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Orchid Island Capital, Inc. (ORC 1.47%)
Q3Â 2020 Earnings Call
Oct 30, 2020, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
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 statements made during today's conference call relating to the matters that are not historical facts are forward-looking statements subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
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 Cauley. Please go ahead, sir.
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
Good morning, everyone, and welcome. I hope everyone has had a chance to pull our slide deck off our website last night. As usual, I'll be going through the deck, won't necessarily touch on every slide, but they're all there for your reference as needed.
As always, I'll start on Slide 3, 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. And then I'll go into our financial results in a 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 $0.42, net earnings per share of $0.33, excluding realized and unrealized gains and losses on our RMBS and derivative instruments, including net interest income on our swaps.
We had a gain of $0.09 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 $0.22 or 4.21% from the value at June 30th.
During the quarter, the Company declared and subsequently paid $0.19 per share in dividends. Since our initial public offering, the Company has declared $11.525 in dividends per share, which includes our most recent $0.065 dividend declared in October, payable in November. Total economic return was $0.41 for the quarter or 7.9%. That is not annualized.
Turning to Slide 5. 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 Orchid'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.
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. 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 we -- as 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 month or a one-quarter lag. And in this case, the most recent data will 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 8, 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 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 9, 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 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.
Now, let's turn to Slide 11 and look at the mortgage market. And there's several slides here that are very important. And 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 we all know, the Fed is a very active purchaser of mortgages. They typically -- not typically, they exclusively buy TBA. The Fed does not by spec pools and they tend to focus their purchases on the production coupons.
Those coupons -- most production have been drifting down. In fact, yesterday -- the day before rather, the Fed announced they would be buying 1.5s 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 loan 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 2 mark -- Fannie 2s, Fannie 1.5s, those roll markets are very strong. And the net interest margin in that market is very, very attractive. These are -- these bonds were all with implied financing that is materially negative, and the all-in spread is 200 basis points, 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 then the TBA form, they have not done particularly well.
With respect to 4s; 4s 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 seasoned bonds and they'd 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 at extremely high levels. Just now going through the most recent cycle, they remain very elevated.
And then 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. It only last a few months. But in the spec pools, especially the higher quality ones, they have very attractive carry versus TBA. And as a result, those pay ups remain very much in high demand.
Moving on Slide 12, we just show a picture of implied Vol in the market. And 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 movements 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 that's just irrelevant for today's discussion, so I am just going to skip that.
Slide 14 just shows you as we always do returns across the various asset 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 then 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. And in fact emerging market high-yield is negative, and a lot of them were safe haven or risk -- 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 the borrowers and 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 a 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 of 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, we are -- this has an implication for us in that we continue to own spec pools. And the reason is it's kind of found in this slide. If we do get some movement up in rates, there's still the possibility that even if 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 with high degree of confidence that speeds will remain fast for some time. And that just gives us comfort in all-in spec pools realizing that rates could probably go even over a 100 bps, probably as high as 110 basis points or 120 basis points 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. It's -- that's been remedied and is now there. So, if you're trying to follow along and did not have the materials, they should be on the website now. Apologize profusely for that. Sorry. Sorry, thank you for bringing that up, Hunter.
I'll give everybody a moment here to catch up to the extent they're just getting the slide deck. My next slide that I'm going to discuss is Slide 17. We're going to start talking about our financial results. As usual, we continue to use the same format. Hopefully that makes it easier on our listeners because they can follow quite easily.
The left hand side, this is the decomposition of our earnings. And you can see we show at the bottom, our earnings per share, our proxy for core, although it's not exactly akin to what most of our peers report, but it does disaggregate the $0.42 per share and show the realized and unrealized gains on a separate column.
And as you can see, it's kind of noteworthy with respect to the realized and unrealized gains both on our RMBS assets and our hedges that they're all positive. That's not typical obviously. It's certainly something we welcome, but it just show that the quarter was a very favorable environment for us.
On the right hand side, we show the returns from our respective strategies, pass-through and our structured securities, mainly IOs. And as you can see the 9.6% return was very strong, not quite as strong as the second quarter, but nonetheless, a very high number and a number we expect to continue in this -- as long as this current environment remains and we would expect it to do so.
