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spk00: Good morning and welcome to the second quarter 2021 earnings conference call for Orchid Island Capital. This call is being recorded today, July 30, 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 safeguarder provision of the Private Securities Litigation Reform Act of 1995. Listeners are cautioned that such forward-looking statements are based on information currently available on the management's good faith, belief with respect to future events, and are subject to risk 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 filing with the Securities and Exchange Commission, including the company's most recent annual report on Form 10-K. The company assumes no obligations 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 Poli. Please go ahead, sir.
spk05: Thank you, operator, and good morning. Welcome to the second quarter organ earnings call. I hope everybody's had a chance to download the slide deck from our website. And as usual, I will proceed through the slide deck as I go through our remarks before we open up the call for questions. Just to lay out the agenda for today's call, I'll start off with a brief review of our financial highlights, and then I will go through a review of the developments in the market for the quarter, and more importantly, how ORC had reacted or interpreted these developments and the decisions that were made regarding the portfolio and our hedges and leverage ratio. I'll start off with just giving a brief review of how the company and the portfolio are positioned coming into the quarter, and then also provide some comments on our outlook on see how in terms of how we see things evolving over time in the future and then i'll return and go through the financial results in more detail as well as the portfolio and our hedges and then finally just wrap it up with some closing comments in our outlook and then turn the call over to questions so with that i will turn to uh slide four uh so the results for the second quarter 2021, Oak Island had a net loss per share of 17 cents. Net earnings per share were 24 cents, excluding realized and unrealized gains and losses on our RMBS and derivative instruments, including net interest expense on our interest rate swaps. We had a loss of 41 cents per share from net realized and unrealized losses on our RMBS and derivative instruments, again, including net interest expense on our interest rate swaps. Book value per share was $4.71 as of June 30th, 2021, versus $4.94 at March 31st, 2021. In Q2 2021, the company declared and subsequently paid 19.5 cents per share in dividends. Since its initial public offering, the company has declared $12.11 in dividends per share, including the dividends declared in July of this year. So like an economic loss of three and a half cents per share for the quarter or 0.7 cents. Turning to slide five and six, we give the results of ORCID versus our peer group, which is defined on the bottom of the page in the note on each page. And you can see our results both with a year-to-date, and one, two, and three, set-up-a-year look-back from the end of June 30th, as well as for the calendar years. This is both on the case of page five, using stock price and dividends to compute total rate of return. In the case of page six, we use book value. I'm going to have a few more comments on these slides at a later point in the call, so for the moment, I'm just going to move on and turn to market developments. As ORCID entered Q2, and as we positioned the portfolio towards the later stages of Q1, we had shed a lot of our exposure to lower coupons, production coupons in 30-year space predominantly, and our TVA positions. We had added to our hedge positions. And we started to deploy capital more towards IOs. That allocation had gotten actually inside of 10%. And since then, we've keep 2N and moved to 18, and it's actually slightly higher. In that, we were positioned quite defensively entering the quarter. So now, just to kind of go through the developments that took place in the quarter and how we responded and how we view these developments. I think if you see on slide eight, you can see the movements in the Treasury curve. Obviously, the blue line there on the left or right represents the market as it existed at 331. The red line is June 30, and then the green line is at the last Friday. So obviously, the market has rallied. I think you can break down the developments in the market into three phases for this year. The first quarter through early April, the economy was recovering rapidly. Stimulus was being administered by the government. We saw growth in any measure of surge. And we saw the emergence of meaningful inflation worries. The market sold off and the curve steepened very rapidly. In early April, it started to change. The events of Q1 led the market to adopt a very, very defensive, extremely defensive short positioning in the rates market. This was evident in the futures, open interest markets, and so forth. But also, one other development that started to push things and kind of counter to one's intuition For one, the Fed was very skeptical in terms of their views of inflation. Chairman Powell stressed over and over that he thought inflation was going to be transitory and that he did not think that it would persist. And also, while the economic data was generally very strong, there was one notable exception, which was job growth. It was definitely lagging expectations. We had a number of non-farm payroll reports that were below expectations. And as we heard yesterday or Wednesday from the chairman, something that's very important to them in their outlook in terms of gauging whether or not we've made, quote-unquote, substantial further progress. There are a few other outside factors that kind of cause this pain trade, if you will, or conundrum, as the markets seem to rally in the face of ever-stronger economic data. Some of these outside factors were simply things like yen-denominated investors were able to deploy capital into the treasury market and realize very strong returns. And we also heard of insurance companies deploying capital from equities into bonds. And so all of this kind of led to what one might call very counterintuitive development in the rates market. Then the third phase was really kind of mid-June when we had the FOMC meeting. And a few things emerged from that meeting. One, we saw that there was some disagreement amongst the members of the committee, even though the chairman was very much in charge. We saw that they had indeed have inflation concerns. They were starting to think that maybe inflation might be a little stronger than they first expected. And I guess more meaningfully, we saw in their docs that at least some members of the committee thought the Fed would have to hike much sooner than the market had thought previously. So this seemed to kind of all quest together to form what we would call a very hawkish meeting And then also around that time, we saw the Delta variant, which we're all very much aware of, begin to emerge. And that very much caught in the question of growth outlook, not just in the U.S., but on a global basis. And so the market, you know, has since rallied again and has rallied as we speak today. So, you know, clearly we've gone through, you know, quite a shift from where we were