Orchid Island Capital Q1 2025 Earnings Call Transcript

Quartr
Provided by Quartr
April 25, 2025

There are 8 speakers on the call.

Operator

Good morning, and welcome to the First Quarter twenty twenty five Earnings Conference Call for Orchid Island Capital. This call is being recorded today, 04/25/2025. 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 act annual report on Form 10 k.

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.

Speaker 1

Thank you, operator, and good morning. Thank you for joining us today. I'm sitting here with Jerry Cintas, our Controller and Hunter Haas, our Chief Investment Officer and Chief Financial Officer. We will follow by the way, before we start, I hope everybody had a chance to download the deck, which will be following on over the course of the call. So presuming you have that with you, we will be proceeding in chronological order.

Speaker 1

Just to give you a summary of what we'll do, we'll first have Jerry go over our financial results for the quarter. I'll then discuss the market developments that shaped the decisions we did and the performance of the portfolio. Then Hunter will dive into the portfolio and hedging positions, describe where we stand and what we've done. And then finally, I will do a kind of wrap up and then we'll open the call up to question and answer. So with that, I will turn the call over to Jerry Sinton.

Speaker 2

Thank you. If we turn to Page five, we'll start with the financial highlights for the quarter. For Q1, we earned zero one eight dollars per share compared to $07 in Q4. Book value at threethirty 1 was $7.94 per share compared to $8.09 at twelvethirty 1. Total return for the quarter was 2.6% unannualized compared to 0.6 for Q4.

Speaker 2

And we declared and paid dividends of $0.36 per share for each quarter. If we turn to Page six, we go over some portfolio highlights. For Q1, the average portfolio was just under $6,000,000,000 compared to $5,300,000,000 in Q4. Our leverage ratio at threethirty one was 7.8 compared to 7.3 at twelvethirty one. And prepayment speeds were 7.8% at fourth Q1 compared to 10.5% for Q4.

Speaker 2

Liquidity at threethirty one was 52.2% compared to 52.9% at twelvethirty one. On page seven is our summarized financial statements, which you can read at your convenience. And now I'll turn it back over to Bob for market development discussion.

Speaker 1

Thanks, Jerry. And before we move on to the market developments, I just want to apologize. In our initial release back in the month, I think it was on the ninth when we released our preliminary earnings per share and book value numbers, we have the breakdown of earnings per share between net interest income and capital gains and loss reversed. And it implies that the capital gain component was the larger of the two and in fact, it was the much smaller. As we show in the press release, it was roughly low under $02 for the capital gains and the rest of it was from net interest income.

Speaker 1

So I do apologize for that. Turning now to Slide nine. It's been Q1 was actually very much a continuation of what we saw in Q4, absent what happened very late in the quarter and then of course very much changed a lot in early April. So just with respect to Q1, as you see in the top left, you can see the red line there, that's just where we were at the end of the year and we had a significant rally in cash treasury curve, the green line. And then since quarter end, we've had a significant move with respect to the tariffs and their expected impact on the economy and inflation.

Speaker 1

The market moved to price in three Fed cuts or three plus Fed cuts by the end of the year. In the long end, off quite a bit. The initial concern was that this was foreigners dumping treasuries with the safe haven status of the dollar and U. S. Treasury somewhat in doubt.

Speaker 1

Not so sure now that that's the case. We did see earlier this week the results of last week's auctions, specifically the ten and thirty year. And there was really nothing that changed with respect to foreign participation in those auctions. But what we have seen in long end pressure, there's probably a couple of trading trends that explain that. One is what are known as basis trades with respect to the futures market.

Speaker 1

They're typically very highly levered trades put on by hedge funds. And when they have to delever, they involve selling the long end quite a bit. Another is just the fact that with the forced selling that was caused by the disruptions in the market, dealers had to take a lot of bonds onto their balance sheet and that tends to, one, just selling of treasuries or any instrument that was liquid enough to be sold. But also when dealers take on a lot of positions on balance sheets, you typically see movements in swap spreads downward, more negative. And in fact, if you look just to the right, you can see what happened to the swap curve.

Speaker 1

It's notable two things. One, if you look at the movements over the course of the quarter from twelvethirty one to threethirty one, similar to what happened in the cash market. And of course, what happened since quarter end kind of mirrors that as well. But notably, the absolute numbers are much lower. So swap spreads moved meaningfully negative late in the quarter and into April.

Speaker 1

And that had a lot to do with mortgage performance, which we'll get to in a minute. In fact, arguably, movements in swap spreads are the biggest drivers of mortgage performance today, and we'll talk about that, as I mentioned. Moving on to the next slide on Slide 10. As you can see at the top, this is just the spread of the current coupon mortgage to the ten year. Over very large periods of time, that's probably the most appropriate benchmark.

Speaker 1

But more meaningfully of late, it's really the five year just because the current coupon mortgage is a higher coupon premium or not premium, but higher coupon security and it has a shorter duration than a ten year. So really, if you look at this versus five year, you would see that the spread had widened out quite a bit because basically looking here, you would say that we really haven't widened that much. However, as I mentioned previously, swap spreads are very negative. And if you look at the spread of the current coupon to benchmarks of the swap curve, that spread is at very wide levels. Widest we've seen probably since the outbreak of the COVID pandemic.

Speaker 1

The bottom left, you can

Speaker 3

see the performance of

Speaker 1

mortgages. Absolute what happened in late in the quarter and early April did quite well. In fact, if you look at the Bloomberg indices, mortgages, agency mortgages were the second best sector in the fixed income markets behind only tips. And as you can see here on the left here as we approach late February and the March, the market was rallying. Mortgages did very well.

