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spk02: Good morning and welcome to the first quarter 2022 earnings conference call for Orchid Island Capital. This call is being recorded today, April 29, 2022. 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 the management's good faith, beliefs 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 filing with the Security 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 Covey. Please go ahead, sir.
spk05: Thank you, operator, and good morning, everybody. I hope everybody's had a chance to download both our press release as well as our slide deck. I'm going to follow the similar format. So if everybody's ready, I will begin. First, I'll just kind of give you an overlay of what we're going to discuss. As usual, I'll just give a brief touch on our financial highlights. Then we'll go through market developments quickly, financial results. And then talk about the portfolio positioning and so forth. With that, on slide four, Okinawan Capital reported a net loss per share of 84 cents. This was actually net earnings per share of 20 cents, excluding realized and unrealized gains and losses on RMBS-derived instruments, including net interest expense on interest rate swaps. A loss of $1.04 per share from net realized and unrealized losses on RMBS-derived instruments, including the same net interest expense on swaps. Book value per share was $3.34 at March 31st, 2022 versus $4.34 at year end. In Q1 2020, the company declared and suddenly paid 15.5 cents per share in dividends. Since its initial public offering, the company has declared $12.53.5 in dividends per share, including the dividends declared in April. Total economic loss was 84.5 cents per share, or 19.5% for the quarter. Turning to slide five, this first slide pictures our stock performance in QN. And as you know, we did have reductions in the dividend twice, and we did have a value decline, which obviously the market anticipated. As a result, the first quarter on stock-based performance lagged our peers meaningfully. And this really has changed all of the comparisons versus our peers on a 12-31-2022 look back. It really reflects probably what happened in Q1. If you look at the calendar periods on the bottom of the page, you can see these are results that we are very happy with. However, the first quarter is not something we're happy with, but obviously it happened and we have to live with it and move forward. Turning to the next page, this is our book value performance. This tends to be with, as always, a one-quarter lag. So you see through the end of 12-31-21, we don't have updated information. That will, again, just be with a lag. Turning to market developments, just going to kind of give you a high-level view of things before I go through the slides. And you can see the pictures, and they can fill in from there. If you look at the backdrop of where we were before the first quarter, inflation started to accelerate in the second quarter of last year. That's continued well into 2022 already. And over that period, the Fed kind of gave up on their notion that inflation was transitory. The big developments in Q1 were two, and these are very meaningful and really caused everything to change. The first was the war in the Ukraine between Russia and the Ukraine. And then the second is COVID-19-induced shutdowns in China. Both of these have proven to be very inflationary, and they're expected to continue to be so for some time going forward. The net result of this are three developments. The first, the Fed has pivoted and adopted a very aggressive tightening stance. They expect to get to neutral by the end of the year, which is somewhere in the 250 to 275 range. The second is that interest rates are much higher and the curve is very much flatter. And the third, and this is more germane dollar obviously, is that the MBS universe now is essentially all discount. In fact, most of the mortgage universe is at a very deep discount, well below par. To give you some added color around this, there's only about 1% of the mortgage universe that's in the money or refinanceable. And the current coupon mortgage represents about 1% of the entire outstanding universe. That is something we've never seen before. So obviously a profound change this quarter. And as I said, brought about by these two events, which are very significant events, but also will play heavily in terms of what we see over the course of the balance of the year. Now I'm just turning to the slides. A couple of things I point out. On the left-hand slide, you can see the red line is where we stood at the end of the year. and the blue line is the end of the first quarter, so obviously a meaningful move. The green line is through last Friday, so as you can see, the market has continued to both sell off and flatten, and this is also reflected in the swap curve. At the bottom of the page, we show the change, and that's through last Friday. That's not through quarter end. Turning to slide nine, you can see how things really pivoted in late February when the war began in the Ukraine. So we had had a sell-off in the early parts of the first quarter, but this really accelerated when the war started. And I just want to point out that many of these slides go through 422, not just the end of this quarter. So through 422, the cash tenure was up 139 basis points, slops at 137. Turning to slide 10, this is the slope of the curve, five tens, as you can see. We have flattened materially. The lowest previously were in July of 18 that have been taken out. And as we sit here today, we're actually toggling right around zero. It's actually