Orchid Island Capital Q4 2024 Earnings Report

Orchid Island Capital EPS Results

• Actual EPS: $0.05
• Consensus EPS: -$0.03
• Beat/Miss: Beat by +$0.08
• One Year Ago EPS: N/A

Orchid Island Capital Revenue Results

• Actual Revenue: N/A
• Expected Revenue: $4.24 million
• Beat/Miss: N/A
• YoY Revenue Growth: N/A

Orchid Island Capital Announcement Details

• Quarter: Q4 2024
• Date: 1/30/2025
• Time: After Market Closes
• Conference Call Date: Friday, January 31, 2025
• Conference Call Time: 10:00AM ET

Orchid Island Capital (NYSE:ORC), a specialty finance company, invests in residential mortgage-backed securities (RMBS) in the United States. The company's RMBS is backed by single-family residential mortgage loans, referred as Agency RMBS. Its portfolio includes traditional pass-through Agency RMBS, such as mortgage pass through certificates and collateralized mortgage obligations; and structured Agency RMBS comprising interest only securities, inverse interest only securities, and principal only securities. The company has elected to be taxed as a real estate investment trust (REIT) for the United States federal income tax purposes. As a result, it would not be subject to corporate income tax on that portion of its net income that is distributed to stockholders, if it annually distributes dividends equal to at least 90% of its REIT taxable income to its stockholders. Orchid Island Capital, Inc. was incorporated in 2010 and is headquartered in Vero Beach, Florida.

Orchid Island Capital Q4 2024 Earnings Call Transcript

Presentation

[Operator]

Good morning, and welcome to the 4th Quarter 2024 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, January 31, 2025. 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 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 ks.

[Operator]

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 Cauley, Chairman, President & CEO at Orchid Island Capital]

Thank you, operator, and good morning. Thank you for joining us today. Hopefully, everybody has had a chance to download the slide deck and they can follow along with us during the call. As usual, we'll be following the slide deck loosely. And just to give you kind of an intro of how we plan to proceed, we are going to make one slight change this quarter.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Jerry Simtas, our Controller, has joined us. He will go over the financial results. I'll walk you through the market developments, which are the things that occurred in the market that shaped our decision making and the positioning of the portfolio. And then Hunter, the Chief Investment Officer, will walk you through the portfolio and hedge positions and things that we did during the quarter with the portfolio. So with that, I will turn it over to Jerry, and he will walk us through the financial highlights.

[Jerry Sintes, Vice President & Treasurer at Orchid Island Capital]

Thank you. Starting on Page 5, we are showing a net income of $0.07 per share for the 4th quarter compared to $0.24 per share for the 3rd quarter. Our book value decreased from $8.40 at Q3 and to $8.09 at twelvethirty one. Total return for the quarter was 0.6% on annualized, and that includes a $0.36 dividend that we declared during the period. On Page 6, we present some other portfolio metrics.

[Jerry Sintes, Vice President & Treasurer at Orchid Island Capital]

At 4th quarter, we had $5,300,000,000 in MBS assets. Our leverage ratio decreased slightly to 7.3 times equity. Prepaiding speeds increased to 10.5 CPR compared to 8.8 CPR in Q3 and our liquidity at twelvethirty one was approximately 53% of equity. On Page 7, we present year to date full year income of $0.57 per share compared to a loss of $0.89 per share for 2023. Book value went down from $9.10 at the end of 'twenty three to $8.09 at the end of 'twenty four.

[Jerry Sintes, Vice President & Treasurer at Orchid Island Capital]

Our total return for the year was 4.73% and our dividend for the year was 1.44 dollars Our initial calculations show that 96% of that was paid out of re taxable income and 4% out of return of capital. On Page 8, we present our financial statements. For your review, we're not going to get into the detail of that here. And with that, I'll turn it back over to Bob.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Thanks, Jerry. Now turning to the market developments on Slide 10. The biggest development and really it was quite a pivotal quarter, the Q4 that is, and that the curve, the treasury curve, especially the cash curve, which had been inverted for 2 years, which by the way, I believe is a record period of inversion, disinverted, if you will. And the swap curve, as you can see on the right side of the page, is still slightly inverted, and that's just because swap spreads have been trending negative in a meaningful way for some time and remain so. And so that curve is still slightly inverted.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