Speaker 1

Orchid did well. Most of our peers had solid positive returns and kind of characteristic with mortgage market as a whole. To the right, you see the role market. I'll point out a couple of things. On the left two thirds of that slide, you can see during most of 2024, roles were not very attractive.

Speaker 1

That did change quite a bit in the first quarter. They became did quite well. That also just helps the class as a whole. There's a lot of factors that drive roles, one of which is just a technical supply and demand, such that if there's demand for mortgages in the front month, but there's not a lot of supply, the price of the front month mortgage can get bid up and the drop appears to be larger and that gives you a nice attractive role. Most of what we saw in the first quarter was actually demand from CMO desks for mortgages as they were generating unprecedentedly high levels of CMO floaters, mainly for the banking community.

Speaker 1

So that helps support the role. It did fall off quite a bit as we enter April. Now just moving on to Slide 11, volatility, as you can see, the top slide is quite high. This top slide is a twelve month look back. We are at the highest levels for that period.

Speaker 1

I would note that the VIX, which is equity vol, was also very high. And correlations, which we typically see that have been in place for decades between bonds, treasuries rates, treasuries in particular, and equities has really broken down to a large extent over the last month or so. So for instance, when you would typically have equity weakness and a flight to quality bid, you would see treasuries rally. In fact, we saw just the opposite, and their correlations have become more positive, which is very atypical. Just looking at some perspective here on the bottom just shows this vol levels going back ten years.

Speaker 1

And you can see we're at quite high levels. That big spike you see in March of 'twenty three is the regional banking crisis. And then back in March of twenty twenty, that's the COVID pandemic. So the vol has generally been elevated and outside of the regional banking crisis, the current level of vol is really at the highs of the range that we've had for the last few years. Now moving on to slide 12, and this is a new slide.

Speaker 1

This shows swap spreads, as I mentioned, they've moved quite a bit. So what we show here are just four different tenors. The top one is the two year, the orange line is the five year, the green line is the seven year and the blue line is the ten year. As you can see, they have moved dramatically and become quite volatile of late. So there's two takeaways from this.

Speaker 1

One, if you have new capital to deploy today and you're looking to hedge that with swaps, the investment opportunities are phenomenal, extremely attractive spreads, the wider spreads we've seen in quite a time. The flip side of that is if you entered this period by hedging with swaps, it might have been painful. Hunter is going to talk at length about what we've done in the portfolio. I will just give you a brief executive summary. What we generally did, we raised quite a bit of capital during the quarter.

Speaker 1

We deployed a lot of that proceeds into higher coupon, but shorter duration assets. So shorter duration assets and we hedged them predominantly with longer duration hedges. So the combination of a short duration asset being hedged by a longer duration hedge means that you don't need as much notional to do so. So that mitigated our exposure to these declining swap spreads. And going forward, we would also change the mix, as much swaps, we use more treasury futures.

Speaker 1

And so if you, for instance, look at our swap notional versus our repo balance, it's much lower. And the reason is the repo balance tends to track your asset size, but because the asset mix has moved to more shorter duration assets and we're using longer tenor swaps or futures, the notionals are low in relation to the repo liability. Moving on to Slide 13, this story hasn't this just remains the same. It's just what we've been experiencing for quite some time. The top left, the blue line there is just the refi index.

Speaker 1

We are at historically low levels. And the red line is mortgage rates. They are very, very high and it's keeping refinancing activity low. If you look at the bottom chart, you can see that the percentage of the mortgage universe that's refinanceable is very low by historical standards. The top right just shows the primary secondary spread.

Speaker 1

That chart is somewhat misleading. Just reflects the fact that one, rates have been very, very volatile. But also we have rate data on a minute by minute, day by day basis. Mortgage rates, we don't get the data as regularly. And so sometimes you just have timing differences where you can lead to apparent spikes down in the primary, secondary spread basis.

Speaker 1

But that really has been fairly stable. One thing with respect to spreads we do want to mention is that, as you probably heard, the merge between Rocket Mortgage and Nationstar. This has the potential to definitely increase speeds or hurt the convexity of the mortgage universe. We have added a slide to the appendix, which we will talk about later, Slide 28, and it basically breaks down our exposure to loans serviced by Nationstar. And obviously, there's the potential for this development to affect performance and the pay ups for specified pools.

Speaker 1

But as of yet, we really don't have any hard data to point to, so that's still TBD. Slide 14, I don't really have much to say about that other than it just shows you the long term historical relationship between nominal GDP and the money supply. As you can see, as the government's been running massive deficits of late, money supply is very far above its long term trend growth and has corresponded into higher GDP growth. With that, that's it for the market and I will turn it over to Hunter, he will go through the portfolio.

Speaker 3

Thank you, Bob and good morning. We have a lot to discuss this morning. We've been very busy, quite active in the capital markets in the first quarter. And so I have a lot of updates for you. We also want to be mindful of letting our shareholders as well as our, as well as the counterparties with which we have credit relationships, know what measures we've been taking to safeguard ourselves from recent market volatility.

Speaker 3

As such, I'll be discussing activity and several metrics that are as fresh as last night's close. And I just want to mention that's April 24. Want to reiterate that how important it is that these discussions relating to activity this month are our company's best estimates and are internally generated, unaudited, subject to change and all the things that Howard said in the safe harbor discussion at the beginning of the call. So with that, on slide 16, as I mentioned, we were quite busy. We raised quite proportion to our size or quite a bit of capital in the first quarter, dollars '2 zero '6 million worth.

Speaker 3

In fact, we sold 25,000,000 shares of stock. We estimate that the shares that we sold were a little bit accretive, slightly accretive to shareholders so above book value in the aggregate net of any fees we would have had to pay. With that said, as the market became more volatile coming into the March and really more so in April, the stock price just didn't perform very well. And we implemented we reactivated our buyback program. April month to date, we've repurchased over a million 1 point 1 million shares of stock.