been negative a couple of times this morning already. Turning now to the mortgage universe. Top left, you can see this is the same side we've been presenting for some time. We've kind of normalized prices starting at the beginning of the period. So each line represents a respective coupon. And what this shows is just the price change relative to where the price was at the beginning of the quarter. So these are not necessarily actual prices. And as you can see, it's been a meaningful sell-off. Again, this data goes through the April 22nd. And you can see, to the end of the first quarter, there was a meaningful sell-off. So in the case of Fannie Two's, for instance, the longest duration assets, they were down about seven points to the end of the quarter. But now they're down about 12. So April, obviously, has witnessed even more sell-off than what we saw in the first quarter. As the market is now predominantly in a discomposition, call protection has reflected in the specified pull pay-ups have collapsed. And arguably, these pay-ups just reflect option value, if you will, to the extent the market rallies. With respect to rolls, You can see there's only two roles that are trading above the rest that are very, very elevated levels. And those are the current production coupons, fours and four and a half. And really what that reflects is a lot of mortgage investors wanting to own the current coupon, and there just isn't enough supply. So you have a big supply-demand imbalance. Even the Fed's exacerbating that for the time being. And so you have a specialness in the role. The rest of those roles are actually trading at or below carry. Moving on to slide 12, vol, as you can see, is very elevated. Not quite as high as it was in March of 2020 when we were north of 160 in this particular index, but very, very elevated. Moving through the rest of the slides, I'll just accelerate now. I think we've made major points here. You know, the LIBOR OAS on slide 13, obviously we've had some cheapening and specified poll pay-ups, as I mentioned, have collapsed. Slide 14 just gives you a picture of the whole financial markets really the top chart shows you the Q1 returns and the bottom one is through the end of last Friday and you can see all these returns are negative so obviously mortgages the one that's in green had a rough quarter but every sector did including equities S&P 500 so it's been a very difficult quarter for all financial market participants slide 15 is an important slide as I mentioned if you look at the bottom of this slide You can see the shaded area. That represents the percentage of the market that's in the money. And as I said, it's only 1%. So we really have had a paradigm shift whereby the market went from very much premium with the Fed buying and driving up prices and everybody was concerned with prepays. You had two ways to avoid those. Either you'd use the dollar old market or you own specified pools. And you were trying to minimize premium amortization. Well, now we're all at a discount. So now it's no longer premium loss due to pay downs for us. It's discount accretion. And fast speeds went from being a bad thing to a good thing. And high gross wax on poles was a bad thing. And now it's a good thing. If you look at the right side, I'll just make one point here. And this is kind of germane, I think, for what we see going forward. You can see the primary secondary basis looks very volatile. I think that speaks more to the volatility of the underlying. which would be rates because they've been so volatile. But it also points out the fact that originators, now that the universe is at a discount, are doing everything they can to maintain production volumes. That's primarily in the form of cash-out refis or turnover, but it also points to the fact that they're going to have a challenge to keep their production levels and their staffing levels higher. And really, it just speaks to the fact that all rate-sensitive sectors of the economy are going to be feeling things. Smaller financial results, slide 17. As you can see, if you kind of try to dissect what happened, this left-hand slide just shows our returns absent the unrealized gains and losses. And as you can see, those numbers were large, and it's really all because of the past year portfolio. The past year portfolio had an annualized return of almost negative 40%, obviously a very big number. And that was really driven by the performance of TBAs. If you look on that that chart there, you see realized and unrealized losses of $378 million. Outside of realized losses, over 80% of our mark-to-market losses for the quarter were the result of changes in TBA prices. About 17%, 17.5% were the erosion of pay-ups on specified pulls, and the rest was just premium loss. And you may wonder how we could have premium loss, but that's just because That's a function of prices at the beginning of the period when the portfolio is still at a premium. Turning to slide 18, this is just a picture of our NIM, if you will, and shown kind of along with the dividend. It appears that our funding costs went down. That's really just some tiny differences there. Obviously, our funding costs will be going up. Even with hedges, there's probably going to be some modest upward pressure. This number dropping down just kind of reflects the fact that our hedges started to move up before our funding cost. So you should see that be stabilized. You may see slight upward trend in the funding cost. None of the hedges and the MIM remains to be seen. That will be predicated on how the asset yields go. Slide 19, just again, this shows you our proxy for core income, this