in Q1. But in terms of our view, work at Ireland, and how we position both at the end of Q1 and today, we are still positioned defensively. We're not convinced that inflation isn't temporary. We think that that's somewhat of an oversimplification in the sense that while there are clear elements of the price pressures we've seen that are transitory, lumber prices and some of the more popular ones, that some of the developments in the inflationary side are clearly not. And we think it's somewhat just an oversimplification to just dismiss it so out of hand. That being said, the Delta variant does pose a risk to growth. But even as bad as it's been, we do think that eventually we will see growth recover and start to see the economy resume the growth trend that we were on up until a few weeks ago. And in fact, you could maybe argue that the Delta variant, in a sense, could prove inflationary in the sense that as more and more people are reluctant to go back to work or, for instance, if the federal government were to extend the supplemental unemployment insurance, that would extend and exacerbate the job shortage and wage growth that we've seen. So that's possible, but that may have a kind of counterintuitive outcome as well. But generally speaking, as the Fed eventually does taper their quantitative easing, they will stop pumping reserves into the system, and the sources of downward pressure on rates will start to abate. And as a result, we remain defensive, and we kind of view the balance of risk towards higher rates. And also, it's important to note that, you know, we do have an inflation outbreak, especially if it is a significant one, and we're certainly not calling for that. But if it does occur, as levered bond investors, we know that can have a very meaningful impact on on our portfolio and our book value, whereas a continuation of low rates, while it can put pressure on our earnings and maybe generate faster speeds, it doesn't tend to have the devastating impact on book value that a spike higher in rates can generate. So moving on through the slide deck, slide nine, I really don't have to say any much. You know, the picture tells a thousand words. Obviously, we've been rallying Slide 10, I do want to make a couple of comments. The one notable development we saw this quarter reflected in the green line at the bottom of the page is the curve has flattened. Obviously, we've had a bull flattener in the second quarter and into the third. And we had, as I said earlier, added to our IO positions. Obviously, this did not happen. was not a good outcome for them. But that being said, we do view this movement rate as an opportunity to add to those positions at attractive level. That all being said, we have maintained significant allocations to polls and specs in particular. And as we'll see in a few moments, those have behaved extremely well in terms of prepayments. And that's very important for protecting our net interest margin and, of course, ultimately our dividend. Turning to slide 11, starting with the top left, you see the performance of the various TBA coupons this quarter. It's really a mirror image of what we saw in the first. In the first quarter, you saw lower coupons suffer and move meaningfully down in price, and the higher coupons were flat to slightly up. This quarter, we have slightly pretty much the opposite. Now, that being said, this slide does end at the end of the second quarter. Since quarter end, higher coupons have actually done a little bit better. A big driver of that has been most recent prepayment speeds. We have started to see the emergence of some burnout, but I would say that remains very much an open question going forward. With this rally in rates and compression in primary spreads, secondary spreads, which I'll talk about in a minute, I think it very much remains to be seen just how much burnout we do see in higher coupons. And, of course, that will affect the performance of both the TBA and the rolls. as well as specs in those coupons. As you can see in the bottom left, the rolls in the production coupons remain very, very strong, which is not surprising given the presence of the Fed. What is surprising is the roll in the particular three coupon, which as we speak is trading, is almost as big a drop as we see in the 2% coupon, and that's very much counterintuitive. It's clearly been driven by a squeeze in the front month as the back month rolls. It's still positive, but much lower. And then finally on this page, just point out the fact that spec pay-ups have recovered. Sometimes this reflects a combination of factors. For instance, the underlying TBA is stronger or weaker. You may see movement in the pay-ups, which kind of captures some of that. But generally speaking, we have seen recovery in TBA specified pull pay-ups this quarter, and it remains reasonably healthy in the Q2, not necessarily meaningful strengthening versus, say, duration expectations, but still attractive. Turning to page 12, this is our proxy for implied vol in the market. I think one point I want to make here is if you look at this picture, you can see that while vol spiked quite dramatically late in the first quarter, and has since come off, it does still remain above the level we saw for the last nine months of 2020. So the ball is still modestly elevated, although, as we know, that may be not likely to persist after another shock because we have generally been in a very low ball environment for a number of years for the most part. The next slide I want to talk about a little more depth because this is really germane to both what happened in this quarter, but much more importantly, how we position ORCID's portfolio and how we see things evolving over time. And I want to really focus on the left-hand side here. This is the TBA LIBOR OAS. And I want to make a few observations. You see all these various lines. They correspond to the different coupons. The gray line on the bottom, that represents a thin two and a half. And if you look at where that line was back in June of 2020, it was north of 50 LIBOR OAS. And as you can see, in April and May of this year, it got all the way to negative 20. So obviously, that is a very big move. Other coupons have made similar moves, maybe not necessarily getting into negative territory, but clearly a big move. And of course, it's all driven by quantitative easing and the Fed buying in combination with paydowns north of $100 billion a month in mortgages. So obviously, mortgages have gotten very tight now that since rebounded, especially when the Fed first started to hint at possibly tapering. And so locally, they look more appealing than they did then. But I think if you look in a much longer horizon, they are still not quite all that attractive. And you would assume that once we're completely out of the quantitative easing and rate hikes and so forth, that eventually those levels will tend to migrate back towards where they were. They may or may not get all the way back to those levels, but you would assume that they would tend to do so. And that really drives our thinking with respect to the mortgage market. So I think you can make the following statement. I think it's very likely, not certain ever, but likely, that the following three things will occur. One, I think it's very likely that we will not see QE tapering before the end of the