But the cash curve did disinvert and now is positively slow. So mechanically, how that came about, the Fed starting in September lowered rates, the overnight rate by 100 basis points. But more importantly, longer term rates went up quite meaningfully in the case of the tenure by about 80 basis points. So the question is why, and I'm just going to briefly give you some highlight reasons why, and you're probably all aware of them, but just to bring them in the focus for the call. I guess I would highlight 5 things.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

The first would be the fact that the economy has just been strong all through 2024. GDP was 2% to 3% 3 plus percent. Retail sales as a proxy for consumer spending were very strong all throughout the year. Retail sales reported on a monthly basis generally exceeded expectations by economists almost all year. The labor market, which had been weakening, stopped doing so as the year came to an end.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

The labor market appeared to be at least leveling off, if not improving. The unemployment rate, which had been rising, stopped doing so and has settled in at a low level. Inflation, which has been very sticky, it's much lower than it had been when it peaked. But as we saw it today, it still seems to be stubbornly just above the Fed's target and not really making meaningful progress towards it. So it has kept the Fed from being overly aggressive in easing.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Fiscal spending deficits are still very large. We don't expect those to decline. And I guess finally, with the election results in the Q4, the new administration, Republican sweep, the current administration has a very strong pro growth agenda and in fact may even use tariffs, which probably, if anything, to the extent they are used, might be inflationary, at least in the near term. So for those reasons, the curve has inverted. I want to walk you through some more macro variables and then I'll finalize my comments by just kind of give you a summary of what these things mean for us specifically.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So you can see on Slide 10, the bottom, this is the spread between the 3 month treasury bill and the 10 year note. As of January 24, last Friday, it's 31 basis points, so it is now in positive territory. Moving to Slide 11, looking more specifically at the mortgage market. You can see it is a proxy for mortgage performance and trading levels, the spread to the 10 year treasury of the current coupon, while it's at maybe say local lows, it still remains at very attractive levels on an historic basis. As of last Friday, 125 basis points.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Prior to the outset of COVID, trading levels there were typically in the 80 or so basis point range. And really the reason this is probably still the case is that one of the largest marginal buyers of mortgages, which would be banks, have not been huge buyers of late. And to the extent that were to change, I think there's a good chance we could trade back to those ranges we saw pre COVID. With respect to mortgage performance for the quarter, on the bottom left, these are normalized prices. So the price of each coupon normalized to 100.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

As you can see, with rates higher, prices were down. But since year end, they've actually stabilized quite well. With respect to the dollar roll market, they've all improved. Most of these rolls are now positive, and that's generally a positive for the sector. Even though from what we understand, a lot of money managers are overweight the sector, the fact that dollar rolls are strong, while it may not be good for spec investing, it is generally a good sign for the mortgage market when those rolls are attractive and carry is present in the market.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

With respect to volatility, obviously, a very big driver of mortgage performance. If you look at the bottom of the chart, you can see on a long term perspective, we're still somewhat elevated, but we're very much at the local lows. And I think there's reason to believe that we may see vol come up a little more in the near term. And the reason for that and the reason I have that view is that it seems the market and the Fed are kind of comfortable with the notion that they're not going to have to act very quickly and they have a lot of time to normalize rates. So absent any shock in the data or anything, I think we could see very stable rate environment for the next few months.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

If that were

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

to come past, it's obviously a positive for mortgages. Slide 13, we show the mortgage bankers rate and the refi index. And you can see with rates now above 7%, refi activity is extremely low. The housing market is not doing all that well just because affordability is so low, and that can and will likely continue to keep refinancing activity low and purchase activity for that matter. Now the primary secondary spread did spike down recently.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

We've seen that in the past. I don't think there's anything significant in that fact. And given the state of the housing market, I don't expect that to be drop much lower. I think it will remain in that level. Finally, Slide 14, this is just one of my favorite slides.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