Speaker 3

We did so at a weighted average price net of commissions of $6.44 at a time when we spotted our book value at roughly $7.36 give or take. So that buyback was also quite accretive to shareholders equity. Getting back to the portfolio and what we did with that capital that we raised in the first quarter, we bought quite a bit of Fannie five point five, sixes and 6.5 exclusively those three coupons. We did early in the quarter, we've been carrying a $200,000,000 Fannie 3 short just because that role was trading really poorly. It firmed up a little bit and we found some slow paying Fannie threes that really weren't doing anything for us and more or less just delivered them into that TBA.

Speaker 3

I think we've a little bit of pay up for the pools we sold, but we just sold them on swap and took a little pay up in, reduced our exposure to Fannie threes by $200,000,000 and really sort of helped the carry of the portfolio overall. So going back to the capital, the new capital,

Speaker 1

we

Speaker 3

added approximately $3.00 6,000,000 Fannie 5 30 year, Fannie 5 and a half. Those were all either New York or Florida pools. Were kind of on to the Florida story, I think relatively early and I think that those are going to be good assets to hold, especially in the premium space. We added a lot of thirty year sixes, predominantly Florida's and low loan balance pools and kind of the 200 to $2.75 ks max range and some FICO's. And we also added $458,000,030 year 6 point 5.

Speaker 3

Again, those are the same sort of combination as the six is two twenty five ks Florida FICO. During the month, we also put on a little bit of a basis hedge or what we hope would be a little bit of a basis hedge in a door 15, Fannie five point five swap. We like that for times when mortgages get a little too snug, as they were really in going into February. With respect to the going back to slide 16, sorry. I just want to point out one more thing or two more things.

Speaker 3

The WAC of the portfolio, importantly, the December was five zero three. As you can see, the result of the securities we purchased in the quarter that drifted up to five thirty two. And we have sold some assets since the end of the quarter and as so the lack of portfolios drifted up a little bit more. And that leads me to some activity that's taken place since the end of the period. We sold roughly $692,000,000 worth of securities, basically to get our leverage back into check.

Speaker 3

Our leverage at the December was 7.3, seven point eight at the end of the first quarter and I spotted it last night at 7.4. Just to kind of carry through that thought. You have a choice to make anytime that you suffer some losses and the portfolio is down in value. We estimate that the portfolio was down, book value was down roughly 8.3% as of last night. And so, as we move down a book value, experience some losses, you have the choice to either explicitly let your leverage ratio rise or, you know, mitigate that by selling some some securities.

Speaker 3

We thought it would be prudent to go ahead and sell some bonds. And so the ones we sold were lower carry assets, lower coupon, as I discussed, the lack of the portfolio drifted up slightly because of what we sold. We sold, $353,000,000 Fannie fours, a hundred and 25,000,000 fives and a hundred 14,000,005.5. We also put on TBA hedge, shorting 200,000,000 more, Fannie fours. I would look last night, I think that we're maybe four or five basis points tighter on a mortgage swap basis than what they were at the time that we execute these sales.

Speaker 3

And the market has swung around violently since the first few or first couple of days of this week. And and so, you know, we're starting to recover some. The the past three days have been, quite positive for mortgage assets. And so we jump back into those securities as things if and as and if things continue to quiet down, volatility drops, portfolio gains value, and and our leverage ratio would then, you know, start going lower and lower. So we like where we are positioned, kind of mid-7s leverage ratio.

Speaker 3

We're comfortable with that. Our liquidity position is actually a little bit higher than it was at the end of threethirty '1. And so, we feel good about the risk of a portfolio and the steps that we've taken to mitigate potential for future losses. Slide 17 is just kind of a rehash of the portfolio strats that we've just discussed. The on slide 18, the end of twelvethirty one, our weighted average repo rate was four forty six.

Speaker 3

It was actually 66. Four 60 six. I'm sorry, four sixty six. Four 40 six the March. And as of last night, the way debit repo rate was four forty seven.

Speaker 3

So not a lot of change there. We have not seen a change in any material changes in haircuts or the counterparties pulling back from the space, so far at least. So, I think that people in our space are reasonably well positioned. While we might incur some losses, it's nothing as dramatic as it was say during COVID times. But, you know, who knows anything can change, right?

Speaker 3

So, the average term for the repo book was also twenty six days at the December, '40 days at the March is currently days at the March and is currently thirty days right now. So not a lot of changes to report in the repo side of the house. As it relates to slide 19, we talked about our hedges. Of course, I mentioned we unwound several mortgage securities, several different mortgage securities. We also unwound a number of swaps to offset that risk.

Speaker 1

We

Speaker 3

just kind of go through some of the hedging activity that we did in the period. Early in the quarter as expectations for Fed cuts were low, the Fed funds curve was very flat really with only one full cut priced into the 2025 and 2026. We use that as an opportunity to unwind $500,000,000 1 and two year swaps on the very front end of the curve. We move that duration out the curve to kind of ten year point. And then as we added assets during Q1, we predominantly hedged them with a mix of five, sevens and 10s skewing a little more heavily towards the sevens and ten year and skewing more heavily to swaps than treasuries.

Speaker 3

And we did short some ten year ultra futures. Late in February, early March, the market had gone from pricing in only one cut between 25 to 26 to almost four. And so we reestablished a hedge on the front end of the yield curve to economically lock in those projected Fed cuts. We did so by adding two years SOFR future strip and I think 115,000,000 and $250,000,000 6 months by two year forward starting swap. Those are done at rates around three sixty Because I think the yield that we were that we were that we have achieved on the incremental capital that we put to work was in the five kind of 60 area, whereas the legacy portfolio is quite a bit lower than that.