year. We'll certainly, given what we heard this week, end of year at the absolute earliest, probably next year, early next year. And then also there will be prorata. Mortgage market participants will worry that the Fed might start to taper mortgages before Treasuries. And it seemed pretty clear when Chairman Powell was speaking Wednesday that that he does not share that mindset. He thinks their impact on the market is the same. So I think it's safe to say they'll be pro-rata. I think the second point you can make with a fairly high degree of confidence is that once it starts, it's likely to be very gradual. They're going to telegraph it before it happens, and when it happens, they're not going to do it in such a way that it's going to have a violent impact on the market. So it's probably going to play out over six or 12 months. And then the third point is that Assuming, maybe you can't say this following point with as much conviction, but assuming the Fed follows their previous course of action, whereby they first taper QE, then they have a period of rising rates, and then the third leg of that is quantitative tightening, where they stop reinvesting the paydowns in their portfolio and remove reserves from the system. If that does, in fact, play out, then that means that the Fed will be buying mortgages, at least in the form of reinvesting paydowns, probably in the late 2023 and maybe beyond. So all of that kind of paints a fairly benign picture in terms of the impact of tapering on the mortgage market. With that being said, and this is where we go back to this slide at the top of the page, we are coming off extremely tight levels. And while it's true that many sectors of the fixed income markets are equally tight, the fact that you've had so much buying pressure in the market, not just by the Fed, don't forget, as the Fed pumps reserves into the system, the banking system, you know, those funds are invested again. So we've seen the banks be very large buyers of mortgages for some time now. And as that updates, you're going to take a lot of that pressure, downward pressure off. And I think this decline in sponsorship will, as I said, I think we'll start to see these levels back off. And as a result, while we don't think this is going to be an extremely violent move, we do, in fact, think it will play out fairly benignly over time. But it will, in fact, occur. And so we will position so as to avoid or minimize our exposure to the coupons we think are the most vulnerable, and those would be 30- and 15-year NG production coupons. And so we will continue to stick with our overweight, if you will, to pools of predominantly higher coupons and inspect forms so that we can protect ourselves from prepayments and protect our NIMs. So I think that's a very important slide. Slide 14, the top of the page just shows the returns for the quarter from the U.S. Aggregate Bond Index. And it's, you know, the picture that this paints, very obvious, was very much a risk on quarter. Risk-taking is obviously animal spirits are very, very robust. You can just look at the returns for the quarter here. You know, the high-risk sectors, emerging market high yield, the S&P 500, high yield, emerging investment grade, investment grade and so forth have all done very well. And the more risky sectors, versus asset classes, treasuries, mortgages, and each asset is done relatively poorly in comparison to those sectors. Turning to slide 15, a couple of important points here. I think I'm going to start on the top right. What we see here is the primary-secondary spread. We've talked about this at length for some time. Obviously, this kind of represents the difference between rates in the treasury market and rates available to borrowers. And we started at a very high level, and we knew that there was a lot of room for that to compress. In fact, it has. And it has come down close to 100. It seems to have leveled off some. We also know part of the reason that that couldn't compress quite as rapidly is just simply the fact that originators didn't have the capacity to handle more mortgages, so they had to increase their income. Well, in fact, they have. And now we're in a position where they're very responsive to movement in rates. Also recently, there was a regulatory change. The adverse market fee was removed. And this basically just represented another fee that was paid on new mortgage originations that was typically passed on to the borrower. So, in effect, it's kind of just a one-time shift down in rates available to borrowers. We refer to this as an elbow shift. But it just means that rates can go lower. And, in fact, they have. And if you look at the left side of the page, the two lines there, one's the refi index, the red line is the rate, mortgage rate. That has since quarter end. Note that this ends at the end of the second quarter. It has moved lower. As you would expect, the refi index has responded. although not as strongly as you may have expected. It's still only in the 3,000s. It may go higher. But so far, we've taken rates, you know, back down close to where they were at their trough late last year, and the refi index is not back to the peak that we saw at that same time frame. How that plays out over the balance of the year remains to be seen. But as it does occur, you know, obviously, or doesn't, This will also coincide with what we see in terms of burnout and higher coupons, you know, how much of it we see. And obviously, that's a big driver performance of the TVA versus SPEC poll. So that remains to be seen. Now I'd like to speak about financial results in a little more detail, slide 17. As always, we present this slide. It kind of decomposes our income statement. into, I guess, our proxy for core earnings, which is simply our net interest expense, net repo in expenses, and in the middle column are realized and unrealized gains and losses. And as we said at the onset of the call, we had a 17-cent loss for the quarter, a 41-cent loss on our realized and unrealized gains and losses, on our MBS assets and derivative assets, inclusive of interest rates, swap approvals. and then 24 cents out of that. And one thing to note is, as I mentioned, that we were positioned defensively coming into the quarter, and we remain so. So there wasn't virtually nothing done to the hedge book over the course of the quarter, and essentially very little done since. So most of these losses, these 41 cents in losses that you see most, are unrealized. And while that, who knows exactly what the future holds, It's possible, since most of these losses are unrealized, that to the extent that the market were moving the opposite direction, there is some potential for those unrealized losses to go away and reverse that impact that they had on our results and book value. Again, that's just a potential, not making any predictions. With respect to the right side of the slide, we just show the returns of our allocation of capital between pass-throughs and structured securities. We had modestly negative return. And the pass-through portfolio this quarter really just reflects the fact that mortgages lagged our hedges. We did have a positive mark-to-market on the pass-throughs, but we did reflect premium amortization in our mark-to-market, so it did decrease it. And then, of course, with the bull flat, we're in the rates market. It had an