red line, as you can It's been running in the low 20s. Our ultimate low was back in 19 and 18, and it's been fairly stable since then. We expect it to remain so, but there's still a lot of block cards on the table. We'll have to see how things play out. Slide 20 just shows you our dividend versus our peers. We will say that in this type of environment where the curve is very, very flat and liquidity is at a premium, this is not going to be an emphasis. going to manage the portfolio as prudently as we can. We don't know what our peers will do dividend-wise, but as you know, we've reduced ours twice just to reflect current market conditions, and we don't know what the future holds. We hope that all of that's behind us, but again, there's just a lot of moving parts in the economy, so there's potential that you could have with us or anybody, so it's really hard to say what's going to happen to relative dividend performance, but I don't think it's a primary concern for any of us. Slide 21, this just gives you the two important things, the roll forward of each portfolio and then the capital allocation. As you can see on the left side, the mean development here is the allocation to IOs has increased and passers has decreased. We had mentioned last year that because of the current market conditions that we were going to take our allocation to IOs up. We had mentioned on previous calls a target of around 25%. We actually got up to 38% beyond that. Now, what does that mean going forward? It's kind of hard to say. IOs have obviously had a good run. While we would like to own some more, they're really becoming somewhat rich and it's hard to find value. There might be some good sale candidates, and we actually sold a few in early 2020 in the second quarter. Some of the details of the change, the sales that we did in the quarter were predominantly in the past year portfolio. We'll talk about that in a little more greater detail in a moment. And then we had paydowns as well, and then mark-to-market losses. Suffice to say, these asset sales occurred. to maintain leverage, but also just to shed duration. And then we did not reinvest paydowns for the most part. So that's how we migrated the portfolio to its current position. Now we'll talk in a little more detail about the portfolio. Before I do that, I just want to say a few words, kind of give you some background. As you recall, last year through most of the last three quarters of the year, we talked about being positioned defensively. We thought that the Fed was going to end their tapering program. and that we were trying to do everything we could to minimize the impact on us. Obviously, we are an all-agency REIT, so we're kind of locked in the building, if you will. We have to own mortgages. So we tried to avoid production coupons, and we took our allocation up to IOs to a higher level, and we own specs. And even to this day, we still see long-term value in them, even though they're trading at fairly distressed levels. We were right, the Fed did exit, but obviously the events of the first quarter, especially the second half, have changed things quite materially. And so that positioning and the way we looked at things last year really doesn't apply as much to the current environment. So just again to review the actions that we took, we did reduce the portfolio. We had 1.4 approximately billion of sales of pass-throughs. Those were mostly lower pay-up specified pools, mostly lower coupons, two and a half. We had about 147 million paydowns and 10 and a half million in return of investment on our IOs, which was not reinvested. And all of this was enough to not only allow us to maintain very high levels of liquidity, but it also allowed us to actually lower our leverage ratio. So from the low eights to the mid sevens, we're actually below that today. We might go – probably won't go meaningfully lower than this. This is probably the floor. With respect to post-quarter end, we have done some up in coupon trades, both 30-year and 15-year. We will continue to refine our hedge positions. We'll talk about that in a little bit more detail. But the important thing and the key takeaway here is that Well, it was a very difficult quarter. We were able to navigate through it successfully. We did have to shrink the balance sheet somewhat to maintain leverage at prudent levels. But we also did so in a manner where we could maintain very high levels of liquidity. Our target is to maintain 50% cash. That's not even including unencumbered assets, just cash relative to equity. Because first and foremost, we need to be able to weather any of these storms. And we've obviously had some very volatile days in the market. days with mortgage underperformance versus hedges and margin calls and so we want to always be in a position where we can deal with those quite comfortably and we have. We know this is a difficult market environment. We also know it's not likely to last indefinitely and so given the very favorable opportunities that are in the market today, we want to be able to take advantage of those once the market has stabilized. and we're in a position to do so. Now, with respect to the portfolio on slide 23, just going through the column for fair market value on the pass-throughs, two big changes with respect to 30 or 2.5. We took that down very materially, sold about $941 million, mostly in, again, low pay-up specified. and we sold over $900 million in 30 years. Same thing, predominantly in low pay-up pulls. Our weighted average coupon is a result of the relatively more sales to 2.5 versus 3. Weighted average coupons a little higher, went from 293 to 301. We