Earnings Call Transcript - ORC Q1 2020

Operator, Operator

Good morning and welcome to the First Quarter 2020 Earnings Conference Call for Orchid Island Capital. This call is being recorded today May 1st, 2020. 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 files 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 factors affecting forward-looking statements. Now, I'd like to turn the conference over to the company's Chairman and Chief Executive Officer, Mr. Robert Cauley. Please go ahead sir.

Robert Cauley, CEO

Thank you, operator, and good morning, everyone. I hope you are all safe and have not been negatively impacted by the pandemic. Hopefully, by our next quarterly call, this will be mostly behind us. This quarter was heavily influenced by COVID-19, and I won’t follow the usual practice of going through the slides in order. The events we encountered this quarter don’t lend themselves to that format, so please bear with me as I navigate the slides a bit differently. I will focus on six key points and refer to the slides as needed. I will not cover every slide, concentrating instead on those that support my main points. The six points I want to emphasize are: first, a brief overview of Q1 without dwelling too much on it; second, I'll revisit our investment strategy and highlight how it contrasts with other mortgage REITs; third, I will review our actions throughout the quarter as events unfolded; next, I’ll discuss our financial results; then, I will share our current positioning, how we perceive the future, and our expectations for rates, speeds, and spreads; and finally, we’ll open the call to questions. Starting with slide seven, which illustrates what occurred with the treasury and dollar swap curves. A crucial observation is that financial markets were the first to feel the effects as the crisis unfolded. The stock market and subsequently the fixed income markets reacted swiftly once the extent of the measures needed to control the virus became clear, making the economic impact obvious and severe. The first noticeable trend was the surge in demand for cash and liquidity as individuals anticipated job losses, businesses saw revenue declines, and investors sought to mitigate losses. This rush led to significant deleveraging among leveraged investors and was seen primarily through sales made in mid-March. The first markets affected were the most liquid ones, as these showed the smallest losses or easiest positions to exit. Consequently, treasuries and agency mortgage-backed securities initially felt the impact. This mass selling led to further selling and deleveraging to satisfy margin calls. On slide 10, you'll see the agency mortgage market trends throughout the quarter, where TBA prices, despite declining rates in March, actually dropped. The performance of TBA mortgages versus hedges was extremely poor, with instances of the 10-year treasury climbing while certain mortgage securities fell. Hence, these liquid markets generated the majority of sales. In response to the situation, the Fed intervened quickly in three phases, starting with a rate cut on March 3 and more substantial measures on March 15, including slashing the effective fund rates to near zero and announcing a considerable asset purchase program. By the end of that week, it was clear that more action was needed, as the offers to sell overwhelmed the Fed's purchases. By March 23, the Fed announced they would buy whatever it took to stabilize the markets. By looking at the TBAs on Page 10, you’ll note how quickly the market responded to the Fed's large asset purchases, initially exceeding $100 billion a week, before tapering down significantly. They have committed during their recent meetings to continue supporting these markets. Switching to our investment strategy, Orchid has remained focused solely on the agency market since inception. Within that scope, we have a strong emphasis on pass-throughs, with very little investment in agency MBS or multifamily. We've utilized derivatives, including IOs, in the past but tend to focus on a narrow section of the agency market, mainly spec pools from Fannie and Freddie, benefiting from our strategy during this quarter. Moving to Slide 13, you’ll see how the performance dynamics from Q1 this year starkly differ from 2019; last year was characterized by a high-risk appetite, while Q1 2020 saw agency mortgages perform positively against a backdrop of losses elsewhere in the fixed-income market. On Slide 30, sourced from BAML, you'll find returns across various sectors for 2020, highlighting that agency mortgages ranked high with an impressive return amidst declines in other fixed-income sectors. Our focused strategy has resulted in less erosion of book value compared to peers, allowing for a quicker recovery once the Fed stepped in. We have been able to capitalize on attractive net interest margins and compelling returns on equity. As we moved through the distress of the quarter, we prioritized maintaining a reasonable leverage ratio of 8.5% to 9.5% while ensuring adequate cash liquidity. We significantly reduced our hedges early on as rates rallied and the situation led us to believe the economy would continue to face challenges. We began selling assets on March 16, ultimately selling about $1.1 billion in mortgages by the end of that week, incurring losses of approximately $30 million. Our sales targeted lower pay-up specified pools or faster-paying bonds to minimize losses since we anticipated future paydowns and margin calls. To summarize, we met all margin calls decisively, maintaining our unrestricted cash and unencumbered assets at historical ratios. Furthermore, all asset sales were conducted at the discretion of Orchid management, never pressured by counterparties. Regarding our financial results for the quarter ending March 31, 2020, Orchid experienced a net loss of $1.41 per share. Excluding realized and unrealized gains and losses on RMBS and derivatives, our earnings per share stood notably higher. By March 31, our book value per share was $4.65, marking a decline from the previous year. Despite this downturn, our market has seen a quick recovery since the Fed's intervention, with our book value climbing to about $5.14 by the end of April. Looking ahead, our capital allocation within pass-throughs has significantly increased and focuses on high-quality specified pools. We have reduced our exposure to CMOs and repositioned our portfolio towards higher quality, lower pay-off specified pools to manage risk. Regarding our hedging positions on Slide 26, we have reduced euro-dollar exposure and are maintaining a significant portion of our hedges. We expect funding rates to remain low near the end of the year, which informs our hedging strategy. Overall, we anticipate a continued low-interest rate environment. We expect our interest expenses to decrease further as our repos roll off, allowing us to benefit from the Fed’s cuts, despite a reduction in revenue side assets due to the portfolio size. Concerning refinancing speeds, we expect high activity in upcoming months despite the constraints posed by COVID-19 affecting loan originations and approvals. This dynamic reflects the differing conditions in the market, with an eye towards long-term recovery. In conclusion, our mortgage performance has been favorable and we remain optimistic about the attributes of the agency mortgage sector, which we believe will provide solid returns moving forward. Operator, that concludes my prepared remarks, and we can now open the floor for questions.

Operator, Operator

Our first question comes from Christopher Nolan with Ladenburg Thalmann.