With respect to IOs, it was a negative number. As you might expect, prepayments are very high. The IO securities, we all prepay at a fast rate. We want them to be in the money, so to speak. And the reason is, is to the extent rates would have backed up, they have room to extend and work as very effective hedges. That's precisely why we own them.
Looking at Slide 18, we've kind of described this environment, which we see as very favorable and we expect it to be going forward. Nonetheless, if you look at the green line on the top of the page, we can see that the economic return is stabilized and improved of the troughs of recent past. And we expect NIMs to remain quite strong, especially relative to the absolute level of rates. And that's why we're bullish on our performance moving forward.
Slide 19 is just another picture of the same story that shows our core versus all-in earnings per share. Slide 20, we show our capital allocation, and it continues to drift more toward pass-throughs de-emphasizing IOs of late and using other hedge instruments, not materially changed, but as I said, the IO position has continued to dwindle.
We may replenish that, although we are not looking to build that in a meaningful way. In the near-term, we'll be using a Vol-related rate products. So swaptions and combinations of swaptions is an effective hedge instrument for us. Turning now to the portfolio on Slide 22. This picture does not look materially different than what you saw at the end of the second quarter. In fact, we -- if anything, we probably made more changes since the end of the quarter than you saw during the quarter. So, since the end of the third quarter.
The TBAs, as I mentioned, a very attractive investment area. We have increased those positions, we're up now to about $465 million. With respect to our pools, which are almost all [Indecipherable] spec pools nearly, we have reduced our exposure to some of the higher coupons, 30-year 5.0s, 30-year 4.0s, and we've added to 30-year 3.0s. Otherwise, not a lot has changed in that regard. Slide 23, again, just gets to show that our allocation to the spec pool market, these are high quality specs, remains very high. This is a cornerstone of the strategy in conjunction with the TBA market, and we expect this to remain high for the foreseeable future.
The next slide shows the benefit of doing so. In this slide, we're showing our prepayment speeds for the most recent three months, the three months of the third quarter, in comparison to the Fannie Mae fixed rate coupon cohort. So, for each respective column, it's as indicated, 30-year 3.0 or 30-year 3.5. These are all Fannie Mae cohorts. Some of our securities are in fact Freddie's, but the results would not be materially different if we were to combine them.
As you can see, our securities have been prepaying a very small fraction of what the cohort has. And in fact, if you look at the bottom right, you can see the rolling four quarters, the most recent four quarters in each case, what we're showing here is how our securities are prepaid as a percentage of the cohort. And as you can see with the exception of 30-year 5.0s, which we've since reduced very, very low, in most cases, well under 50% of the cohort. And that's what is critical for us to maintain the carry and the returns that we've been able to generate.
Slide 25 is just -- one point I want to make here, you can see the orange line is the 10-year treasury. As you can see it's dropped and stabilized at the current level. But the green line is our prepayments and this is shown to normalize the effects of changes in the portfolio side. So, what we're really doing here is dividing prepayments and dollars by the unpaid principal balance of the portfolio.
And as you can see with an extremely low level of 10-year while it's elevated versus norms and slightly outside of one standard deviation above the mean, it's still lower than it was in 2019. So, our allocation suspects has paid-off and we've been able to realize attractive returns as a result. A few more points before we wrap up and start the Q&A session. Our leverage ratio continues to be in the high 8s, low 9s. We anticipate that being the case going forward, given the environment that we're operating in. And moving on, our interest expense, as you can see is basically bottom at $0.01. And it looks like we'll probably stay there for some time.
And then finally on Slide 28, I want to say a few -- make a few points on our hedges. In the top right, we show our swaptions positions. As you can see, we've added to that slightly. We like these as hedges for two reasons. One, obviously they give us a positive performance in the event of a rate increase, but they also benefit to the extent volatility increases. And we strongly suggest -- suspect that if and when we do get a meaningful move higher in rates, it will be accompanied by a commensurate increase involved. And these instruments tend to benefit very well when that happens.
Otherwise, our Eurodollars on the top left are pretty much at a four type level. We do not anticipate adding to those. We have a modest position in treasury futures and our swaps are stable as you can see for the quarter. We may add to those, but not in very near-term. So, otherwise, that is it. I've run you through the market environment, our results and our positioning.
