Orchid Island Capital, Inc. Q1 FY2024 Earnings Call

Good morning, and welcome to the First Quarter 2024 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, April 26, 2024. 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-K. The company assumes no obligation to update such forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking statements. Now I would like to turn the conference over to the company's Chairman and Chief Executive Officer, Mr. Robert Cauley. Please go ahead, sir.

Thank you, operator, and good morning. I hope everybody has had a chance to download the deck as usual, as that will be the centerpiece of today's discussion. So I'll be walking you through the deck, and then at the end of that, we'll have a Q&A session. As usual, I'll just give you a quick rundown of the agenda. First, we'll go over our results for the quarter, discuss the market developments that shaped our results, and provide our outlook for the future, and then we'll dig into the details of the portfolio and our hedge position. So turning to Slide 5. For the first quarter of 2024, our net income was $0.38 versus $0.52 million in Q4 of last year. Our book value increased slightly by $0.02 over the last quarter. Total return was 4.18% versus 6.05% in Q4, and the dividend was unchanged for the quarter. The average MBS portfolio appears to have declined on Slide 6, but that's somewhat misleading because in the fourth quarter of last year, early in the quarter, we had to deleverage when rates were peaking, and so that calculation is just a simple average of the beginning and ending, which makes it look like it was higher. But if you look at where we were at the end of Q4 versus where we were at the end of Q1, there was not a meaningful change. Leverage increased slightly from 6.7% to 7%. Speeds increased slightly; that's probably more seasonal and just aging of the portfolio slightly. And then liquidity improved slightly over where it was at the end of the fourth quarter, but again, right in the middle of our target range. Slide 7 provides just our preliminary balance sheet income statement. We expect to release our 10-Q sometime today, so you'll get the final numbers. We do not expect these to change. With respect to Slide 8, this is what we call our adjusted economic income. I like to do two things here: one is just walk you through these numbers on the top of the page to show you where they come from, and then at the bottom, just show you on a per-share basis and make a couple of comments about the dividend. So regarding the top, the interest income number comes right off the balance sheet; it is representative of the number we would report for tax. The next number is just the accretion of premium amortization, which is down slightly this quarter. The next item is interest expense; that is both a GAAP number and actual dollars paid in interest expense. Finally, the last two, the hedge number is a close proxy for what we report for tax. This number is a very good approximation of what we would call taxable income. It's not exact, but it is at least representative. On a per-share basis, you can see $0.47, which is above the dividend. So it appears that we're comfortably earning the dividend. We will reassess as we always do as we move through the year to see if there's a need for an adjustment to the dividend after the second quarter, as of now, we'll see. Turning now to market development. The top left is an interesting slide. I want to walk you through this. This is a Q1 discussion. The bookend dates would be 12/31 and 3/31. The orange line represents the peak in rates last October. We had this strong rally between then and the end of the year when it appeared the Fed was about to pivot. Since then, we’ve retraced, and at Orchid, we thought that rally was overdone; our hedging strategy reflected that. The green line shows where we were at the end of the quarter, and the blue line is where we were last Friday, indicating a retrace of that rally. On to the next slide, this is just the current coupon spread. If you look at where we were at the end of the quarter, we were kind of at a range that had been in place since early '22. Mortgages did quite well in the first quarter but backed off since then. On a historical basis, we're still wide by historical standards. Looking at the absolute price change in these various coupons, most mortgages have performed fairly well relative to hedges. With respect to roles, most roles are negative, except for the production coupons. Turning to Slide 12 now. Volatility is a very important driver of mortgage performance. At the end of the year, volatility came off meaningfully, which is supportive of mortgage performance. During the first quarter, there was quite a bit of inflows into money manager funds, presumably out of equities, which made for a good quarter. However, we could see some reversal looking forward, yet we're still not in a bad place. The prepayment activity has really not changed. The average rate has likely gone up a bit, but it is still elevated, with the refinance index at extremely low levels. Additionally, I’d like to add a thought on the economic backdrop of our business. We see a correlation between money supply and economic growth, particularly since the pandemic. The money supply has increased substantially due to outsized fiscal deficits, impacting the growth rate of the economy. Now moving on to the portfolio, I think you need to understand where we were coming into the year. In Q4 2023, we saw the Fed pivoting, and the market quickly priced in six cuts in 2024. We did not buy that, as we thought it was overdone. As we enter 2024, the data has remained strong; inflation has been strong every month. It’s safe to say the pivot is on hold. In essence, we're looking at a status quo outcome where conditions remain as they are, and that's not a bad outcome. Our hedge positions have allowed us to navigate the market effectively, and our net interest margin has actually increased. We continue to migrate to higher coupons. The realized yield on the portfolio increased from $4.71 to $5.03 for the quarter. As we move forward, our target structure is a barbell, with an overweight position in lower and higher coupons, trying to avoid middle-range coupons where performance is more challenging. Our funding and hedging strategy has also remained solid; our economic cost of funds has actually decreased this quarter. Regarding the hedge positions, we added slightly to our swap positions. We're also utilizing a dual digital option to hedge against certain market conditions. Our focus is on maintaining a barbell structure that allows us to mitigate risks and perform in various conditions. The uncertain macroeconomic environment remains a challenge, but we believe we're well-positioned regardless of how the market unfolds. Now, let’s open the floor to questions.