Speaker 3

So, talking about where we got in and where we've been able to hedge our funding costs. Slide 20 is just more of kind of the of the hedge picture. We you can see the the stats gone through most of this. We've as I mentioned, we we we added some five sevens and tens since quarter end. So this gives you a breakdown of the portfolio from 12/31 or from the hedging book from 12/31 to 03/31.

Speaker 3

And subsequent to that, most of what we've done on the unwinds has been in the eight and nine year quarterly curve. So we unwind $474,000,000 7 and 8 year payer swaps and we shorted $200,000,000 number 21, I'll just leave this with you. It's just like what the return and risk reward comparison of the coupon stack. This is generic TBAs. This isn't really specific to our portfolio, although we do it's a little confusing.

Speaker 3

We do add our portfolio allocation over at the end, but these are just generic TBAs. Of course, our portfolio is constructed of almost all specified pools that have some sort of story to them. So we don't really have anything that's we have some lower pay up bonds, which is a lot of what we sell in times like April, but then the distressed periods, but we don't have anything we saw we would really call TBA ish. Page 22 is our interest rate sensitivity profile. It has a DVO one of the portfolio listed there as well as kind of the dollar and percent change of up and down 50 SHOP.

Speaker 3

I just note that since, the March, number one, this was at the March, this was very flat. This won't guard against basis widening that we've seen. Almost all of our losses that we've experienced in the fourth quarter or sorry, the second quarter have been attributable to basis widening. This profile is even more flat as of yesterday. It's down 0.05% in the down 50% and down 0.24% in the up 50%.

Speaker 3

We keep an eye on this every day as well as several other risk measures. Slide number 23 is our prepayment experience. You can see, we had speeds were 6.2 in Jan, '7 point '3 in Feb and nine in March. On an average basis for the first quarter, that was 7.5% versus 10.2% in the fourth quarter. I would note that as we've added assets that are higher in coupon, we're going to start seeing that speed probably creep up a little bit.

Speaker 3

And April's was jumped up a little bit. It was 9%. How did that relates to our book value? Had in January '1 point '2 million dollars worth of accretion. So our discounts were paying fast enough that they overwhelmed the pay downs associated with our premiums to the tune of $1,200,000 So pay downs actually helped us in that case.

Speaker 3

February that number was 800,000, March, it was $6.40. And then as I just alluded to, we've skewed up much higher in coupon over the last over the course of the first quarter. So we had $325,000 worth of pay down related amortization in the month of April. That's about all I have for you. So I'll turn it back over to Bob to give you the outlook and the Q1 wrap up.

Speaker 1

Thanks, Hunter. Just to summarize, kind of looking back, Q1 for the most part was a very good quarter. Mortgage performance was very strong. That was reflected in the price of the stock as well. We were able to raise capital on an accretive basis.

Speaker 1

And we did take some meaningful changes to the portfolio and we're happy

Speaker 3

with how we've repositioned the portfolio.

Speaker 1

Looking forward, tons of uncertainty. The market has become quite volatile. The driver of the volatility, as we all know, are of course the tariffs and the impact it will have on trade relationships, inflation, growth, but also the fact that a lot of this information, as we all know, comes out kind of, in the form of headlines, which means they're kind of hard to predict. It's not like regularly scheduled economic data that's actually taken a big back seat to these developments. In fact, given the fact that most of the economic data is backward looking, it tends to be disregarded by the market for the most part.

Speaker 1

And everything is focused on everything with respect to trade, tariffs and so forth. Clearly the market has taken all of this to process that and try to guess what this means going forward. Obviously the tariffs are expected to have some potential impact on inflation, drive prices higher, at least in the short term, even if it is a one time shock in nature, remains to be seen whether or not it plays out in that regard. But in any event, it's expected to be at least short term inflationary, but also drive growth slower. We've already seen the economy being resilient, but not robust.

Speaker 1

And these events are likely to cause us to slow. As we mentioned before, the market's pricing in three or four cuts this year, maybe as soon as June. And so you expect this combination of slower growth, which would put upward pressure on the unemployment rate and tariffs and pricing pressures, which put upward pressure on inflation. Those work against both of the Fed's mandates. So the Fed is clearly in predicament here.

Speaker 1

In any event, we don't know with any degree of certainty. We have no basis of having any conviction in our outlook in terms of how exactly this is going to play out. It's just too volatile and too much remains to be seen. But as I mentioned, the kind of general takeaway from this is it's probably slower for growth. There's potential for Fed eases and it's going to push inflation up, which would tend to push long term rates up.

Speaker 1

Both of those developments lead to a steeper curve, which is good for us. So if you look at the way we're positioned with a skew towards higher coupon, shorter duration assets that generate lots of carry, hedged on the long end predominantly assuming the steepness of the curve, should work quite well. We're very happy with our position, but we also are very, very aware of the fact that this can all change. And we, as like everybody else, are just watching the market every day and just interpreting the events as they occur and hoping we can be positioned or repositioned as effectively and quickly as possible. But by and large, we are, all things considered, happy with our positioning.

Speaker 1

And that's about it. With that, we can turn the call over to questions, operator. So that is all of our prepared remarks.

Operator

Once again, if you have a question or comment at this time, please press star one one on your telephone keypad. Please stand by while we compose the q q and a roster. Our first question or comment comes from the line of Jason Weaver from Jones Trading. Mr. Weaver, your line is open.

Speaker 4

Thanks. Hi, How are doing?

Speaker 1

For the time. Hey, First of all, can you tell me

Speaker 4

where you see your duration gap both at the end of the quarter and to date after the sales you've made?

