Good morning, and welcome to Q1 2022 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, April 29, 2022. 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, beliefs 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, everybody. I hope everybody's had a chance to download both our press release as well as our slide deck. I'm gonna follow a similar format. If everybody's ready, I will begin. First, I'll just kind of give you an overview of what we're gonna discuss. As usual, just briefly touch on our financial highlights, then we'll go through market developments quickly and our financial results, and then talk about the portfolio positioning and so forth. With that, on slide 4, Orchid Island Capital reported a net loss per share of $0.84. This was actually net earnings per share of $0.20, excluding realized and unrealized gains and losses on RMBS and derivative instruments, including net interest expense on interest rate swaps.
A loss of $1.04 per share from net realized and unrealized losses in RMBS and derivative instruments, including the same net interest expense on swaps. Book value per share was $3.34 at March 31, 2022 versus $4.34 at year-end. In Q1 2022, the company declared and subsequently paid 15.5 cents per share in dividends. Since its initial public offering, the company has declared $12.635 in dividends per share, including the dividends declared in April. Total economic loss was $0.845 per share or 19.5% for the quarter. Turning to slide 5, this first slide pictures our stock performance at Q end.
As you know, we did have reductions in the dividend twice, and we did have a book value decline, which obviously the market anticipated. As a result, Q1 on our stock-based performance lagged our peers meaningfully, and this really has changed all of the comparisons versus our peers on a 12/31/2022 look back. It really reflects probably what happened in Q1. If you look at the calendar periods on the bottom of the page, you can see these are results that we are very happy with. However, Q1 is not something we're happy with, but it obviously happened, and we have to live with it and move forward. Turning to the next page, this is our book value performance. This tends to be with as always a one-quarter lag.
You see, through the end of 12/31/2021. We don't have updated information. Now that'll begin as being as a lag. Turning to market developments, just gonna kind of give you a high-level view of things before I go through the slides, and you can see the pictures and I can fill in from there. If you look at the backdrop of where we were before Q1 , inflation started to accelerate in Q2 of last year. That's continued well into 2022 already. Over that period, the Fed kind of gave up on their notion that inflation was transitory. The big developments in Q1 were two, and these are very meaningful and really caused everything to change.
The first was the war in Ukraine between Russia and Ukraine, and then the second is COVID-19-induced shutdowns in China. Both of these have proven to be very inflationary, and they're expected to continue to be so for some time going forward. The net result of this are three developments. The first, the Fed has adopted a very aggressive tightening stance. They expect to get to neutral by the end of the year, which is somewhere in the 2.50-2.75 range. The second is that interest rates are much higher, and the curve is very much flatter. The third, and this is more germane to Orchid obviously, is that the MBS universe now is essentially all discount.
I mean, in fact, most of the mortgage universe is at a very deep discount, well below par. To give you some added color around this, there's only about 1% of the mortgage universe that's in the money or refinancable. The current coupon mortgage represents about 1% of the entire outstanding universe. That is something we've never seen before. Obviously, profound change this quarter, and as I said, brought about by these two events, which are very significant events, but also will play heavily in terms of what we see over the course of the balance of the year. Now just turning to the slides. A couple things that I point out.
On the left-hand slide, you can see the red line is where we stood at the end of the year. The blue line is the end of Q1 . Obviously a meaningful move. The green line is through last Friday. As you can see, the market has continued to both sell off and flatten. This is also reflected in the swap curve. At the bottom of the page, we show the change. That's through last Friday. That's not through quarter end. Turning to slide nine, you can see how things really pivoted in late February when the war began in the Ukraine. We had had a sell-off into the early parts of Q1 , but this really accelerated when the war started.
I just want to point out that many of these slides go through 4/22, not just the end of this quarter. Through 4/22, the nominal or the cash ten-year was up 139 basis points, swaps at 137. Turning to slide 10, this is the slope of the curve, 5-10. As you can see, we have flattened materially. The lows previously were in July 2018 have been taken out. As we sit here today, we're actually toggling right around zero. It's actually been negative a couple of times this morning already. Turning now to the mortgage universe. Top left, you can see this is the same slide we've been presenting for some time. We've kind of normalized prices starting at the beginning of the period. Each line represents a respective coupon.