I don't want to read too much into it, but I would just point out to the fact that with elevated money supply, we have seen GDP growth. I'm not saying that there's necessarily cause and effect, but it does appear to be the case. We have hedged above normal growth. You can see this trend line going back all the way to 2,009. By the way, this is just GDP and nominal dollars.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

The current growth rate is above that long term trend. And if that continues to be the case, you would expect that the economy to continue to remain fairly strong. So now as I mentioned, I want to just kind of go through all these developments and what they mean for us before I turn the call over to Hunter. He talks about the portfolio. First of all, with the curve steepened and funding levels lower, our cash interest expense has come down.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So now our net interest income is positive absent the effect of hedges. So we now have positive net interest spread, which obviously is very good for income. Longer rates higher, that's been a very good development for us because we have an up in coupon bias to the portfolio. So that results in slower speeds. As we'll see later in the call, they have been, in fact, slowing, which just means we get better carry out of those securities.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

The investment environment, as I mentioned, if you look at the spread of current coupon mortgage as a proxy, is still at very attractive levels. Dollar rolls, positive. That's another good development for the sector. And volatility has been low and coming off. And to the extent that continues, also a positive.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So we're very constructive on the outlook for the market for Orchid and our business model. And looking forward, to the extent we do get additional Fed cuts, not sure if we will or how many, they would be a positive, of course, as well simply because that would lower our cash interest expense. And to the extent that, that curve steepens enough and we get banks back into the market in a meaningful way, could also lead to tightening in the mortgage basis, which again would be good for Orchid in the business model. With that, I'll turn it over to Hunter and he's going to walk us through developments with the portfolio during the quarter.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

Thanks, Bob. I just want to start by sort of giving a little bit of background, chiming on what some of the points brought up, which are we see a pro growth agenda from this administration. We see if the market is largely priced out a lot of future Fed cuts. There's not too many more priced in 1 or 2 last I looked. And so, we're keeping with that sort of theme in the background back of your mind, I think we'll talk about what we've done in the portfolio.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

As you know, we've been building a barbell strategy. We continued with that in the Q3. We're buying assets that are tend to be a little bit shorter in nature, so up in coupon. We did put on a new 15 year five position, which is $50,000,000 in TBA. That TBA has been trading very special and it's been a good trade for us.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

We covered some Fannie III shorts. Basically, we sold some cheapest to deliver type of pools. We sold $190,000,000 worth of New York and Investor Fannie Threes that were paying at sort of deliverable speeds. And we covered $100,000,000 of the short. And then we reinvested the remaining variance in New York 5 and 5.5 as well as a new position in a social bond.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

We like those. We purchased one from one of the faster servicers, but we think they're good credit like stories, so elbow shift type of stories. And later in the quarter, we had raised a little bit of capital. We purchased some another $115 ish million of $200,000 max and FICO 6.5 percent. As it relates to developments that have occurred since year end, we have we've purchased more $5,000,000 let's see $183,000,000 30 year $5,500,000,000 $5,000,000 $2.25,000 max 6.5 percent.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

And we'll talk about the hedge position on those in a moment. But again, this is consistent with the way we're trying to position the portfolio, which is higher yielding assets, the Fannie III portfolio that was dominated the last year, the 2023 fiscal year, we're starting to lighten up on that. Those assets have done very well. We liked them for a long time because they represented a very easy asset to hedge. They were mostly fully extended and they offered very wide spreads.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

We could even hedge some of them with TBAs because the dollar rolls were negative. So that has that picture has changed a little bit. The Fannie 3s have improved over the course of 2024 and the dollar rolls have even spiked and are now trading positive. So we felt like it was time to take advantage of the fact that there's more spread in the market and have transitioned to a higher coupon focus. Again, we're positioning for a strong economy, potentially more inflation, a spook here and there.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

And so we're trying to keep the assets relatively short. You can see that on the next slide, Slide 17. You can see kind of the migration of, if you look from right to left, our portfolio over the course of the last 6 months. So really building a large position in