Speaker 1

Don't do that. Hunter mentioned that we don't look at it in terms of just numbers. We do it in DV01 basis. And I think on Slide 22, we have that as $13 is that what that

Speaker 3

represents? $2,000

Speaker 1

so that would be $13 It's very narrow. And I think you mentioned it was about the same as of now.

Speaker 3

Yes, it's very, very flat. It's slightly we're kind of in this convexity elbow. So we have a decline in value in this 50 basis point shift. If we narrow it in a little bit more, it's the duration the VB-one hasn't changed materially end of the quarter.

Speaker 1

Got it. I was

Speaker 4

just thinking about how you made the comments about how you were hedging with longer dated swaps, I didn't know if that had changed post quarter end, but it seems like you would benefit from a steepening action in that.

Speaker 3

Yes. Yeah. We unwound predominantly longer assets. You know, most of what we unwound was in was were were So fours, I think, five and a half and and a five. So the five and a half is a little closer to par.

Speaker 3

But, I said, we I think we really only had to unwind two swaps, and one was a seven year and one was kinda like a two year

Speaker 1

old Two two year old 10 year. Yeah.

Speaker 3

So other than that, yeah, we we we didn't really have to unwind anything. And they had some TBA hedge as well. So looks looks So I just

Speaker 4

And just one more clarification. I heard you mentioned your quarter to date book value was 8 something and I got cut off.

Speaker 1

Yes. Let me just go through that. So I know a lot

Speaker 3

of our peers have already reported and they

Speaker 1

reflected their book as of last Thursday. Our book last Thursday estimate was $7.24, that's down 8.8%. We had a rough day Monday, but the market's been good since then. So as of last night, our estimate is $7.28, So $04 above where it was last Thursday, and that equates to a decline of 8.3% quarter to date. And as we mentioned, our leverage ratio is about 7.4.

Speaker 1

It's actually lower on the quarter.

Speaker 4

Got it. Okay, that's very helpful. Thanks for the color guys.

Speaker 3

It's worth throwing in, I always like to mention the total returns as well when we talk about book value because our dividend is relatively high. So when we think about how the total return was, of course, it was 2.6% we mentioned for the first quarter. Quarter to date, the change in book value reflects the dividend accrual. So it's dividends has been taken out of book, if you will. And so the total return if we put the dividend account for the dividend that's gonna be paid in May is 6.8% quarter to date and year to date, having the benefit of three more months worth of dividends.

Speaker 3

Our total return is negative four point o 8%.

Speaker 4

Got it. Thank you for the time.

Speaker 1

Yep. Absolutely.

Operator

Thank you. Our next question or comment comes from the line of Jason Stewart from Janney Montgomery. Mister Stewart, your line is open.

Speaker 5

Hi. Thank you. And thanks, guys, for all the color as usual. Question, after these portfolio changes and hedge changes, where do you see gross ROE sitting today?

Speaker 1

Well, swaps, very, very high. I mean, take your moment because they're very volatile. But I would say 20%, I don't have numbers in front of me, but these are the highest levels we've seen at some time. Yeah.

Speaker 3

We look at the spreads, seven year swaps versus current coupon is above 200 basis points or I don't know what it is right this second, but has been over the course of last week or so. Like I said, it's been it's been very volatile. So I don't on a mark to market basis, it wasn't quite that wide at three thirty one. But going forward, if we were, you know, say putting new money to work, you know, I think very high teens and even in the low twenties is probably achievable with our in the context of our leverage framework, that's our current leverage framework.

Speaker 5

Got it. Okay. Thank you for that. And then as it relates to that return environment and your cautiousness going forward in terms of spreads, capital raising activity versus buybacks and the dividend. It kind of seems like cost of capital is a little north of where the returns are.

Speaker 5

How are you looking at the dividend issuance and buybacks?

Speaker 1

Cost of capital, let me see. To start with, where the stock's trading now, obviously, buybacks off the table. Got so cheap there that we just in spite of the we basically waited for the market to calm down and we felt somewhat comfortable using some cash to buy back stock, we did. Given where we're stocks trading today, we're not far from book. I would say that going forward, assuming nothing changes from where we sit today, which is a big if, but we will even consider raising some capital just if nothing else to pad liquidity, not so much to miss as much as the market's appealing, and we would love to put money to work, we would also be cognizant of the need maybe just to add some liquidity, just because you never know when the turbulent period is going to come back.

Speaker 1

But even if you do, I mean, at these levels, the yield on the stock got, I don't remember what it was at the lows, I assume mid-20s when we were trading in the low 6s. It's come up, so it's not as heinous the yield, but these are pretty attractive returns. And just I know this question comes up a lot when people look at the dividend yield and so forth. A component of the dividend that we pay and have always paid is derived from hedges, in particular closed hedges. And so that's you can't ignore the fact that when you put on significant hedges and then close them out that they have a lasting impact on your tax warnings because the gains on those derivatives at the time you close them are amortized basically over the remaining term of that hedge.

Speaker 1

I know us and our peers in the past have talked about the benefit of these closed hedges, But that's coming out of book value. Those dollars are no longer present on the balance sheet, right? And so if you look at the dividend that's paid versus taxable earnings, it looks like it's fully covered, but not necessarily by current period GAAP earnings. So I wanna make that distinction. What you can earn today on, you know, forgetting the effective hedge and hedge accounting and tax accounting, is extremely attractive if you're hedging with swaps.

Speaker 1

And we really like I said, we haven't seen anything like this, in some time.

Speaker 3

Yeah. I'd just reiterate that point. It's when companies in the space talk about earnings available for distribution and and those those types of non GAAP metrics. We we prefer to talk about tax, I guess. And, you know, for tax, you defer the benefit of those closed hedges and realize them over time.