did not reinvest paydowns, and so our portfolio is aged by four months, and speeds remain very subdued, high single digits, and we would expect them to stay there if not even decline. We did make meaningful changes to the hedge book. We'll get into that a little in a moment here. But if you look at the notional amount of the hedges versus the total mortgage assets, the coverage went from about 45% to closer to 80%. That's notional. That's somewhat misleading because the DV01 of our hedges is quite high. In fact, we have a lot of ultras in our swap positions and so forth. So if you look, for instance, in the far right column, and you look at our rate sensitivity to plus or minus 50 basis point shocks, you can see it's a very flat profile given the size of this portfolio, and that's much flatter than it was at the end of the year. And that really is consistent with what we're seeing, even though rates, as I mentioned earlier, have sold off quite a bit in April. And mortgages have widened. Our book value is probably down just a few pennies. And we really trade pretty much in line to hedges net-net so far. So it basically reflects the fact that mortgages have extended and they kind of trade in line with the hedges. So even though it's a high rate environment, it's stabilized. And that reflects the nature of the hedges we have in the assets that we own. Slide 24 is interesting. This is something we used to take pride in because we've reflected well on our asset selection, our prepayments versus the cohorts. This is, of course, backward-looking, so it's our legacy portfolio. As I mentioned, we have not been reinvesting too much. We've done some up-and-coupon trading, but it also kind of reflects kind of the prior reality that we lived in, which is where premium amortization was the thing you avoided and everybody was trading at a meaningful premium. Now, obviously, we're at a discount. So you can see these slides change going forward. Slide 25 is just the same point. The red line or the orange line there is the 10-year treasury. This one only goes through the end of the quarter. That number is now at 2.9 or so. But the prepayments, you would assume, in this environment are going to stay low, kind of like they were in 2013 and 2014. I mentioned on slide 26, our leverage ratio is down. It's actually down a little bit from where it shows here, but we're probably pretty much where we want to be. Finally, slide 27, these are our hedges. Just make a few points here. On the top left, we have our treasury futures, and we've shifted those materially. These numbers are up higher. The five-year sector is off by almost a billion dollars, and the ultras by not as much, about 50 million. We have no TBA shorts in place at quarter end, although we have placed some on since quarter end. We have some shorts and Fannie Twos. And then with respect to swaps, the belly or the three to five year has come down. So we've moved our swaps out the curve. That was about 950 million at the end of the year. It's only about 300. And then expiry greater than five years was about $400 million. Now that's $1.1 billion. And you can see the average pay fixed rates. And those of all obviously are very much in the money in the secure environment. And so they are effectively helping us with our increased funding costs. With respect to the swaps and swaptions, I'm not going to say much about that. If somebody wants to ask a question, wants detail on that, what I would say about those is that we dynamically hedge those positions. So as our strikes move more or less in the money, we take action to ensure that they're going to work as effectively as possible going forward. So in this environment, that basically means taking some profits and extending strikes higher. And that has worked very well for us and probably explains why we've had the stable performance we've had so far in April. So with that, that concludes my prepared remarks. Operator, I will turn the call over to questions. Thank you.
spk02: Thank you. To join the call to ask a question, please dial 1-888-510-2356. We'll pause for 30 seconds to allow time for you to dial in.
spk01: At this time, I would like to remind everyone, in order to ask a question, press star 1.
spk02: We'll pause for just a moment to compile the Q&A roster. Our first question comes from Mikhail Zuberman with JMP Securities. Your line is open.
spk03: Hi, good morning, gentlemen. I hope everybody's doing well. Good, good. I apologize. I missed a good chunk of... the collage for a little trouble getting on so I apologize if you mentioned if you covered something that I'm about to ask but I do believe I heard you saying that um IOs are becoming a bit rich you've already sold some in the second quarter if if that's the case how much have you sold so we are a I've got some numbers here I can feel more specific so in the
spk04: In the first quarter, we sold roughly $80 million worth of IOs backed by loan balance threes. So that profile, as of March 31st, those would be out of that. And then in the last month, or this month, I guess I should say, we've sold another $200 million. It's like $35 million market of loan balance three and a halfs.
spk05: Okay. And those, again, as I alluded to, they extended pretty much as far as they could. They just get to where the profile is very asymmetric. You know, you don't get much bang for your buck in the future further sell-off, and they have downside exposure. So it's kind of like what we mentioned about the hedges. Sometimes you kind of restrike to a higher level. That's probably what we're looking to do there, just have to find the opportunities to do so.