What this shows is just the price change relative to where the price was at the beginning of the quarter. These are not necessarily actual prices. As you can see, it's been a meaningful sell-off. Again, this data goes through the April 22nd. You can see through the end of Q1 , there was a meaningful sell-off. In the case of Fannie 2s, for instance, the longest duration assets, they were down about 7 points at the end of the quarter, but now they're down about 12. April obviously has witnessed even more sell-off than what we saw in Q1 . As the market is now predominantly in a universe of this composition, call protection as reflected in the specified pools payoffs have collapsed. Arguably, these payoffs just reflect option value, if you will, to the extent the market rallies.
With respect to rolls, you can see there's only 2 rolls that are trading above the rest that are at very, very elevated levels. Those are the current production coupons, 4s and 4.5. Really what that reflects is a lot of mortgage investors wanting to own the current coupon, and there just isn't enough supply. You have a big supply-demand imbalance. Even the Fed's exacerbating that for the time being. You have specialness in the roll. The rest of those rolls are actually trading at or below carry. Moving on to Slide 12, vol, as you can see, is very elevated. Not quite as high as it was in March of 2020 when we were north of 160 in this particular index, but very, very elevated. Moving through the rest of the slides, I'll just accelerate now.
I think we've made the major point here. You know, the LIBOR OAS on Slide 13, obviously we've had some cheapening and specified pools payoffs, as I mentioned, have collapsed. Slide 14 just gives you a picture of the whole financial markets, really. The top chart shows you the Q1 returns and the bottom one is through the end of last Friday. You can see all these returns are negative. Obviously mortgage is the one that's in green, had a rough quarter, but every sector did, including equities, S&P 500. It's been a very difficult quarter for all financial market participants. Slide 15 is an important slide. As I mentioned, if you look at the bottom of this slide, you can see the shaded area. That represents the percentage of the market that's in the money. As I said, it's only 1%.
We really have had a paradigm shift whereby the market went from very much premium with the Fed buying and driving up prices and everybody was concerned with prepays. You had two ways to avoid those. Either you'd use the dollar roll market or you own specified pools and you were trying to minimize premium amortization. Well, now we're all at a discount. Now it's no longer premium loss due to paydowns for us. It's discount accretion. Fast speeds went from being a bad thing to a good thing. High- gross WAC on pools was a bad thing. Now it's a good thing. If you look at the right side, I'll just make one point here. This is kind of germane, I think, for what we see going forward. You can see the primary-secondary spread looks very volatile.
I think that speaks more to the volatility of the underlying, which would be rates because they've been so volatile. It also points out the fact that originators, now that the universe is at a discount, are doing everything they can to maintain production volumes. That's primarily in the form of cash-out refis or turnover. It also points to the fact that they're going to have a challenge to keep their production levels and their staffing levels higher. Really, it just speaks to the fact that all rate sensitive sectors of the economy are going to be feeling things. Now our financial results, slide 17. As you can see, if you kind of try to dissect what happened, the left-hand slide just shows our returns absent the unrealized gains and losses. As you can see, those numbers were large.
It's really all because of the pass-through portfolio. The pass-through portfolio had an annualized return of almost negative 40%, obviously a very big number. That was really driven by the performance of TBAs. If you look on that chart there, you see realized and unrealized losses of $378 million. Outside of realized losses, over 80% of our mark-to-market losses for the quarter were the result of changes in TBA prices. About 17%, 17.5% were the erosion of pay-ups on specified pools. The rest was just premium loss. You may wonder how we could have premium loss, but that's just because that's a function of prices at the beginning of the period when the portfolio was still at a premium. Turning to slide 18, this is just a picture of our NIM, if you will, and shown kind of along with the dividend.
It appears that our funding costs went down. That's really just some timing differences there. Obviously, our funding costs will be going up. Even with hedges, there's probably gonna be some modest upward pressure. This number dropping down just kind of reflects the fact that our hedges started to move up faster than our funding costs. You should see that be stabilized. You may see slight upward trend in the funding cost. Net of the hedges in the NIM remains to be seen. That'll be predicated on how the asset yields go. Slide 19, just again, this shows you our proxy for core income. This red line, as you can see, it's been running in the low 20s. Our ultimate low was back in 2019 and 2018, and it's been fairly stable since then.
