change #115: [inaudible]
Robert E. Cauley: And that's why I was going to bring up the Fed, not because I'm making a call on the Fed, but if the Fed were to ease, to Hunter's point, the value of those swaps would decrease, right? Right. Because, you know, we're not that. There's what the Fed does and what the market's pricing the Fed to do. If you look at the curve, the swap curve, you know, where's the 10-year swap yield? Well, it's a hell of a lot lower than fed funds.
Speaker Change #116: And that's why I was going to bring up the Fed, not because I'm making a call on the Fed, but if the Fed were to ease.
Speaker Change #116: To Hunter's point, the value of those swaps would decrease, right?
Speaker Change #116: Thank you very much.
Speaker Change #117: There's what the Fed does and what the market's pricing of the Fed to do. If you look at the curve, the swap curve, you know, where's the 10-year swap yield? Well, it's...
Robert E. Cauley: Now, the 10-year point on the swap curve is 4%. So the market expects six eases, you know, on average over the next 10 years. So just the fact that the Fed eases may not do anything. But potentially, if you do get more eases than expected, those swaps start to lose value, but your return on marginal equity goes up because, as Hunter alluded to earlier, the NIM on the unhedged position grows.
Speaker Change #118: a hell of a lot lower than fed funds.
Speaker Change #119: So, the market expects six eases, you know, on average over the next ten years. So, just the fact that the Fed eases may not do anything.
Speaker Change #119: but
Hunter: Potentially, if you do get more eases than expected, those swaps start to lose value, but your return on marginal equity goes up because, as Hunter alluded to earlier, the NIM on the unhedged position grows.
Robert E. Cauley: So in that sense, I look at that as being a geographic change on your economic, uh, on the economic income schedule. I mean, nimble increases, and the swap benefit will decrease, and the net benefits or bottom line should be should approximate no change. Yeah, I was just looking, yeah, I was just looking at this and saying, you know, I was looking at the first quarter number where it was such a strong performance; the economic income was such a strong performance relative to the distribution.
Hunter: So in that sense, I look at that as being a geographic change on your economic
Hunter: on the economic income schedule, the NIM will increase and the SWOT benefit will decrease and the net benefits on the bottom line should approximate no change.
Speaker Change #120: Yeah, I was just looking at this and saying, you know, I was looking at the first quarter number where it was such a strong performance, the economic income was such a strong performance relative to the distribution. And then in the second quarter, it was even slightly better, thinking that that was indicative of the opportunity to address the distribution. But then with the capital being raised, it's going to cause on the margin that delta to decline in the third quarter and in the fourth quarter. So I just wanted to see what your view on that thinking was, but I appreciate the insight. Thank you very much.
Robert E. Cauley: And then in the second quarter, it was even, uh, slightly better, thinking that that was indicative of the opportunity to address the distribution. But then with the capital being raised, it is going to cause, on the margin, that Delta to decline in the third quarter and in the fourth quarter. So I just wanted to see what your view on that thinking was, but I, uh, but I appreciate that.
Robert E. Cauley: I appreciate the insight and advice. Yeah, I think you might have that. But just one more point on that. And that's why the legacy portfolio is largely a lower yielding portfolio. And so what we've actually seen is if we think about marking our portfolio and our hedges to market every, every day, really, as far as that goes, but every quarter, you know, our mix of assets wants to mark to market doesn't fall out of line with that 180 to 200 basis point economic return that gets us to that sort of high teens type of number. And so, you know, as we have added higher coupon production, production coupons, those have come at a slightly wider NIM than the legacy portfolio.
Speaker Change #121: You know, I think you might have that, but just one more point on that, and that's that the legacy portfolio is largely lower yielding portfolio, and so what we've actually seen is if we think about marking our portfolio and our hedges to market every
Speaker Change #122: But every day, really, as far as that goes, but every quarter, you know, our mix of assets
Speaker Change #122: wants Mark to market.
Speaker Change #122: [inaudible]
Speaker Change #122: Those have come at a slightly wider NIM than the legacy portfolio, and so if we just think about moving from one quarter where we were marked both on an asset and hedge basis to the next quarter, the recent capital raises have actually increased our
Speaker Change #122: A blended income earning capacity in the portfolio.
Robert E. Cauley: And so if we just think about moving from one quarter where we were marked both on asset and hedge basis to the next quarter, the recent capital raises have actually increased, or the blended income earning capacity in the portfolio. Operator, next question. Hello, Operator, are you there? All right, I seem to have lost the operator. I'm assuming that we don't have any more court cases. Okay, I'm told that the operator is still on. We just can't seem to hear them.
Speaker Change #123: Operator, next question.
Speaker Change #123: Hello?
Speaker Change #124: Operator, are you there?
Speaker Change #124: Alrighty, I seem to have lost the operator, and I'm assuming that we don't have any more quit.
Robert E. Cauley: In any event, we appreciate your time. Thank you for joining us today. To the extent that any other questions come up, and because of these apparent technical difficulties, we were unable to ask. Please reach out to us at the office. The number is 772-231-1400.
Speaker Change #125: Okay, I'm told that the operator is still on, we just can't seem to hear them. In any event, we appreciate your time. Thank you for joining us today. To the extent that any other questions come up, and because of these apparent technical difficulties we were unable to ask,
Speaker Change #125: Please reach out to us at the office. The number is 772-231-1400. Or, for instance, if you don't get a chance to listen to the call live and listen to the rebroadcast, if you have any questions, you can use that same number to call us.
Robert E. Cauley: Or, for instance, if you don't get a chance to listen to the call live and listen to the rebroadcast, if you have any questions, you can use that same number to call us. Otherwise, we look forward to speaking to you at the end of the third quarter. Thank you. And that does conclude today's call. Thank you for attending. [inaudible] Music by Edited by Sound by Edited by Music by Edited by Sound by Music by Edited by Sound by Music by, [inaudible] ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? [inaudible] Music Music Music Music Music Music Music Music Music Music Music Music, [inaudible] Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... Recap Don't Forget To... [inaudible] Recap Don't Forget To... [inaudible] Music Music Music Music Music Music Music Music Music Music Music Music Music Music Music Music Music Music Music, [inaudible] [inaudible] I-N-G-U-S-E-N-T-Y-A-N-D-O-N-E, [inaudible] [inaudible] Music Music Music Music Music Music Music, ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? [inaudible] Theme Music Theme Music, ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? [inaudible]
Speaker Change #125: Otherwise, we look forward to speaking to you at the end of the third quarter. Thank you.
Speaker Change #125: And that does conclude today's call. Thank you for attending.
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Speaker Change #129: Yeah, Yeah. Mhm. Yeah. Year. Yeah. Mm. Mhm. Yeah. Yeah. Mhm. Mhm. Yeah. Mm. Mm. Mhm. Yeah. Mhm. Mhm. Mhm. Mhm.
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