Release Date: July 26, 2024
For the complete transcript of the earnings call, please refer to the full earnings call transcript.
Positive Points
- Orchid Island Capital Inc (ORC, Financial) raised substantial capital, increasing the portfolio size from $3.9 billion to $5.1 billion.
- Liquidity remains strong, representing just under 50% of equity.
- The company has been deploying capital into higher coupon securities, increasing the weighted average coupon from 4.38% to 4.88%.
- Net interest spread improved from 2.47% to 2.64%, with room for further expansion.
- The company is well-positioned for potential market changes, with a strategy that benefits from both rate rallies and sell-offs.
Negative Points
- Orchid Island Capital Inc (ORC) reported a net loss of $0.09 per share for the quarter, compared to an income of $0.38 in the previous quarter.
- Book value declined by approximately 5.9%, from $9.12 to $8.58.
- Total return for the quarter was slightly under negative 2%.
- The leverage ratio increased slightly, now in the mid-7s, which could pose risks in a volatile market.
- The housing market remains weak, with high mortgage rates and low affordability impacting turnover and inventory levels.
Q & A Highlights
Q: Could you comment on the pace of deployment over the quarter of the ATM issuance and if that represents any sort of meaningful cash drag? Or were you able to get that invested relatively simultaneously?
A: We did wait a little bit in June. We raised a lot of money in ATM in June, and with the market, especially the mortgage market underperformance late in the month, we did wait. So we didn't deploy most of that until July. So that would cause a slight drag for the first month because we just have less income on more shares, but we then did deploy it. We're fully deployed at this point, although our numbers in June and July would not reflect being fully invested. The money will be fully put to work starting in the month of August.
Q: Where do you think benchmark mortgage rates or spreads have to come in for you to begin to get really concerned about your convexity exposure?
A: The current coupon is about 5.58% or 5.60%. We have a lot of 6%s and 6.5%s. They would have to be quite in rally for those to become meaningfully in the money and become a concern. Exact number, you're probably looking at, I don't know, 25 basis points or more. The strategy has been to stay sort of close to TBA, recognizing that convexity risk, and monitoring our hedge ratios as they change from day to day.
Q: What is the current cash ROE of the portfolio and what are you seeing in terms of incremental capital deployment on current cash ROEs?
A: We've seen, we were at [150] for quite a while. Now, we're getting closer to [200] over, especially as we've been using more of the longer-dated swaps. Yields on the new acquisitions were in the very, very high [5s] on average and using a combination of 7- and 10-year swaps therein, depending on when we put them into the low [4s] or even high [3s]. With 7x leverage, 7.5, those are pretty decent ROEs.
Q: How are you looking at the spread duration and hedging risk on the pay-ups?
A: We've seen that be very painful in the past. We try to avoid that as much as we can. We have not been buying all loan balance 7%s, for instance. The pay-ups are a little bit different than the traditional pay-up stories. A lot of times, the pay-ups that is embedded in some of those less expensive stories is really months to breakeven sort of play. They do carry a little bit better than worse to deliver. We don't expect them to defy gravity into a huge rally.
Q: How are we thinking about the range for your leverage right now?
A: The range is 7% to 8%, maybe a little less than 7%. We're about 7.5% now. We were right around 7% and 7.1% at the end of the last few quarters. I would say at the moment, I don't see a reason to take it meaningfully higher. We think this fall could be very volatile, so we're content to sit at this level for the time being.
Q: How are we also thinking about repo rates in light of higher volatility?
A: Repo rates have been remarkably stable despite the volatility. We're taking longer term, putting on some longer-term repos or two, three months, every day that passes start incorporating more of that September rate cut that's baked into the market. So spreads may widen out a little bit, but I think we'll see the nominal level of repo rates come down.
Q: Are you thinking about book value stability or book value growth in a lower rate environment?
A: Stability versus growth. I don't know that we have that quite an outlook. I think as I said, I'm going to see the curve steeper on the front end. So obviously, the swaps are going to suffer there. But if you look on the asset side, especially with large allocations of 3s, I think a lot of that can be offset. So I guess, without thinking out too much, it would be stability, but there is certainly room for growth.
Q: What was the average share issuance price for the ATM in the quarter?
A: It did vary quite a bit. I would say in the second quarter, we were probably around 97% of book on repo we are selling, what was moving around. The last sales we did were even in the [8.60]s gross, but the stock has since fallen back. So we traded in quite a range probably [8.25 to 8.75] throughout the second quarter, and the selling price tracked bulk more -- like I said, it was kind of 97% of book of gross, maybe 97.5%.
Q: Given that you're raising equity capital, which is dilutive to book value, how much of the swing in book value in the second quarter was due to these capital raises?
A: About $0.09. We had GAAP earnings of negative $0.09 and we paid dividends of $0.36. So if you don't issue any shares, the change in your book value is just going to be earnings less the dividend, right? So minus $0.09, minus $0.36 gets you to minus $0.45. But we did issue shares and book was down $0.54, so that delta is $0.09. It was attributable to share issuance.
Q: How long will it take for the portfolio economic return of 28% on average invested capital to converge onto the marginal investment return on the cash ROE of approximately 19%?
A: The convergence, if we were to get an easing cycle, would be more mortgage tightening. If mortgages don't tighten at all for the next two years, as we raise capital, we will continuously dilute the return, the NIM. But there is potential for price return, and that would cause the marginal return to be higher. The rationale for doing so is the expectation that there's the potential for a fairly meaningful price return because we're putting the money to work at assets that we view as historically cheap.
For the complete transcript of the earnings call, please refer to the full earnings call transcript.