adverse effect on our I.O. positions. and we generate a return of negative 15%. But we do, as we said, we still have the same view of the market going forward, and that is just creating better entry points for those assets. Turning now to slide 18, this kind of captures the economics of the portfolio and of our hedges in pictures. I'll point out the green line. I'll just identify what we have. The blue line is the average yield on our assets. The red line is our funding cost, our economic funding cost, which means it's incorporating our hedges. We don't use a hedge accounting per se. We do reflect it in these numbers. And then the net of the two is the green line. And there's some obvious conclusions we can draw from this. One, this green line, as you can see, has been quite stable. And that kind of translates into what you see in the dividend. But also the blue line, while it has been declining rather sharply, it also is starting to stabilize. And then finally, the red line, I mean, given where we sit market-wise and the outlook of the Fed, especially the leadership of the Fed, I think it's reasonable to expect that our funding costs will remain low, probably certainly through the end of this year and quite possibly through most of the balance of next year. So the sum of all these things makes us optimistically constructive on the dividend. This appears to imply that we should be able to maintain this level for at least the next six to 12 months, maybe beyond. Slide 19 just shows The same thing, slightly differently, this is in earnings per share where we disaggregate the mark-to-market gains and losses from our proxy for core. It's not exactly the same as what you see from our peers. And then finally, slide 23. in terms of the results. And as I said earlier, I wanted to defer the discussion of our results versus our peers and the reasons I wanted to kind of go through this first. And what you see in this chart are these two graphs. We've never shown this in our presentation before. The top one just shows you our annual dividend yield in the top half of the page using the bulk value at the beginning of the period as the denominator. In the bottom, we just used the beginning stock price. And in both cases, the blue line represents orchid's yield. In the bottom, it's the peer group. I apologize, in the bottom of the page, we don't define the peer group. But if you go back to page 5 and 6, it's the same. That's the exact same peer group. So that's what we're comparing. And I think what you want to distinguish, you see, is that ORCID has clearly paid a higher dividend versus the peer group, you know, basically all the way back to 2014. And that's reflective of the strategy. And we tend to have a high dividend yield. We tend to have a higher leverage ratio. And we tend to put a lot of emphasis on higher-yielding assets, which are, in many cases, spec pulls, high-quality spec pulls. And as a result, we can generate those yield growth speeds and high income. So that's, as you might expect, it's a very high-yielding portfolio, and it's reflected in each chart. That being said... As is the case with anything in the financial markets, when you have a slightly higher risk portfolio, you're going to tend to have higher volatility as well. And that's reflected, for instance, in the first quarter of this year, the fourth quarter of 2016. We have had episodes where our book value volatility or performance has lagged out of our peers and is reflected in those results back on page five and six. Now, that being said, we did just have such a quarter in the first quarter. Frequently we don't have those episodes too often. They tend to occur not even within a quarter, often within a matter of weeks. But otherwise, the higher yield of the portfolio tends to make up for and often in most cases lead to outperformance versus the peers. And as a result, that's why we continue to pursue this strategy. So while the result as of Q1 or Q2 aren't as good as they were prior to that quarter, again, I think it just reflects the proximity to Q1. And I think, you know, barring another shock to the market in the near term, the higher yield of the portfolio will close that gap and ultimately hopefully lead to outperformance, not underperformance. So that's that for that. Moving on to slide 21, we've talked in the past about the reposition of the portfolio. Here are the numbers. On the left-hand side, you can see that the allocation of the structured portfolio at the end of the first quarter was 9.5%. It's now 18%. It's at the end of T2, in fact, even higher now as we speak. And then, again, on the right side, we just show you the actual numbers that we invested in the various subportfolios and then the details of the changes in those, you know, in terms of asset purchases, sales, and so forth. And now, with that, I'm going to move on and talk a little bit about the characteristics of the portfolio as we sit here today on slide 23. As usual, We go through the composition of the assets and the hedges on the bottom of the page. The structured assets are in the middle. The weighted average coupon has actually not changed very much in the past report boil. It's 2.97. It was 2.95 at the end of the first quarter, so it didn't change much. The price is slightly higher just because of the rally. But I will make a few observations, you know, some small, some large. First with the smalls, you can see the lower duration assets, 20-year and 15-year assets, they essentially are unchanged from last quarter. The changes just reflect runoff. And in some of the highest coupons, four and a half, again, pretty much unchanged, and our 30 or three and a half since quarter end, we haven't made a change in that bucket. But the more notable developments and really meaningful developments are in our exposure to the 2.5 and the 3% coupon. One, we reduced our exposure to 2.5 coupon from north of $1.1 billion to under $700 million. And we've also increased our exposure to the 30-year threes. That was about $1.85 billion. Now it's $2.725. So that growth there reflects two things. One, allocation out of a lower coupon, as I just mentioned. But also, we were able to grow the portfolio through our ATM, as were many of our peers this quarter. And most of that growth is reflected in that coupon. One other point I'll make with respect to the pastures, our exposure to the 30-year-four coupon is reduced by about $140 million. And that really was a case where we sold poles to a structuring desk and took back an I.O. So that was actually part of the allocation of capital from pastures to I.O.s. And, of course, in the middle page, you see our positions in structured I.O.s. That reflects trades such as the one I just described, but also just the acquisition of new I.O.s. With respect to the hedges, A notable change. If you look at our TVA shorts, it was $400 million at the end of this quarter. That number was $1.3 billion at the end of the first. So we took off TVA hedges and we added to our shorts in five-year treasuries and 10-year ultras. Otherwise, pretty much everything's the same. Since quarter end, we have done some trades. We sold and we bought a new 2.5 with the intention of selling some of our existing assets that are just ramping up the curve and prepaying fast. So the net effect on that, on our allocation of that coupon will not change. But