Speaker 3

But for GAAP, once it's mark to market, it's coming out of book value to the extent that you have it in the money swap, whether it's open or closed.

Speaker 1

Yeah, that's just slightly different way we different tack we take on how we approach that.

Speaker 5

Yeah, I guess just coming back to the economic side of it though, I mean, the dividend on a book value basis compared to the marginal return, it seems like once you take out operating costs, I'm struggling to see why raising capital here is accretive on an economic basis relative to the dividend unless you obviously change the dividend.

Speaker 1

Well, like I said, the dividend that you're paying is closely related to taxable earnings. So but you're not some of that's coming out of book because it's closed. A component of that are the deferred interest expenses associated with hedges that have been closed. And that's coming out of book, simple as that. Those dollars are no longer here.

Speaker 1

Let me explain another way. Let's say you have a billion dollar portfolio and you hedge it. Let's say the market sells off and the value of your assets goes up by a hundred thousand and the value of your hedges goes up by a hundred thousand. So there's no impact on book. Right?

Speaker 1

Now let's say, shortly after that, you close those hedges. The value of the open equity in that hedge, hundred thousand dollars, is amortized against interest expense over the balance of that hedge period. Right? However, in my example, you had a hundred thousand dollar gain on your, hedge and a hundred thousand dollar gain or loss on your assets. Now let's assume that your counterparties are efficient with respect to margining activities.

Speaker 1

So in other words, your hedges went in your favor by 100,000, you called in 100,000, your assets went against you by 100,000, and your counterparties called you for a hundred thousand dollars. So your net economic impact of that is zero. Right? A hundred thousand went in, a hundred thousand went out. So your cash balance is unchanged.

Speaker 1

For tax purposes, that hundred thousand dollars of gain on those hedges, if you close the swaps at the end of that period, is amortized against interest expense for the remainder of that term. Let's say it's a ten year swap. You're gonna reduce interest expense over the remaining term of that ten year swap by a hundred thousand dollars. You don't have that in book value. Right?

Speaker 1

That hundred thousand was sent out to your asset counterparties when they called you. But it's a component of taxable income. So you pay a dividend based on that. And you say, well, look, the yield on that dividend is so high. Why would you raise new capital?

Speaker 1

But how much of that dividend, which is a byproduct of taxable earnings, is actually being earned in the future. It's coming out of book. So you have to look at what are you going to earn on a purely economic basis versus what you're paying on a purely economic basis, apples to apples. And it is higher on the current market.

Speaker 3

Guess I'll just add that the portfolio hasn't changed so much that and it could very well change. If we have to cut the portfolio more, we might get in a position where we're not earning as much. But our outlook now is that we have a tax obligation. We have distribution obligation to pay out taxable income as go through the course of this year. And part of that is attributable to things that aren't on the books anymore.

Speaker 3

So, we don't have a lot of leeway there. We can either pay taxes or we can pay a dividend. With respect to your question about whether or not it's prudent to raise capital, I think either one of us were trying to say that we're 100% going to be doing that. The market's been very volatile. We're just pointing out the fact that we trading close to book, closer than we were, especially when we bought back shares.

Speaker 3

I mean, when we bought back the shares at $6.44 after commissions, book value we estimated at that time was around mid 7 thirty's, right? So that was enormously accretive. It's much less so now is the only point.

Speaker 5

Yeah. I got it. And I I understand the accounting. One last just question and then I'll jump out. So the expectation is that at this current dividend level and based on your taxable earnings outlook that the 2025 dividend would be 100% taxable income and not return to capital?

Speaker 1

Certainly not going to say that in late April. I did mention earlier this year with respect to 2024, the I think it was 96% of the 2024 dividend was taxable. At this point, I would say that does not appear to have changed, but we've got a lot of months to go. And we have no idea what's going to happen. And the last thing I want to do is say on a recorded earnings call that our dividend is going to be all taxable earnings for 2025.

Speaker 1

I have no basis for making such a statement. Year to date, what ended in what was the case in 2024 has been the case. In other words, the percentage of the dividend, its taxable earnings is retained and stayed in that level. The balance of the year is completely uncertain.

Speaker 3

Yeah. Year to date, we've our taxable income has been right on top of our distribution. So, you know, and those are massive estimates at this point in the year. So but we're not formally, you know, doing this, but we do keep track of tax on a month to month basis every time factors come out. And and so far, the distribution has been, right on top of taxable earnings.

Speaker 5

Got it. Alright. Thank you.

Speaker 3

Yep.

Operator

Thank you. Our next question or comment comes from the line of Mikhail Goberman from Citizens. Mister Goberman, your line is now open.

Speaker 6

Hey. Good morning, guys. Hope you're doing well. Much for me given all the much for me given all the terrain that we've already covered. But if I could ask, you mentioned Slide 28 in the appendix.

Speaker 6

Just maybe some thoughts the Rocket Mr. Cooper deal and how that affects what prepay speeds in the MSRs there? Thanks.

Speaker 1

Yes. So just I did want to go over that and I'm glad you brought it up. So on the bottom of the slide, it just shows you by coupon the dollar amount of loans serviced by Nationstar versus our total holdings in that coupon. As you can see, runs in the high single, generally high single to low double digits. I think what's constructive to consider is what percent of the universe is serviced by Nationstar and how do we stack up.

Speaker 1

So for instance, let's say that in the 6% coupon across the cohort, Nationstar service 15% and only 12.1% of ours are. So that's somewhat beneficial position to be in. So that's just kind of observation. We know that Rockets are very fast servicer and we presume that once they start servicing nation star loans, they're going to get faster. So the convexity of the mortgage universe will be impacted in a negative way.