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

6.5

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

and also bolstering 70 to 5 and 5.5 to a lesser extent. Just briefly on funding costs, Bob alluded to the fact that we were we had positive net interest income above our funding costs. Now in the Q3, we averaged roughly 5.62 for a repo funding rate that came down to 4.98 in the 4th quarter. And more recently, we're trending down to sort of a 4.45, 4.46 type of levels where we're putting on new repos. One other point I'd like to mention with respect to the funding portfolio, we have aligned and MRAs in place with 27 entities, and we recently executed in the Q4, we executed our first indemnified repo.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

So I don't want to go into it too much, but we are actively pursuing cash providers directly through this indemnified repo program. So that's exciting development for us. With respect to the hedge book, again, I discussed the new securities that we added during the Q4. On the hedge side of the equation, we are also sort of focusing on this idea of a bear steepener, stronger economy being our biggest risk really. So we're trying to address that risk by pushing some of the hedges farther out the curve.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

So in the Q4, we unwound sorry, we put on for the new purchases we put on, we did a combination of some 7 year swaps and roughly $320,000,000 5 year 7 year FEs and T wise on futures. We unwound what we saw as roughly $425,000,000 equivalent of sulfur futures. So we think of those in swap terms, it was roughly $400,000,000 If you recall, we put those on throughout the course of last year when the market was pricing in really deep Fed cuts through going out into 2025, 2026 and 2027. So we locked a lot of that stuff in with sort of an implied terminal fed funds rate in the very low 3s. We unwound them at a time when the future was after the December meeting, after the December cut and there was basically not much by way of cuts priced into the market at that point.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

So, if the market reverses course, the economic data weakens a little bit here in the near term, We'll look to reload those positions and capture more implied Fed cuts to the extent the market cooperates with us to do that. But right now, we're flat. Continuing on that theme into the Q1 of this year, we unwound $500,000,000 legacy payer pay fix swaps, which were very low strike. But again, one of them was a 2 year, 5 month to expiry and one of them was a 1 year, 2 months to expiry. So keeping with that theme of getting the hedge out of the front end of the curve because there's not much by way of Fed cuts priced into that right now and pushing that out a little bit further.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

5, 7, 10s is sort of the place where we like to hang out. So a little bit of a there might be a little bit of a duration mismatch with respect to some of the things that we've added, because they're a little bit shorter in nature. But again, we're trying to position ourselves to be have our assets really sort of are incrementally the assets that we're buying with incremental capital will be more in the sort of front to middle part of the curve and pushing our hedges out just slightly longer than that because we think that as a sell off bear steepening scenario is one where companies like ours are going to suffer. Mortgages will probably suffer in that environment. So we're trying to over hedge that a little bit.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

Conversely, a big rally, we think mortgages will tend to do very well into that type of move, especially if it's a rally in rates that is driven by some kind of equities, market selling off, that kind of thing, could be very positive for bonds. So that's where we're trying to keep our hedges. Going to the next slide, couple of slides too much, I'll leave that for you. I would just like to point out on Slide 22, we are extremely flat from a model duration perspective, about 0.28 is our duration gap. If you were to take these shocks and sort of average them and see what the resulting damage would be from those 2 plus or minus $50,000,000 on the $5,300,000,000 portfolio.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

So very flat model wise and again leaning into a bear steep nerd because we not because we think that's necessarily going to what's going to happen, but because we think that's the scenario that would be the most painful for our portfolio. I'm not going to touch on 23, and I would like to turn it back over to Bob now to wrap up and give us his outlook.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Thanks, Hunter. Just kind of reiterating what we've already said, The barbell strategy, we think, is a very appropriate strategy for the market. We do have an up in coupon bias to it. We do have a kind of a bullish view of the market and the economy. And we think the administration will be very pro growth, and we think the risk of a recession is extremely low.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

That all being said, we also think that the Fed has made it quite clear that they have no compelling reason whatsoever to start or continue to ease aggressively. I think we'll see we may not see anymore, who knows. It might be 1 or 2, but we think that to the extent we do, that's a positive. We don't see a reason for them to hike, and we expect long term rates to be at or where they are, slightly higher under pressure. Deficit spending is probably here to stay.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

And inflation has been very sticky and the growth of the economy is very strong. So very good carry for the bonds that we own. Higher rates are good for premiums. And as Hunter said, we've moved our hedges off the curve. So to the extent we do get a more meaningful sell off in the long end and those bonds start to extend, we have much longer duration hedges in place to help with the convexity of those.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So that's pretty much it. I will turn the call over to questions. So operator, please instruct and we will answer any and all questions.