we have added, again, we've kind of been growing and kind of investing with somewhat of a lie, trying to pick our points, trying to maximize our entry points. We have added to the 3% exposure and, again, some IOs. we've added. And one other thing, as I mentioned, we could sell some three and a half and took back in Iowa, some kind of trade I mentioned. With respect to the hedges, there have been no changes. Slide 24, as you can see, our allocation, the very high quality specs has come down, but the specs generally has not. We're just trying to change the mix. And these are obviously very important for us because we don't use the TVA dollar row market, so we have to generate our income through our capacity pools. And that's really critical that we maintain our speeds, realized speeds, as low as possible. And if you turn to slide 25, and you'll see on this slide and the next one, we've been successful. What we show here on slide 25, four graphs or charts. The first top left is June and May and April, and then quarter by quarter going back several quarters. And I want to point out that our greatest exposure in 30-year space is the 3% coupon. And if you look in both June and May and April, you can see our performance versus the cohort has been very good. Our pass-through portfolio prepaid At 10.9 CPR in the third quarter, obviously very good result. It was 9.9 in the first quarter when rates were much higher. So the strategy is working in that regard, and that's what's critical to our ability to generate income and pay the debt. The next page is just the same kind of story in different pictures. I will apologize. This does end at the end of the second quarter. Obviously, since then, the orange or yellow, whatever you call that line, which represents the 10-year yield, has declined back into the 120s. But importantly, the green line, which is our prepayment speed, which, again, we depict in this picture as basically just doing the following mathematical calculation. We just divide the total dollar amount of prepays by the principal balance of mortgages. And so it's kind of normalized for size. And as you can see, we've been in the range. We continue to be in the range as we enter this quarter. And it's even below where we were back in 19. So even with rates both touching all-time lows in 2020 and rallying back towards those levels this year, prepayments have been well-maintained. Moving on to slide 27, we show our leverage ratio. As you can see, it's down. It reflects a combination of two things. One, more allocations to IOs, but then also somewhat defensive posturing, and as we have raised capital, kind of taking our time somewhat, deploying it so that we can make sure that we pick what we view are often entry points. And so it's probably somewhat lagging, It may migrate up slightly from there, but it's not going back to the mid to high nine range that we saw in prior years. Slide 28 just shows our hedge positions. As I said, very little, essentially nothing has changed with respect to those since quarter end. And with that, that concludes my long-winded prepared remarks, and we can open up the call to questions operator.
spk00: As a reminder, to ask a question, you will need to press star 1 on your telephone. To reply your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from Jason Stewart from Jones Trading.
spk03: Hey, good morning. Bob, thanks as always for the commentary and perspective. So I appreciate that. so I did I love the increase in the IO exposure maybe you could talk a little bit about what the lever are we looks like in terms of the eye of strategy versus just a core agency strategy oh it is well the IELTS which would go under chime in here too first of all a lot of the is that we've added a
spk05: are defensive in nature. So they're currently, they're collateralized by assets that's in the money prepaying class. So those tend to be some negative yielding assets. The idea being that in the backup and rates, those cash flows will extend and those will become positive yielding assets. With respect to the pass-through portfolio, I would say they're comparable, which slide it was, but the NIM is very comparable to where it's been. And so, you know, the combination of the two is site compression in the overall ROE available, but very much predicated on how rates in the market evolve over time. If we were to stay here, we'd probably stay near those levels, as you would expect, and then with upside in the event of rate backup. And I'll open that up to Hunter if he wants to say anything.
spk04: Sure. Just with respect to the IOs specifically, I think we've been targeting really two types of asset classes. One is call-protected securities with good underlying pool convexity. We have been sort of mostly focused in the three three and a half the occasional four percent uh primarily backed by loan balance collateral some of which is paying a little bit faster but where we're putting those on those faster speeds and faster speed expectations are built uh already built in and um You know, our effective yields or option adjusted yields on that, those types of assets are generally kind of in the two and a half to three and a half percent model projected range. The front carry might be a little bit lower than that just because just because there is some burnout that's being baked into the model. So anytime you have a yield over a lifetime of cash flows or the remaining life of a bond's cash flows, to the extent that speeds are going to slow down in the later years, it tends to be kind of backloaded. But I think that the ROEs, based on where we are currently, putting on uh we're repoing some of these anywhere about 50 to 65 basis point sort of area and so if we said you know just as kind of a generic target we were able to achieve a three percent yield on these ios uh and uh 55 basis points, you're getting into that sort of low double-digit return on capital after taking into effect the haircuts, which are a little bit higher, say, predominantly, I think the majority of our portfolio is on it with 20% haircuts. So, you're looking at maybe a maximum 5% leverage and maybe 2.5% above funding there. But I think more importantly, the benefit for us is that we're able to decrease our reliance on rate hedges. And that's particularly important. Bob spent a fair amount of time talking about how we always need to guard against a snap higher in rates because that could be very devastating to us. But one of the things that we're also focused on is The fact that if we get something crazy and unexpected that causes us to rally or for rates to stay low, that IOs tend to, or mortgage rates in general, tend to sort of bottom out into a widening event. So it's very simple mechanics. To the extent that mortgages widen, then that means that the rates to borrowers are not going down as quickly as, say, the risk-free rates like treasuries or swaps or whatever. And so while we may experience some short-term pain owning IOs in a basis-widening move, ultimately the cash flow streams are better because fewer borrowers are able to refinance, or at least they're not refinancing at the same sort of clip that we would have modeled into a lower rate environment. So that's the removal of those costly rate hedges and the ability to preserve a cash flow stream into a rally is something that we really like here.