Speaker 1

We own specified pools, specified pools traded a pay up. The reason they traded a pay up is because of a slower speed. Now in this case, it remains to be seen. Certainly the specified polls would be expected to pay faster because more of them are going to be serviced by nation star. Same with respect to the TBA though, the underlying cohort.

Speaker 1

So they're both going to get faster. The question is, does the relative speed stay the same? In other words, does one hundred fifty ks six pay at 80% of TBA or is it pay at 90? That will determine over time how TBAs evolve. That remains to be seen.

Speaker 1

But there's no question that having ROCCAT service a greater percentage of the mortgage universe is not a good thing from the perspective of the convexity of the mortgage universe.

Speaker 3

Yeah. I would just add that we have a lot of discounts. I think this slide kind of alludes to the fact that, at the time we put this together at three thirty one, five and a halfs and below were discounts and six, six and a halfs and sevens were premiums. So we have a little bit of exposure in the premium space, but we've also noticed the rockets are faster for out of the money, borrowers as well. So mixed bag, TBD, I don't think it's today's problem that might be coming down the pike in a few months as the transfers have occurred and the loan officers are able to, you know, start using Rockets technology to try to refi people.

Speaker 3

So, I'm not terribly worried about it. We did see in the GSEs sold some pools, earlier in the month. Fannie Mae didn't really restrict the percent of Nationstar on their their list. I don't it may have even come out before the announcement. But, and then Freddie was Freddie pulled back, limited the amount going into the cash window pools, to 10% going forward.

Speaker 3

I think they've indicated that going forward, they're gonna they're gonna keep that rule in place. We have some things to do to the extent we have a few pools that are, you know, high nation star percentages. We combine them with other other pools we own and get the, you know, kind of the percent nation star slash rocket down. I I don't expect it to be a material impact to the portfolio. It's been certainly something to talk about though.

Speaker 6

Great. Thanks for that. And just a follow-up on a piece of that, slide two slides prior to that. Given perhaps expectations that the margin for Fed easing at some point, what are your thoughts generally on the MBS supply going forward if that were to happen?

Speaker 1

I wanted to mention this. The one thing we don't have in our slide is affordability, which as we all know is extremely low. And if there's any credence to the argument that these tariffs are going to be harmful to growth, slow growth, drive the unemployment rate higher. I see supply getting too high. I mean, far as the coming summer, I would expect it to be a below average supply of summer.

Speaker 1

And there's just a combination of too many factors working against it. Affordability is low, rates are still high. If there's inflationary impacts on these tariffs, it's going to keep the long end higher. And if you have people worried about their jobs, that's not good. One thing that's interesting, you mentioned that, the home sales data that came out.

Speaker 1

New home sales, I don't know what the change was month over month, but if you looked at the details, the number, absolute number of new homes for sale is the highest since 02/2009. We all know what happened in 02/2008 and 02/2009. That's not a good sign. So there's builder buy downs, that's very prevalent. They can support the market that way.

Speaker 1

But I don't think we're going to have a huge surge of supply.

Speaker 3

No, I totally agree.

Operator

All right, guys. Thank you very

Speaker 6

much as always and best of luck going forward.

Speaker 1

Thanks, Mikael.

Operator

Thank you. Our next question or comment comes from the line of Eric Hagen from BTIG. Mr. Hagen, your line is open.

Speaker 4

Hey, Eric. Thanks, guys. How are doing? Hey, good to hear from you guys. I want to ask about whether you think the level of spreads has reset higher, wider as a result of the tariff war, like in a scenario where interest rate vol comes down and spreads tighten.

Speaker 4

Like what do you think the level that we could tighten to is and has that level changed over

Speaker 5

these last few weeks?

Speaker 1

Well, pre COVID, it was 80. I don't think we're going there. We haven't seen on slide 26, banks have been not very aggressive participants. They used to be kind of the backbone bid. Money managers were very supportive of late.

Speaker 1

They've had redemptions. They haven't been tighter. Don't know, you got to depends on your benchmark. Obviously, swap spreads are wider number than the ten year or the five year. I think tightening, but I don't think we're going to have a outsized tightening.

Speaker 3

Yes, it's tough to say. Like on an OAS basis, and versus treasuries, mortgages don't look nearly as compelling as they do versus swaps. I think that's because treasuries have almost kind of traded like a risk asset here in this more recent move in April. So, you know, this could certainly be constrained just owing to the for entering a period of where the market expects increased volatility, that's certainly not good for mortgages and that could keep spreads on the wider side. But it's been amazing to see how with one tape bomb, you know, things tightened back up.

Speaker 3

So, you know, on Fire Pal Day, you know, 04/21, it was looking pretty bleak and then things have just, you know, we've we've come back as much as 26¢ in a couple days very quickly. So so, yeah, I think that comes kind of full circle, I guess. If this is going to be how things are, then I think investors are gonna demand a wider spread to deal with that uncertainty and the ability for them to take leverage down to a more appropriate level for this type of volatile environment.

Speaker 1

I would say one thing. This is purely speculation, though. But if there is really a softening in the economy and it really truly weakens, mortgages could just benefit from spread widening in corporate bond market, high yield and investment grade, and they could be deemed to be more of a safe haven asset. That could be beneficial in the short term, especially if long end stays high and speeds are slow. You could see that in the near term.

Speaker 1

Money managers making relative value allocations, but, you know, they were pretty overweight mortgages not long ago. So I don't know how much more they could go back the other way from where they are now. So no, I don't see any, catalyst for us materials tightening in the near term.