[Operator]

Our first question comes from Jason Stewart with Janney Montgomery Scott. Your line is open.

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

Hi. Thank you guys for all the details today. Maybe we can start with a book value update year to date, if you don't mind.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Sure. Just because some of our peers have already announced this week, and I believe in all cases, they gave book value as of last Friday, just so we can have an apples to apples comparison. Our book value was as of last Friday. In fact, our daily estimate, which is not a GAAP or not an audited number, but just an estimate, was literally unchanged to the penny as of last Friday, $8.09 This week mortgages have had a good run, so we're up about 1% this week.

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

Got it. Okay. Thank you for that. And then if I could just shift to ROE, where you see ROEs on a go forward basis, maybe on an economic basis? And if you don't mind footing that, thanks for the taxable income number, that's helpful.

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

And putting that to where you see taxable income, I mean, and I guess I'm coming at it I'll just start there and we'll follow-up, if you don't mind.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Yes. Well, as I mentioned, the way we ended the quarter, net interest income is positive. So even though for the year, the taxable income number was pretty much covered, as I said, 96% of the dividend. The trend was positive. So I think we ended the year the Q4 was probably a higher percentage.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So we're entering the year on a good note there. ROEs, you were just saying we could get as well north of 150, maybe 200. If you could get to 200, obviously, our leverage has been on the low end of the range. We didn't stress that point on the call, but we're in the low to mid-7s, even today still in the low like 7.25%. If we were to stay there close to 200 over, that's 14s plus the unlevered return.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So you're comfortably into the mid teens at a relatively low leverage level.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

The swap curve is very flat. So we will lag in leverage as I guess as kind of the basis moves around. So we're things have tightened up a little bit. So we're on a tighter end. But when we think about the investing environment, swap curve is very flat.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

So pick your point and it's going to be low 4% paid fixed, right? And I think 6% yields are achievable with the help in coupon strategy, especially in

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

some sort of specified pool that's going

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

to pay relatively slow. So high fives to low 6s. So I think 200 basis points is right in the sweet spot and pick your leverage ratio from that point.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

And I would say the risk to that is a rally obviously, because we have an upper income bias.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So to

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

the extent we do get a rally, the economy softens, whatever, then those numbers are a little probably not obtainable. But the way we see things evolving, we think that, that is doable.

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

Got it. Okay. And then on the ATM program, do you have handy what the discount to book was for the issuance in the Q4?

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

No, I don't have it. I think for the year, we were around $0.17 for the book. We were running around we try to I think we've said in the past, when we're close to book or above book, we'll sell. I think we were generally in the 97.5% to 99.5% range when we were selling. We didn't sell a ton of stock in the 3rd or the 4th quarter.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

I think it was $36,000,000 So we had done much more in the 3rd. The 4th quarter, the impact on book, I'm guessing, is less than $0.01

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

Okay. I guess, Bob, where I'm kind of coming to all this is, I'm trying to figure out how much book value degradation you're willing to sort of accept? I mean, if we have an 18% to what is the dividend on the book, 17.8% dividend on book, I guess, based on the numbers you gave, you're very close to that on a taxable basis. Just sort of how you're thinking about maintaining the dividend, which is obviously, it's a great yield, but it's definitely north of where some of your peers are pegging ROEs. And just trying to put together how you're thinking about the dividend versus maintaining or growing book value?

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

And I know there's a taxable element to that, but that's really, I guess, where I'm trying to go high level to that question.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

I would say that the trend this year was, I said, was in our favor. So we're obviously, it depends on where the stock is trading and we don't want to do much of a discount. But if we're going to be earning those kind of levels on a GAAP basis or a taxable basis, I guess, I should say, and we can maintain that dividend level, we're not foreseeing an increase, absent meaningful seeping of the curve. But if we can maintain that level and basically earn what we pay and with some upside, I think, as I mentioned, I think mortgages are still attractive. We've been saying that for a while.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Who knows how long they stay that way, but there is upside, which would offer some book value appreciation potential. But if we can earn this dividend on a taxable income basis and with minimal cost on the book value if you're selling shares to the ATM, I think we plan to continue to do so.