spk03: Right. And so maybe, Bob, how do we foot what you just said with the disclosure that plus 50 still leads to a $45 million loss to book value? Because it seems like that there might be some discrepancy between like a perfectly parallel shift up and some sort of elbow or, you know, seeping in the curve.
spk04: Yeah, that we've for a long time, a long time that we've been empirically trading much, much shorter than those rate shocks would imply. And so we like to look at those and certainly pay attention to them. But really, the last couple of years, we have been empirically much more flat than those rate shocks would imply.
spk05: I would say that the Just going back to the dollar amount of the losses, you had a very modest positive number on pass-throughs, but then you have, you know, we captured premium amortization in that market. We also had a very big negative number on the I.O. book. So the net of the portfolio was net negative. And then, you know, the biggest position in the hedge book, the swap book, and also our swaptions. We had a very meaningful erosion in those over the course of the quarter. And so, you know, the bulk of the loss was in the hedge book. But, you know, unfortunately, it was not offset by gains in the pass-through slash IO book, but, in fact, a loss. So it exacerbated it. So, again, it was all... If you had to summarize it in one phrase, it was just a meaningful underperformance of mortgages versus their hedges. And that's it. I mean, we got hit both ways. The assets were down in price, as I said, mainly because of the IOs. But, you know, obviously the hedges rallying. across the curve, but our exposure, we don't have as much exposure to the long end of the curve, but in the belly of the curve, we have plenty, and it was felt there.
spk03: Okay. I got it. It just seems to me like that number may be overstating the projected net loss, but we'll leave it at that. And then I think maybe the most important question, and I'll jump out here and let my peers keep going. When we talk about levered ROEs sort of high single-digit, low double-digit kind of range versus a 17% payout on book value. What's the reason for keeping the dividend at that level versus just changing it to a level that's consistent with levered ROEs?
spk05: Well, I mean, I will say this. I mean, the dividend is $0.065. It's certainly not because we earn $0.065 every quarter or every month. And we do have episodes where we earn above and below that. And what we're trying to do when we set the dividend is try to pick kind of the center of mass, if you will, of where we think we're going to earn going over longer periods of time. And there are episodes where you're above the line and there are periods where you're below the line. But unless we feel that that's a permanent shift, then we're not typically going to change the dividend. And, you know, given our outlook and what I said earlier about how we view the IO positions, you know, we expect that we'll be at that number on average going forward. If something were to change, you know, we were to, you know, see a meaningful deterioration of the economy or the outlook, and it looked like we were going to stay in this low-rate environment, then obviously the allocation to IOs would probably not be warranted. The composition of the hedge book would not be warranted, and the allocation to patents would go back up. So there would be, you know, a second transition in that direction. But if you go back to where we were in, you know, 19 and 20, and when we entered even even in early the first quarter when we had a very high allocation to pass-throughs last year, over the last year and a half. I mean, we were generating very attractive ROEs through that period. You know, it's just when you go through these periods of transition like we did in the first quarter and even this quarter, you know, sometimes you get these outcomes. But we don't think that's going to change the long-term outlook. And so, you know, like I said, barring a change in such outlook, we will continue on this path, even if it means we're slightly under-earning for a few months.
spk03: Okay. Well, I appreciate the time. And as always, you guys do a great job on giving us color. So thank you for that. Sure thing.
spk00: Your next question comes from Jim Delisle from Seven Canyons.
spk01: Good morning, guys. I echo his sentiment. You guys give great call. You have a lot of information on where you are and where the market is, and I tune in every quarter for that. Thank you very much. Can you refresh me what you came into this quarter as a book value as?
spk05: Into the second quarter was 494. Into, well, the end of the second quarter. Oh, 471. All right. Can we have an update as to where you expect to be right about now?
spk01: Yeah, we're probably up.
spk05: Yeah, I think we're up slightly from that number.
spk01: All right. And you were here at the end of the month.
spk05: based on... Jim, are you breaking up a little bit?
spk01: I apologize. Have you updated, let's see, your release of about a week ago or so showed you to have been very active going into quarter end with your ATM as well as into this new quarter.
spk05: Is it still active or will it be as soon as this call is done? Yes, we're probably likely to do so, yes. All right, so...
spk01: How much accretively, how much of the book value maintenance so far this quarter in a quarter where, you know, objectively it looks like rates have moved in, have been moving in the wrong direction, how much of the slide this quarter so far can be laid at the feet of the accretive offerings you've been able to make so far this quarter? In Q3? Yes. Okay.
spk05: I would have to, well, we were only up slightly. Our equity issue this quarter is modest, so I don't have that number. I apologize, but I do not think it's significant just because we have an issue that ensures. Now, we did some of the sales that occurred at the end of the second quarter settled in the first, so they're not reflected on the June 30 balance sheet, but The share issuance in this quarter, obviously, is much, much less than Q2. And by the way, equity issuance through the ATM in Q2, I wouldn't say was so much backloaded. You know, we announced a new ATM on June 22nd, but we had sold quite a few shares under the previous program in Q2 up till that date. So, yeah, we just, you know, their programs have a certain size. It ended and we started a new one on June 22nd. But at that point, we had already sold quite a few shares. So we were selling shares accretively to bulk throughout most of Q2 and, you know, much lesser amount early in Q3. And we would assume after this call, depending on market conditions and the price and performance of the stock, that we may sell in the future. But I wouldn't say that it was so backwarded.
spk04: I would attribute most of the gains this quarter in the portfolio as being from, very specifically, the Fannie three specified pools. Payups for those have really done very well, especially into the end of the first three weeks of July. They really ratcheted tighter versus where they were at the end of July. at the end of June and have outperformed, in general, mortgages have outperformed over the last week or two. We've seen a lot of tightening in the last week or so, even in the TBA markets, but specified pools for the first few weeks of the quarter did quite well.