spk04: Now, that's exactly right. It's... Unfortunately, I think as Bob alluded to earlier, I don't know if you're on or not, but only 1% of the mortgage universe is refinanceable at this point. So it's tough to find IOs that don't have a great deal of extension already baked in, even if they're paying fast. So just not something we're highly constructive on right now. So we've been focused more on doing things in rate derivatives and trying to improve the complexity of our profile through an increased focus on options that will increase in value at an increasing rate into a continued sell-off and have limited downside if we were to rally from here, whereas the IOs are sort of the opposite of that. They have a tremendous amount of downside into lower rates, and the durations on some of that stuff had gone from negative 15 to 20 down to negative 4 to 6. That's not the case in a lower rate environment. They have a lot of value that could be lost at this point. We think it prudent to trim back our exposure there, at least until enough higher rate mortgages have been produced that the CMO machines turn back on and focused on something that that could continue to extend.
spk05: And that's a good point, just to add two cents to that. Production of new IOs is minimal. I mean, the CMO machine, as it's referred to, has shut down to a large extent, but new IO creation is very sparse.
spk03: That makes sense. So you said like about $200 million sold in the second quarter. That effectively kind of zeros out the portfolio almost at the moment. No, no, that was the face amount.
spk04: It was $35 million.
spk03: million market. Oh, okay. I got you. All right.
spk04: Sorry for the confusion there.
spk03: Ah, no worries. No worries. Um, and then you mentioned that on book value only down a few pennies this far in the second quarter, uh, despite, um, the spread widening and the volatility. And what would you guys describe that, that, um, relatively strong performance, um, in the month of April too?
spk05: Well, we didn't, Reposition the portfolio meaningfully. So I mentioned we've done some modus up in coupon training. So we basically own a lot of threes. And, you know, they're very extended. It makes them a lot easier to hedge. And we extended the duration of the hedges. And we keep restriking in the case of the swaptions or the swaps. So that even with – I mean, we're down in books some. And that reflects the widening. But it's really the fact that they're just much easier to hedge.
spk04: Our exposure, you know, a reason – Part of the reason for what I'm – well, not everyone has reported their earnings yet, but we felt like we had a particularly rough quarter, and a lot of that had to do with the fact that we had such a heavy focus on specified pools, whereas a lot of our peer group had a much higher concentration on TBA portfolios. So we felt maybe our pain disproportionately in the first quarter, and if I managed to do a little bit better. And again, it's all, I think, attributable to this focus on improving the convexity profile of our net asset hedge book.
spk03: Great. So beyond maybe stepping up further in coupon, do you guys see yourself maybe stepping up the 15-year mortgages as well? Not necessarily.
spk04: We've done some. We think there's some opportunities in TBA space. We've rolled out of some of the specified pools there that just looked fully valued, and there's some specialness in some of the 15-year rolls, and so it could be an area where we add a little bit, but on the margin, that's usually a relatively small part of our building.
spk05: Yeah, and also, with this curve, this flat 15-year production, it's pretty light, and so... What's out there has been pretty picked over. I think now the market's really starting to focus, given that we're in a discount environment, at seasoning. And there's not a lot of trading. Obviously, we get the cash window, all the production lists come out, and you see how new production specs trade. You don't see a ton. Well, I'll put it this way. There are season pulls trading. You don't always get the color. So the price discovery is a bit challenging at times. But there's no question that the market is very much seeing the value of season pulls. And they pay faster when they're at a discount. And so one of the benefits that we have is that because we haven't rolled the portfolio much, the vast, vast majority of it is seasoned, and it has greater value for that reason.
spk03: Gotcha. Thanks for that, Colbert. That's pretty helpful. And that's it for me. Best of luck going forward in a continued difficult environment. Take care. Yeah, thanks. Thank you.
spk01: Again, if you would like to ask a question, press star 1. There are no further questions at this time.
spk02: I will now turn the call back over to Robert Colley for closing remarks.
spk05: Thank you, operator. Thank you, everyone. To the extent there are those of you who were not able to make the call, the live call, And if you call later with questions, we'll be glad to take those. Our office number is 772-231-1400. Otherwise, we look forward to checking in with you next quarter. I hope everybody has a great weekend. Thank you.
spk02: This concludes today's conference call. You may now disconnect.
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