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

Okay.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

I would

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

add that the money that we've the assets that we've been acquiring with the incremental capital are adding to the earnings power of the portfolio. So, and that's not to say that the legacy portfolio was worse. It's just we have that lower coupon part of our barbells already built, not really expected to grow much. And so the growth has been in higher income earning assets. So as you've seen over the course of the year, we've added a lot to 6% and 6.5% coupons.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

6% is largely when they're kind of hanging out around par. So I don't think our numbers are that far. 200 basis points over at 7x leverage is over 16.5% return plus we're still earning almost 4.5% on unlevered capital in money market funds, right? So I think high teens is kind of where we're at right now.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

And also, I mean, wishful thinking maybe, but it would be nice to see the stock trade at a lower yield as a result of price appreciation. I mean, to the extent we're earning this dividend and we're paying out 96% of the dividend on taxable earnings trending higher, you would think that the stock should not be trading at a discount. I don't control that obviously. But we've seen our peers, especially this week, all now I believe Dynex, Annaly and has joined agency trading at a premium to book. And I think that that is, in our case, justified.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

I haven't seen it yet, but I think it's very much justified given what we just said about the nature of the dividend we're paying. So that would be helpful in a meaningful way for us to the extent that would have come true.

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

Yes. I guess I would just pull that altogether. I don't think the stocks are traded at a discount to book either, especially if you're using front assets, shorter duration assets, you're hedging the long part of the curve, you should have a pretty good risk profile. I guess where I'm struggling is, I don't think anybody of the peers have noted ROEs close to 20%. I mean, they're mostly in the 16% to 18% range.

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

So I guess I think that's what

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

we said. There was 200 over, but Hunter was saying 16%. 16%.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

That's on incremental

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

capital as well. We have part of portfolio that doesn't again, what we're discussing is what I was trying to articulate was what we've been doing with incremental capital is putting it to work in some of the higher earning assets. So across the entire portfolio ROE blends out a little bit lower than that. But I think there's no reason why we couldn't continue to add in the upper coupon portion of the book. And I think it fits our strategy right now.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Yes.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

And just to walk you through the marginal return on capital, just so we're clear. Swap spreads are all right in the very low 4% range. So that's our hedge instrument. And we can get yields on assets in the very high fives, if not 6. So you're close to 200 over using a fairly conservative leverage multiple of 7.25 on around up to 200 over that gets you in that 14 plus percent range, plus the return on levered capital that gets you up to about 16%.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So that's what we're saying is the return on marginal capital today is around 16%. And that reflective of the fact that we started 2024 with a lower yielding portfolio and still managed to pay out $1.44 dividend, 90 6%, which was taxable income. I think that trajectory plus the return on marginal capital, we're comfortable where we are. And I think the stock should trade at a premium to book for that reason. Whether or not it does, I don't have any control over that.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

But we're comfortable with where we are.

[Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott]

Okay. All right. I appreciate the help walking through that. Thank you.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Yes.

[Operator]

Thank you. Our next question comes from Jason Weaver with JonesTrading. Your line is open.

[Jason Weaver, Managing Director - Equity Research at Jones Trading]

Hey guys, good morning. Thanks for taking my question.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Good morning.

[Jason Weaver, Managing Director - Equity Research at Jones Trading]

Bob,

[Jason Weaver, Managing Director - Equity Research at Jones Trading]

I appreciate your comments on the outlook, but I'm interested in your thoughts on what's priced in. So could you speak to how you see the incremental risk to spreads under the Fed moving towards more of a holding pattern versus possibly even reversing to a more hawkish stance?

