Orchid Island Capital, Inc.

Good morning, and welcome to the third quarter 2020 earnings conference call for Orchid Island Capital. This call is being recorded today, October 30, 2020. At this time, the company would like to remind the listeners that the statements made during today's conference call relating to the matters that are not historical facts are forward-looking statements subject to the State Harbor provisions after Private Security's Litigation Reform Act of 1995. 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 risks and uncertainties that could cause actual performance or results to differ materially from those expressed in such forward-looking statements. Important factors that could cause such differences are described in the company's filings with the Securities and Exchange Commission, including the company's most recent annual report on Form 10-K. The company assumes no obligation to update such forward-looking statements to reflect actual results, changes in assumptions, or changes in other factors affecting forward-looking statements. Now, I would like to turn the conference over to the company's Chairman and Chief Executive Officer, Mr. Robert Colley. Please go ahead, sir.

Good morning, everyone, and welcome. I hope everyone's had a chance to pull our slide deck off our website last night. As usual, I'll be going through the deck. I won't necessarily touch on every slide, but they're all there for your reference as needed. As always, I'll start on slide three, which is just the table of contents, just to give you an outline of the agenda for today. The first thing we'll do is just give you a summary of our financial highlights for the quarter. Then I'll spend some time talking about the market developments in the background for the quarter and how that influenced our results. Then I'll go into our financial results in a little more detail, and then finally delve into our portfolio, credit, and hedge positions in some detail. With that, I'll get started. With respect to the quarter, we generated net income per share of 42 cents, net earnings per share of 33 cents, excluding realized and unrealized gains and losses in our RMBS and derivative instruments, including net interest income on our swaps. We had a gain of 9 cents per share from net realized and unrealized gains on our RMBS and derivative instruments, including interest on our swaps. Book value per share at the end of the quarter was $5.44. This is an increase of 22 cents. or 4.21% from the value at June 30th. During the quarter, the company declared and subsequently paid 19 cents per share in dividends. Since our initial public offering, the company has declared $11.52.5 in dividends per share, which includes our most recent 6.5-cent dividend declared in October, payable in November. Total economic return was 41 cents for the quarter, or 7.9%. That is not annualized. Turning to slide five, in this slide we show our performance on a stock basis. This is calculating total return based on the change in the price of the stock and dividends paid. This is through September 30th of 2020. The peer group that is listed in the middle column is actually described on the next slide. I apologize for that. We typically show these slides in the opposite order. But the peer group is described on the next page. And what we show here is ORCID's return in the first column On the top, we show to date returns. In other words, year to date with a one year look back, two year and so forth. And in the middle column, our peer average and then our performance versus the peer average. So as you can see, looking back year to date, one year, two year, three year, all the way back to inception, we've had very strong performance relative to our peer group. On the bottom of the page, we show these returns for calendar periods. So for instance, the top row is the third quarter of the current year. And then we go back through the various calendar years all the way back to 2013, which was the period when we had our IPO. Again, very strong relative performance. The next slide basically shows the same thing, only this is book value-based total return. So total return would be calculated as the sum of the change in book value plus dividends paid. As is often the case, we do not have all of the return data for our peer group for the third quarter, so we tend to show this data with a one-quarter lag. In this case, the most recent data would be the second quarter of 2020. And it's the same format. On the top, we show one-year through six-year look-backs, including inception to date. And on the bottom, it's for the calendar periods. With respect to the most recent look-back data, again, from second quarter of 2020 all the way back to inception, as you can see, very strong returns relative to the peer group and even with the calendar periods strong as well. Now I'd like to talk about market developments on slide eight. And we have a few slides here to give you a picture of what happened in the market. And the most important thing is the fact that rates are relatively stable. As you can see on this slide, both cash and swaps were relatively unchanged for the quarter. And this makes for a very favorable in rate environment for levered MBS investors. And we have reason to expect that this will probably continue into 2021, given the state of the economy and Fed policy. If you turn now to slide nine, you see the same kind of thing in pictures, only this year, in this case, we're showing 10-year treasuries and 10-year swap rates, both for the quarter and with a two-year look back. And if you focus on the right side of the page, as you can see, really since March, we've been in a very stable rate environment, which, again, is very, very favorable for both leveraged investing and mortgage-backed securities as well. Turning to slide 10, we show the spread between the five and the 30-year treasury. And what's notable here is the simple fact that even though rates have been stable, where we have seen movement, it's been on the long end, as the front end of the curve is anchored by Fed policy. So we've seen a steepening of the curve, which, again, is usually favorable for mortgage investors because it has positive implications for both carry and also prepayments, although I have a lot more to say about prepayments in the next few minutes. Let's turn to slide 11 and look at