Speaker 4

Okay. I appreciate you guys. What are your thoughts on buying swaptions and the overall cost of hedging volatility right now? Like, do you feel like you have the flexibility and the liquidity to to hedge well if if you if you wanted to? Or or we basically kinda like getting the 20% yield as a result of sort of not hedging that volatility risk?

Speaker 1

Well, it's expensive, right? So, yeah, that's

Speaker 3

a great idea in February.

Speaker 1

Yeah. Putting that on now would be pretty pricey.

Speaker 3

Oh, we do. I think, as you know, we have in years past, we've been quite active in vol trades, really caught off guard by feeling pretty good about the world coming into this the first quarter of this year. So, you know, we certainly didn't see the market reacting to the, you know, the tariff of tariff talks and threats as violent as they did, particularly in the treasury market. So, we yes. It's something that we look at a lot.

Speaker 3

We spend a lot of time on trades that we don't execute. We had a great one that we looked at. It would have been perfect for this scenario. We've we've executed dual digital options in the past, whereby, you know, rates up or down and equities down as well. We had one that we evaluated in December, opted not to do it and kicking ourselves a little bit for that.

Speaker 3

But, yes, we will try to, you know, be more cognizant certainly of volatility. I just think it's it's tough to to leg in right now. That's that's a that's a that's tough trade to do right now. So we're just gonna keep doing as we have been, which is sort of delta hedging and and, you know, staying on top, keeping our leverage in check and and, you know, adding when we've had a few days of strength and to the extent that we feel more uncertain about things, we like to use the leverage lever to really help us manage our risk because we can't ever get away completely away from the risk of this portfolio without some volatility and convexity hedging, but we can insulate it through lowering leverage.

Speaker 1

Yeah. Just one final point, not to belabor it, but a lot of our use of swaptions is usually driven by track of entry points into those positions when those present themselves. And sometimes it's just because vol is lower, sometimes it's because you can do a long and a short to get your own all in cost down. That's just really challenging to do right now. We tend to focus on

Speaker 3

data minimization strategies where we're doing some kind of a spread trade or putting on a trade that is very highly geared where we have defined, you know, kind of a defined risk where we are comfortable losing 100% of our premium, but are looking for outcomes that might have, you know, eight to 10 x multiples of that premium to the extent that hedge goes our way. And these tend to be kind of tail risk type of events. And so, you know, it's just tough to put on a tail risk trade when you're in the middle of kind of the tail. So we're deep in the tail.

Speaker 4

Appreciate all you guys' comments. Thank you, guys.

Speaker 1

Thanks, Eric.

Operator

Thank you. Our next question or comment comes from the line of Christopher Nolan from Ladenburg Thalmann and Company. Mr. Nolan, your line is now open.

Speaker 7

Hey, guys. I'll be short. It seems I'm really surprised by your comments saying the banks are not coming back into the market because, looking at the steepening of the treasury curve, deteriorating commercial real estate asset quality, it would seem to me that the banks naturally be increasing their purchases of MBS. Where am I wrong on that?

Speaker 1

I know they have a Ginnie space. I don't know that we've seen an in structured space in agencies, but not I I don't think we've seen a lot in pass throughs, conventional pass throughs.

Speaker 3

They're there. It's just I don't think enough to overwhelm them. What we've seen in, money management redemptions and hedge funds redemptions that's, you know, deleveraging.

Speaker 1

They may as we speak, because mortgages are attractive. But when you look at early April, when you had all the forced selling, money managers, a lot of t plus one settle because when they get a redemption, they have to meet it the next day. So they're selling what they can, mortgages and treasuries, for t plus one settle. So that overwhelmed it. And that created a very cheap attractive mortgage universe.

Speaker 1

They may be now, but, even really in this week, the commentary on mortgage done well this week, I haven't seen other than Ginny's, and again, it's some structured product.

Speaker 7

Final question would be, on housing affordability on the question that asked earlier. Higher property insurance costs are part of it. In some places, you can't even get homeowners insurance. And my question is, why hasn't there been new insurance pools formed for home insurance because rates are so hard there?

Speaker 1

Don't know whether Oh, it's really hard. Mean, to me that's, well, two things. One, the yield book, which we all in this space use, updated their model yesterday. One of the changes in the model was to reflect the slow prepayment activity of Florida pools because of insurance. Insurance is very, very high.

Speaker 1

I've always been a believer that global warming will manifest itself through that. Given what's happened over the last six months with fires in California, hurricanes here, reinsurance prices are on the moon. Don't a new pulse, I mean, I think that's a government source from the government. Private capital to be very expensive. I would think the risk premium associated with entering that business would be very, very high.

Speaker 1

Whether you believe in global warming or not, there's no question in the last few years between hurricanes, floods and whatever, they're not they're very, very high and the costs are staggering and you have to deal with regulators. Look at California where when they set insurance rates, it's backward looking based on historical, losses versus projected losses. A lot of the high end homes in California are insured by D and O providers, which have staggeringly higher premiums and base what they call retention or or deductibles. I think there's gonna be meaningful money brought to the insurance market. It's gonna have to come from the government.

Speaker 7

K. Thank you.

Speaker 3

Yep.

Operator

Thank you. Again, ladies and gentlemen, if you have a question or comment at this time, please press star one one on your telephone keypad. I'm showing no additional questions in the queue at this time. I'd like to turn the conference back over to Mr. Cawley for any closing remarks.

Speaker 1

Thank you, operator, and thanks, everyone, for listening in. To the extent that a question comes to mind after the call or if you listen to the replay and have a question, please feel free to reach out to us at the office. The number is (772) 231-1400. Otherwise, we look forward to talking to you at end of the second quarter. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.

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Earnings Conference Call
Orchid Island Capital Q1 2025
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