spk05: Thank you.
spk01: As you say, thank you for the correction. I completely disregarded the earlier ATMs And will your queue have, will your queue be able to give a little bit better rundown as to the characteristics of the collateral to the I.O. and the inverse I.O. positions? Or would you do that now?
spk05: Yeah, it's not in the queue. And so we can do it now, but it's not in the queue. Thank you. Thank you. Hunter, you want to talk about it?
spk01: Well, just what the general whack is and what kind of seasoning characteristics, I'm sure you would grant me that IOs tend to be a little bit more leveraged to the selection of security selection than general pass-throughs.
spk04: So there's really sort of a barbell approach, and – So we have some higher coupon, predominantly, really predominantly fours with gross wax and say the 430 to 450 range. There's a handful of four to halves in there that are really more generic in nature. These are pools that have very, very large negative durations and very high positive convexity. And then the other side of that barbell is really, the collateral types that we've been adding over the last, really starting in the second quarter and then continued through the third, which are loan balance, predominantly loan balance, higher loan balance, say 150, 175 K max threes, 350 to 375 gross wax off of, you know, that are paying a little bit on the faster side, but priced in, but continue to pay on the faster side. and then some really pristine collateral that these IOs were ones that we made off of specs that we used to own. So 85K Max 4s, New York, slow-pay New York 3.5s. Those were in kind of the 20s wallet. Good gross wax, so less than 40, or I'm sorry, less than probably 50 basis points of spread above their coupons. So for the 3.5s, call it in the 390s, and for the 4s, in the 445 sort of area. And so the idea is pairing positively convex, fast-paying IOs with slower-paying IOs that have a much flatter S-curve that also have good convexity characteristics in the underlying pools. I don't have the combined gross WAC. I think that will actually be in the – no, I do have it. I'll take that back. It's 421 for all of them.
spk05: It's 21 for the combination.
spk04: IOs are 419 and inverses are 440, but they're much smaller. The inverse IOs book is relatively small. It's a little bit of a carry play. We've added some kind of... some higher-risk structures there with that. I think there's only like, you know, $5 million worth of them on the books. But they're like low-strike inverse IOs off of Cuspy Collateral. So, you know, it's sort of the same concept. They have... very high sensitivity to interest rates and are going to do well. Most of the majority of that position was put on one trade, and it was basically sort of fading the Fed in the short term. So buying a relatively short cash flow that was very dependent upon money market rates staying low or LIBOR staying low. And so that cash flow is working its way up pretty quickly and going our way so far. So it's been on the books for a while, though.
spk01: Oh, great. Thank you very much. That was a wonderful level of disclosure there. And once again, you guys used so much information in this call. Thanks for that. Certainly.
spk00: Your next question comes from Christopher Nolan from . Your line is now open.
spk02: Hey, guys. How much was raised in the ATM in the quarter? Which quarter? The second quarter.
spk05: Don't have it in front of me. I want to say $125 million, but at an average price of $540. Give me a second. I can get that number. But I want to say $125 at an average dollar price of $540.
spk02: Okay. Is that net or gross? Net. And follow up on the previous question in terms of using the ATM going forward. Given your comments in terms of your keeping the leverage ratio, it seemed to be not that much changed. But given the outlook, it sounds like it's a somewhat attractive environment for you. Is the capital plan to continue to grow equity aggressively through the ATM?
spk05: If conditions work, so to speak, if price of the stock versus book value and the investment opportunities are there, you know, we will because obviously it's a creative to book value in doing so. And then hopefully it's maintaining earnings. If it's not, if it's hurting earnings, then it's kind of a short-term gain, long-term loss. So we don't want to do that. And as I said, you know, the leverage ratio may be down. It probably will go back up slightly. There's somewhat of a lag as you raise capital and deploy the proceeds and, you know, you don't earn the income on the assets right away. So, yeah, And as far as the IO allocation, which is part of the reason why the leverage ratio is lower, we're not at but nearing kind of the target range for that. So at some point, that will level off. And then I think from there, it really is just a question of how the market looks at the time and where we want to deploy the capital. Right now, it's You know, the 3% coupon, and to a lesser extent, 2.5% and 3.5%. I mean, those three coupons are the vast majority of the portfolio. And then IOs. And, you know, as Hunter alluded to, the IOs strategies, you know, it's kind of some of the barbell in terms of two different strategies, you know, simplifying, but that's kind of where it is. And then the other thing that might affect net income and, you know, earnings would be, you know, substituting IOs in for rate hedges. because those IOs have the potential to be, you know, obviously positive yield versus paying something. So, you know, and the far outlook on rates materializes over time, and we're pretty confident that it will, but, you know, it's been a rough year to date. But if it does, that will bode well for us, book value, and earnings. And that would be, you know, if that again happens, then that would be a very attractive time to be raising capital because we would be raising capital into a raising return environment given our portfolio, which would be, you know, higher coupon and IOs. So if we see, you know, whatever drives it, but if we see rates moving up over the balance of the year in the next year, That's good for us in terms of our positioning and also good for our earnings outlook. So, yeah, we would love to be able to raise capital into that scenario.
spk02: And on the top of the IOs, I mean, given your comments, where you expect at least for the next 12 months or so, short-term rates remain somewhat low and the yield curve to steepen. Given that, are you planning to keep your IO allocation stable? capital allocation at current levels?