And with that, we will open up the call to questions. Operator?
Questions and Answers:
Operator
Thank you, sir. [Operator Instructions]. Sir, your first question will come from the line of Jason Stewart from JonesTrading. Your line is now live. Go ahead, please.
Jason Stewart -- JonesTrading -- Analyst
Hey, good morning. Thanks.
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
Hi, Jason.
Jason Stewart -- JonesTrading -- Analyst
Good quarter [Speech Overlap] How are you doing today?
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
Not too bad. Yourself?
Jason Stewart -- JonesTrading -- Analyst
Good. Good. Thank you. Thanks for taking the question. I wanted to dig in a little bit more on spec pools and wondering if you could give us some more color on the types of pools you own that you're favoring versus de-emphasizing given your comments on primary, secondary in the current rate environment.
Hunter Haas -- Chief Financial Officer and Chief Investment Officer and Director
Sure. Yeah. This is Hunter, Jason. So, as we alluded to you in that slide toward the end of the deck, we have a high concentration of very high quality specified pools. So, those would be lower loan balance $85,000 maximum balance within a pool $110,000, $125,000s to a lesser extent. The higher loan balance stories have just not really been performing very well. So, 175k, 200k max, they're obviously are better than TBA, but it's just not enough, not slow enough to -- not put pressure on earnings if we held a lot of those. So, we have 175k or 200ks have never been much of a core position for us. And we have actually reduced some of -- some of that position even further.
So, that's predominantly in the up in coupon space. So call it 3.0s, 3.5s, 4.0s, 4.5s. We even have a few 5.0s, it's not a huge position. And then in the lower coupon spaces, I think Bob alluded to, we've been allocating more toward TBA trades and lower pay up stories. So just sort of by new issue, lower coupons which are just by virtue of the fact that they have relatively low note rates to the borrowers are going to -- tend to prepay a little bit slower.
So, we've been transitioning a little bit of the portfolio into that bucket as well. So, I guess to sum it up, I would characterize it as up in coupon, very, very high quality specified pools, got a coupon more generic types, LTV, FICO stories, which are just not going to really have much of an incentive to refi from this point.
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
I would say, I want to add a point to that, Jason is we probably deemphasized the New York story because of credit forbearance seen in those elevated most -- because we haven't been adding those.
Jason Stewart -- JonesTrading -- Analyst
Okay. That makes sense. And when you pull that together with -- there's a big allocation of 3.5s and 13 while it's pretty new, but the CPR is quite impressive. When you pull all that together, where do you think CPR is trying to -- assuming constant state, you don't make major changes. I mean, are we talking about a CPR that's going to stay in the teens, do you think, or does it migrate into the 20s over time?
Hunter Haas -- Chief Financial Officer and Chief Investment Officer and Director
No, I think we would -- I think we're going to manage the portfolio in such a way that we would target those teens. The speeds that were released in October, which are reflected in our presentation materials because they reflect paydowns that would have occurred during the month of September or a little bit on the fast side, I think it caught most of the market off guard. It was a little bit of a surprise to the upside, just in terms of how fast the speeds were.
I think going into the end of the year, we'll see speeds remain elevated and then going into next year, I think, you'll finally start to see a little bit of burnout kicking in. So that coupled with the fact that GSEs aren't going to be buying out delinquent loans until they're 24 months delinquent, as opposed to 90 days should give us a couple of CPR relief, which doesn't sound like a lot, but for this portfolio, it has a meaningful impact on earnings.
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
And by the way, I did mention, Jason, that we had done a fair amount of trading since quarter end. And most of that has been focused on bringing the Vol of the portfolio, the average Vol, but bringing that down. So, our Vol is probably lower than that number in those slide today.
Jason Stewart -- JonesTrading -- Analyst
Okay. Okay. Fair enough. One more, and then I'll jump and let other people ask questions. When you think about more broadly, TBAs where they're trading in terms of specialness, how high of an allocation of the portfolio could that get to given how special they are today?