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

I think the market and the Fed are fairly in line in terms of the number of eases. It's depending on the day between 12 over the course of the year. And inflation, we saw today. I think the 3 6 month annualized numbers are still in the low 2s. They're not there.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So I think what's priced in is what we agree with. We're very consistent with that view. The hawkish outcome would be if it reaccelerates, and in which case you'll probably see potential of the pricing in heights, but also probably sell off in the long end. And that's what we're kind of talking about how we're positioning with our barbell strategy. We're using lower coupon or higher coupon low duration mortgages hedged long.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

So as Hunter said, that's what we see as the greatest risk, is a turnaround where the market bear steepens, and that's how we're positioned hedge wise.

[Jason Weaver, Managing Director - Equity Research at Jones Trading]

And in that case, if we were to move more cautiously and that cause for say, a decline in the equity market causing a flight to quality, would that be beneficial to MBS spreads as well? How do you see that shape?

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Well, the problem is when those kind of scenarios play out, you always get a spike involved and that's never good for mortgages. You'd start to see the market sell off and repricing the Fed and you'd have a ball spike. So in the short term, it would be probably detrimental to mortgages and REITs in general. If we settled in at a much higher rate environment with a steeper curve, at the end of that, that will be a very good investment opportunity, stable carry environment, but getting there will probably be painful.

[Jason Weaver, Managing Director - Equity Research at Jones Trading]

Got it. Got it. Thank you very much.

[Operator]

Thank you. Our next question comes from Eric Hagen with BTIG. Your line is open.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Hey, Eric.

[Eric Hagen, Managing Director at BTIG]

Hey, good morning, guys. Good to hear from you. So is there a level of yield curve steepness where you might have more appetite to like deliberately extend your duration gap to maybe express more of a view on rates or spreads? And historically, what would you say is the widest duration gap you guys have deployed in the portfolio?

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Model duration gap, I don't know, 1.5 years maybe. Yes, we've been talking about that this week about mortgages had a good run. It's just the time to maybe extend the duration a little bit. But days like today, we'll probably get to see a lot of profit taking. That's still very much relative value asset.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

There's not a huge marginal buyer out there. Banks are fairly active, but not as meaningfully as they've been in the past. Money managers are generally considered overweight the sector and mortgages lagged corporates in the 4th quarter. So are they going to have a huge run? Not without and I think the banks coming back in a meaningful way and they're just not there.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

And I

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

think you need a steeper meaningfully steeper curve for them to get meaningfully back in. And then there's the whole issue about balance sheet constraints and do they have the capacity to do so. Certainly, with deficits running where they are, these options growing slowly over time, the fact is that the debt of the government is growing much faster than the equity capital basis of the banks. So you can do the math, eventually they just don't have room.

[Eric Hagen, Managing Director at BTIG]

Brian? Yes, sure. I think I heard you guys say you don't expect a lot of spread widening in the current coupons if long term rates are coming down. Can you maybe unpack that a little bit and share why you don't expect a lot of widening when there seems to be a lot of maybe refi risk in these higher coupons? Appreciate you guys.

[Eric Hagen, Managing Director at BTIG]

Thank you.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Yes. Convexity is quite poor. That's why we have paid got some spec pools where we can. We've actually moved into some slightly higher quality loan valve versus like the cheaper, cheapest forms. The problem is you have high gross wax in these pulls, 100 basis points over the net.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

And we saw briefly last fall that when they got the money, they prepaid fast. So we have up to quality in those.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

That's the

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

other side of the barbell really that we've been talking about. And mortgage spreads are still relatively wide by historic standards. The really low coupon stuff has tightened up a little bit. We have been focusing on in like 5.5 percent which not crazy about as like a coupon, but in specified pool space, some higher quality stuff there like we put on some New York's. Those are solidly discount coupons right now.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

And so the pay ups on those pools is relatively low. So that half of the portfolio, little less than half of the portfolio, the 3s, 3.5s, the 4s, 4.5s, the 5.5s, we expect those to do well into that rally scenario. The longer duration stuff like the Fannie 3s will just we would expect them to grind tighter as rates came down and spreads tightened and offset some of the erosion in book that would come from the higher coupon portfolio lagging. So that's the other side of the strategy. We didn't really talk about too much today because we're like we said, we're sort of have been thinking and focusing on the bearish steepener, strong economy type of scenario.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

But there's definitely still a large portion of the portfolio that's designed to do well in our rally.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

And I'll just add one thing we have seen in this backup is that the loan balance pulls, premium loan balance pools I'm sorry, discount loan balance pools have performed very well, especially with any seasoning, and they're very much in demand as a result. But we've seen not so much the very lowest loan balance even, even like the 150s pay very well as discounts mid teens. So those are pretty attractive returns.