the mortgage market. There are several slides here that are very important. This is really what drives the decisions we make with respect to the deployment of our capital. I want to start off by saying that the market today is very much dominated by the Fed. As you all know, the Fed is a very active purchaser of mortgages. They exclusively buy TBA. The Fed does not buy spec pulls. And they tend to focus their purchases on the production coupons. Those coupons that are in most production have been drifting down. In fact, yesterday, the day before, rather, the Fed announced they would be buying one and a half starting in the next cycle. What typically happens is they add one coupon and drop another. The one that gets dropped suffers. If you look in the bottom left, you can see the dollar roll market for various coupons. And if you'll notice that red line there, That was for Fannie 3s when they dropped out of the Fed's purchase bucket. Since then, 2.5s were expected to be dropped. It turns out they were not, just reduced, but that coupon has languished over the last few weeks. That all being said, the two marked Fannie 2s, Fannie 1.5s, those rule markets are very strong, and the net interest margin in that market is very, very attractive. These bonds roll with implied financing that is materially negative, and the all-in spread is 200, 250 basis points. So it is a very attractive market to invest in, and we do invest in that market. As I said, the Fed is dominating through their purchases of the production coupons, which basically means the coupons they're not buying are languishing. If you look at the top left, you can see these lines for various coupons. And in the TBA form, they have not done particularly well. With respect to fours, fours are pretty much not produced anymore. And so it's really not a current production TBA coupon. So really what you're seeing there is more season bonds. And they've been beaten up so bad that they did recover somewhat this quarter. But what that means is given that the TBA market, other than the production coupons, is so weak, The alternative area to invest, and the area that we invest heavily in, is the spec market. So if you look on the right side of the page, you can see the low loan balance, 85k max, 3.5s and 4s. Those pay-ups are extremely high levels. We're just now going through the most recent cycle. They remain very elevated. And on the bottom right, we show pay-ups for just new production coupons. Those are less desirable because the advantage of that carry is usually fleeting and only lasts a few months. But in the spec polls, especially the higher quality ones, they have very attractive carry versus TBA. And as a result, those payoffs remain very much in high demand. Moving on, slide 12, we just saw a picture of implied vol in the market. As you can see, it's quite subdued, although this ends at the end of the quarter. Since quarter end in anticipation of the election, There has been some movement higher, although I would suspect that once the outcome of the election is determined, which may or may not be on election day, I would expect that to fall off as well. The next slide is basically historical information. It's not particularly relevant for today's discussion, so I'm more or less going to skip that. Slide 14 just shows you, as we always do, returns across the various ACTA classes. Many of the investors we compete in are investing across multiple asset classes. And this just gives you a nice picture of the whole market. As you can see on the top of the quarter, on the right-hand side, the riskier sectors, high yield, emerging market high yield, and the S&P 500 did very well. And it's just because it's been generally a risk-on environment for the most part as a result of Fed policy, fiscal policy, although we haven't quite seen much of that lately. But generally, it's been strong. or rumored to be strong in the near future. And so as a result, risk has done well and safe haven assets have done a little less. But if you look at the entire year, year to date, you can see that the S&P, at least through the end of September, is only up modestly. In fact, emerging market high yield is negative. And a lot of the more safe haven or less risky assets still look very attractive on a year to date performance basis. Now turning to slide 15, this is a little more Relevant for us, a couple of things I want to point out. If you look at the top left, the blue line there is the level of the Mortgage Bankers Association's refi index. And as you can see, it's quite elevated. It's moving in a very narrow range, but at a high level. The red line is the mortgage rate available to borrowers. As you can see, it continues to drip down and is now under 3%. So we expect that to continue. If you look on the right side, what you see is the primary-secondary spread. And if you look at the period over, say, 2019, that spread was 100 or a little over. It's still quite elevated. And as a result, there's still room for that spread to continue to come down. We expect that it will. Originators are adding capacity. Mortgage origination business is very robust. The housing market is very, very solid. And in spite of all the impact that COVID has had on the economy, it's not really reflecting the performance of either the housing market or the mortgage finance market. They are both very, very robust. As a result of this spread, this has an implication for us in that we continue to own spec pulls. And the reason is kind of found in this slide. If we do get some movement up in rates, there's still the possibility that even if the rates were to go higher, this spread could compress And therefore, that red line on the left-hand side of the page could still stay very low, which would keep refinancing activity very, very high. And as a result, we expect a high degree of confidence that speeds will remain fast for some time. And that gives us comfort in owning spec polls, realizing that rates could probably go even over 100 bps, probably as high as 110, 120, before we think you'd see a meaningful impact on speeds.

I just want to let the listeners know that I was told that the link to the presentation materials was not working or was missing from the website. That's been remedied and is now there. So if you were trying to follow along and did not have the materials, they should be on the website now.