Hunter Haas -- Chief Financial Officer and Chief Investment Officer and Director
Well, we're probably nine or ten to one specs to TBA. I could see it getting higher. I mean, they do carry extremely well, but there's a lot of duration with those because there's duration with specs as well. And I would say in a stable rate environment, they're probably a little more efficient from a cash management perspective, because you don't get pay downs. Of course, you can get margin cost when rates move higher or lower as case may be, but I could see higher.
I know some of our peers -- those allocations are quite high, probably more like a two to one ratio of specs to TBA. I don't know if we would get that high, but I could see it going higher. I mean, my -- I don't have a set number in mind. It's more -- we go through the month and see how the roll is performing and we're looking to -- maybe unload and where do we go into it. How the options go? I think the markets kind of dictate to us kind of how we do that.
Jason Stewart -- JonesTrading -- Analyst
Yeah. Our preference is now [Phonetic] on pools if we can, but to the extent that the specialness in the roll markets is just so great then we're obviously going to shift the allocation of capital toward that portfolio. I think it's around one and a half turns of leverage now. And yeah, I could certainly see that becoming double the position that it is now, if not more.
Operator
Thank you. [Operator Instructions]. Your next question will come from the line as Christopher Nolan from Ladenburg Thalmann. Your line is now live. Go ahead please.
Christopher Nolan -- Ladenburg Thalmann -- Analyst
Hey, guys. Bob, did you -- in your latest comment, did you indicate that TBAs could double from the current level or just clarification?
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
Yes.
Christopher Nolan -- Ladenburg Thalmann -- Analyst
Okay. Also, I mean, the EPS, the core EPS is very strong, much stronger than expected. It's well above the mid-teen ROE target that you guys were discussing earlier. Given your outlook for continued stable rates and everything else, should there be any sort of update in terms of what your core ROE target would be?
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
It's certainly stable. I don't see it dropping. I did try to mention that on the one slide. We expect it to be stable. I know a number of our peers have had strong numbers. It just reflects the environment we're in. Like as I mentioned, the TBA roll market the all-in NIMs are north of 200 bps in the specs pool space. They're maybe not quite that high, but also very strong. I wouldn't want to guide it much higher, but I would say that I see high level of competence in staying where it is.
Christopher Nolan -- Ladenburg Thalmann -- Analyst
Okay. And then what does that mean for the dividend outlook?
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
Well, we've been raising it. Speeds are the biggest driver. Hunter mentioned that we did get a bit of a surprise this month. I think that was probably a combination of things that caused that. We did have, for instance, the first six month forbearance period end, there may have been some buyout activity related to that. Otherwise, the fundamentals -- if you look at the refinance index, those kinds of things, those have been very stable. They wouldn't have implied an increase in the speed. So, I would expect them to normalize back to where they were.
And I guess the other indicator would be origination. We have -- the third quarter, especially in the early fourth -- origination was picking up, which is an indication that mortgages are being originated because of speeds, presumably. So, they are still elevated. It's not going to change. But I guess that's all I can say.
Christopher Nolan -- Ladenburg Thalmann -- Analyst
And final question. Do you have any sort of update to the book value since September 30th?
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
It's modestly higher, but it's not materially higher. I want to say a nickel, something like that, if that.
Christopher Nolan -- Ladenburg Thalmann -- Analyst
Great. That's it from me. Thank you.
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
All right, Chris.
Operator
Thank you. [Operator Instructions]. All right presenters, I'm seeing no questions on the phone line. Please continue.
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
Thank you, operator. Thank you everyone. Once again, we appreciate your time to the extent you come up with a question later, or you didn't catch or have a chance to catch the call live, please feel free to reach us in our office. Our number is (772) 231-1400. Always look forward to your questions and otherwise look forward to speaking with you at the end of the year. Everybody, please stay safe and talk to you again. Thank you. Bye.
Operator
[Operator Closing Remarks].
Duration: 32 minutes
Call participants:
Robert E. Cauley -- Chairman of the Board of Directors, President and Chief Executive Officer
Hunter Haas -- Chief Financial Officer and Chief Investment Officer and Director
Jason Stewart -- JonesTrading -- Analyst
Christopher Nolan -- Ladenburg Thalmann -- Analyst