[Operator]

Thank you. Our next question comes from Mikhail Goberman from Citizens GMP. Your line is now open.

[Mikhail Goberman, VP - Equity Research at Citizen JMP]

Hey, Mikhail. Hey. I just hope everybody is doing well. Just to clear up, the current book value that you mentioned, does that include today's dividend? Or are we going up 1% and then taking the dividend down?

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

No, that's inclusive of the dividend. So up 1% this week.

[Mikhail Goberman, VP - Equity Research at Citizen JMP]

Great.

[Mikhail Goberman, VP - Equity Research at Citizen JMP]

And obviously, you guys covered a lot of territory. I guess if I could just maybe get your thoughts on MBS your outlook for MBS supply and how any potential GSE reform might affect that? And just in general, any thoughts on any potential regulatory changes coming down the pike with the new administration? Thanks.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Yes. That's certainly getting a lot of press now, regulatory format is. I don't think it's going to happen. That's just my personal view. I think that

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

the given the fact that

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

housing is at an all time low in terms of affordability and rates are high, anything that would make that worse, I think, is just political capital that's not worth spending. You have a new administration. They've talked about what they want to do. They're talking about tariffs and tax cuts. That doesn't seem to me like that's the place they want to spend their capital, making the housing market less affordable.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

It may happen, but I give it a little probability.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

In terms of supply,

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

I think it's I've already started to see a few of the street shops lower their estimates for the year. I think that probably continues.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

Yes. I think that the banking sector is already in has a lot of fresh scars on it. And given the regulatory environment that they're dealing with, I don't think you would be very likely to see the GSEs privatized and now all of a sudden you have an enormous portion of their holdings become private label credit. I don't see how they would be able to comply. Those two concepts of like Basel III and GSE privatization are kind of not congruent with one another.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Yes.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

I mean, that's a great point. Nobody makes that point at all. I mean, if you were if you actually, we have a he's got a chart here in the back. Yes, we do. If you look at Slide 26, give you a second to get there, that shows mortgage backed security holdings by commercial banks and the Fed.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

If all of a sudden you change the risk weighting on all those, that would be devastating for the banks. All of a sudden, these are no longer agency, they're private label. I mean, that's that would be very challenging, especially given where the environment we're in, where bank balance sheets are fairly constrained as it is. I just having to take up more capital as well as that would be very challenging to do.

[Hunter Haas, CFO, Chief investment Officer & Director at Orchid Island Capital]

And the one type of entity that stepped into the bank's place as they lost deposits were money managers, which often have very strict investment guidelines. I think it would create a lot of chaos, I guess is what I'm getting at.

[Mikhail Goberman, VP - Equity Research at Citizen JMP]

Great. Thank you for your thoughts guys and best wishes going forward. Thanks.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Yes. Thanks, Miguel.

[Operator]

Thank you. I'm showing no further questions at this time. I would now like to turn it back to Mr. Robert Cauley for closing remarks.

[Robert Cauley, Chairman, President & CEO at Orchid Island Capital]

Thank you, operator. Thanks, everybody. If anybody does have any questions that come up after the call, please feel free to call or if you listen to the replay, the office number is 772-231-1400, always willing to take any calls. Otherwise, we look forward to speaking with you at the end of the Q1. Thank you.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.

Participants

Executives

• Robert Cauley, Chairman, President & CEO
• Jerry Sintes, Vice President & Treasurer
• Hunter Haas, CFO, Chief investment Officer & Director

Analysts

• Jason Stewart, Director & Equity Research Analyst at Janney Montgomery Scott
• Jason Weaver, Managing Director - Equity Research at Jones Trading
• Eric Hagen, Managing Director at BTIG
• Mikhail Goberman, VP - Equity Research at Citizen JMP