spk05: Yeah, that's the idea, right? We see that steepening occurring, which would be good for those positions. You never know how it's going to play out. We saw in the first quarter it can play out very quickly and very mildly, and so we don't know that. We kind of never knew where we think we're going to head, but we don't know necessarily how that plays out. If at some point we thought we were kind of seeing that, full extent of the sell-off. And, yeah, you want to start getting rid of some of those because you would have been, you know, monetizing those gains and maybe going into pass-throughs. But, yeah, I mean, that's, you know, I don't, I mean, you never say never. And I heard Bullard this morning thinking that the Fed should start raising rates early next year. But I also heard Powell on Wednesday, and I don't see them raising rates anytime soon. So as a result, that means the curve, since it's anchored on the front end, has to steepen. So you never know, but I think that's the way it's going to play out. I think it's going to take a while before they start raising rates.
spk02: Great. Okay. Thanks.
spk00: Your next question comes from Mikael Goberman from J&P Securities. Your line is now open.
spk01: Hi, good morning, guys. Thanks for taking the question. Sure. Your prepared remarks that you've seen some element of prepayment burnout so far in the third quarter. I was wondering if you could briefly just sort of expound on that a little bit. And also on the question of prepays, how do you think they will respond to the removal of this adverse market refi charge? Thanks.
spk05: I'll say a few words and I'll turn it over to Hunter. Well, just in the speeds that were reported. Most of what we're seeing is an acceleration in speed in the lower coupons, production coupons, like two and a half. And the reaction to the movements in rates has been much more muted in higher coupons. You have to factor in some other factors, day count, things like that, which vary from month to month. But not so much the last report, but the one before that, you did see some slowing in higher coupons and and somewhat of a continuation of that this month. And so you, like I mentioned on the call, you've seen some very good performance of higher coupons late June and into July. Um, Whether that's sustained or not remains to be seen, but it seems that the focus for now of the originators is back to the production coupons, because obviously they're the much easier refi to execute, right? The docks are fresh. Everything's fresh. It's the lowest-hanging fruit. So that's where you're seeing those as they ramp up. Don't forget, in 2020, when primary-secondary spreads were high and sales were high, A lot of the one-and-a-halves, twos, and two-and-a-halves that were originated had very high gross net WAC spreads, typically 100. All the twos were 3% coupons to the borrower. All the two-and-a-halves were 3.5% coupons to the borrower. Now, available rates are in the high twos. Those people are the target. You know, when we saw the first quarter and rates spoke, spiked higher, then those borrowers were in the money. So the originators turned their focus to more seasoned higher coupon bonds or high SEDO bonds. And we saw those speeds accelerate, but now it's kind of, that's reversed. And so that's what we're seeing. You know, if we stay here at this level of rates for a long period of time, eventually they'll, you know, refi all the twos and two and a halves, and then they'll turn their attention to the higher coupon borrowers again. And now I'll turn it over to Hunter to-
spk04: Yeah, I think that we've been investing with a little bit of a baseline philosophy that rates aren't going to get materially below, you know, call it 280s to the borrower. And so one of the trades we've been putting on, and have done so in quite large size, are elbow shift strategies with low gross wax. So call it collateral from where the properties lie in the state of New York that are, say, 330, 340 gross wax, where that elbow shift is taking the real So, we've been set up to refi away from those borrowers at 275, 285, call it, refi opportunities. And also, we've gone fairly deep into agency investor pools. There was a release earlier in the year that agencies were going to strictly limit the number of investor pools that could come through that can come through in agency form. We've seen a dramatic drop off in terms of production that production has really shifted over to more private label, the private label side of things. And so, so far it's been a strategy that is also fits with us over elbow shift strategy, where You know, those are typically the ones that we added, I think, were 330 to 350 gross WAC, but the GSEs really don't want to be focusing on those at the moment. And so it's proven to be a good strategy for us. And we'll continue to look at other things. We had a little bit of a disappointment in our loan balance collateral. I think that was in July. That was a I think, a byproduct of the Refine Now initiative, which is looking to refinance low income borrowers. Obviously, that's one of the risks you take when you invest in low loan balance collateral is that it tends to be some low-income borrowers in those pools as well. I think that's going to maybe have a month or two's worth of negative impact, and then all of the borrowers that really qualify for that new program, or that are at least receptive to refinancing as a result of it, that'll work its way through the system pretty quickly, I think, and through our pools pretty quickly. So we continue to be pretty bearish, and hence the allocation that I think similarly i guess two three three to three percent bucket so um you know we've been a very uh very picky about the gross wax and the pools that we've acquired in the three percent bucket and we'll continue to do so trying to keep it you know somewhere under three and a half percent which really in conjunction with whatever specified characteristic we're we're layering on to that collateral makes it at least at this point, not really worthwhile to go through the trouble of refinancing the loan.
spk05: And, Mikhail, you mentioned the adverse market fee. That is a pure cut to the rate to the borrower. Assuming they're passed on to borrowers, which I'm sure in vast, vast majority of cases they are, that reduction or elimination of that fee is all savings to borrowers and just lower the rate available to borrowers on that fee.
spk01: Great. Thank you, gentlemen. Thank you.
spk00: Again, if you would like to ask a question, just press 411 on your telephone keypad. There are no further questions at this time. Presenters, please continue.
spk05: Thank you, Operator, and thank you, everybody. Again, we appreciate you taking the time to listen in on our call. To the extent that any other questions come up after the call or you listen to the replay and you want to call, as always, we're available at the office to take those calls. The number is 772-231-1400. Otherwise, we look forward to speaking to you at the end of the current quarter. Thank you.
spk00: This concludes today's conference call. Thank you, everyone, for participating.
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