Your first question comes from the line of Matthew Erdner with Jones Trading.

Can you talk about the repo markets, the overall health, and how they're functioning right now?

We see no sign of distress. We've actually added some counterparties, and we're exploring more options. We have adequate funding and have not seen changes in haircuts. There might be some month-end oddities driving rates up slightly, but generally, our funding book has diversified adequately across around 25 lenders. Haircuts have slightly decreased, so it seems pretty healthy. However, we know that can change swiftly.

I see the move up slightly in coupon kind of hitting the lows and the highs there in the stack. Have you continued to add higher coupons in the second quarter consistent with the strategy you've laid out?

Not yet, but that's on the horizon. I was unable to use the ATM in the quarter, but the plan is to continue doing that in the near future. We’ll have more progress to discuss at the end of the second quarter.

I hope you guys are doing well. Thanks again for the slide deck. I didn't know it was possible to make it better. It’s really good stuff, especially Slides 16 and 17. Could you flesh out your comments on the dividend from early in the call? You mentioned something about the second quarter, correct?

Sure. The dividend is obviously $0.12. Our proxy for taxable income is running above the dividend, so we will reevaluate if there's a need for an adjustment. We intend to revisit midyear after the second quarter, updating our taxable income estimate year-to-date, and weighing that against the outlook for the rest of the year.

Is that adjusted economic income per share the one for Q2 that you were reporting in July, August, driving any sort of decision?

Yes, that will be part of our decision-making, along with the outlook for the future.

The deck is great, and Bob, I liked your comments. I thought your stuff on the M2 money supply was really interesting. Anyhow, you're dealing with a lot of cross currency here on the macro level. What do you see benefiting more, earnings or book value, or neither?

In a stable scenario without violent sell-offs, book should remain stable, and we can earn the dividend. However, the yield curve has been inverted longer than it ever has been. Eventually, the curve should revert to a more normal shape; the question is when. Given the current fiscal environment, we think inflation will remain elevated. If nothing changes, our book should be stable, and the dividend is well covered, which is a good outcome for us.

Yes, I think that’s the environment where volatility comes off in a rally and just stays range-bound. The last six months have been extremely volatile. As the market processes what exactly is going to happen with the Fed, we have several hedges on the front end of the curve. We are in good position; it won’t be fun if more hikes start getting priced in, but if the market stabilizes, it will create an attractive environment for us.

There are no further questions at this time. I'll turn the call to Mr. Cauley for closing remarks.

Thank you, operator. Thank you, everybody. If other questions come up after the call or if you listen to the replay, feel free to call us at the office. Otherwise, we look forward to speaking to you at the end of the second quarter.

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