We expect it to remain so, but there's still a lot of wild cards on the table. We'll have to see how things play out. Slide 20 just shows you our dividend versus our peers. We will say that in this type of environment where the curve is very, very flat and liquidity is at a premium, this is not going to be an emphasis. We're going to manage the portfolio as prudently as we can. We don't know what our peers will do dividend-wise, but as you know, we've reduced ours twice just to reflect current market conditions. We don't know what the future holds. We just, you know, hope that all of that's behind us.
Again, there's just a lot of moving parts in the economy, so there's potential that you could have movements both with us or anybody. It's really hard to say what's gonna happen to relative dividend performance, but I don't think it's a primary concern for any of us. Slide 21, this just gives you the two important things, the roll forward of each portfolio and then the capital allocation. As you can see on the left side, the main development here is the allocation to IOs has increased and pass-throughs has decreased. We had mentioned last year that because of the current market conditions that we were going to take our allocation to IOs up. We had mentioned on previous calls a target of around 25%. We actually got up to 38%, beyond that.
Now, what does that mean going forward? It's kind of hard to say. IOs have obviously had a good run. While we would like to own some more, they're really becoming somewhat rich, and it's hard to find value. There might even be some good sale candidates, and we have actually sold a few in early 2020 in Q2 . Some of the details of the change. The sales that we did in the quarter were predominantly in the pass-through portfolio. We'll talk about that in a little more greater detail in a moment. We had pay-downs as well, and then mark-to-market losses. Suffice it to say, these asset sales occurred to maintain leverage, but also just to shed duration. We did not reinvest pay-downs for the most part.
That's how we migrated the portfolio to its current position. Now we'll talk in a little more detail about the portfolio. Before I do that, I just want to say a few words, kind of give you some background. As you recall last year, through most of the last three quarters of the year, we had talked about being positioned defensively. We thought that the Fed was going to end their tapering program, and that we were trying to do everything we could to minimize the impact on us. Obviously, we are an all-agency REIT, so we're kind of locked in the building, if you will. We have to own mortgages. We tried to avoid production coupons, and we took our allocation up to IOs to a higher level, and we own specs.
Even to this day, we still see long-term value in them, even though they're trading at fairly distressed levels. While the Fed. You know, we were right, the Fed did exit, but obviously the events of Q1 , especially the second half, have changed things quite materially. You know, that positioning and the way we looked at things last year is really doesn't apply as much to the current environment. Just again, to review the actions that we took, we did reduce the portfolio. We had approximately $1.4 billion of sales of pass-throughs. Those were mostly lower pay-up specified pools, mostly lower coupons, 2.5s. We had about $147 million in pay-downs and $10.5 million in return of investment on our IOs, which was not reinvested.
All of this was enough to not only allow us to maintain very high- levels of liquidity, but it also allowed us to actually lower our leverage ratio. From the low 8s to the mid 7s, we're actually below that today. We probably won't go meaningfully lower than this. This is probably the floor. With respect to post-quarter-end, we have done some up-in-coupon trades, both 30-year and 15-year. We will continue to refine our hedge positions. We'll talk about that in a little bit more detail. The important thing and the key takeaway here is that while it was a very difficult quarter, we were able to navigate through it successfully. We did have to shrink the balance sheet somewhat to maintain leverage at prudent levels.
We also did so in a manner where we could maintain very high-l evels of liquidity. Our target is to maintain 50% cash. That's not even including unencumbered assets, just cash relative to equity, because first and foremost, we need to be able to weather any of these storms. We've obviously had some very volatile days in the market, days with, you know, mortgage underperformance versus hedges, you know, margin calls. We want to always be in a position where we can deal with those quite comfortably, and we have. We know this is a difficult market environment. We also know it's not likely to last indefinitely.
Given the very favorable opportunities that are in the market today, we want to be able to take advantage of those once the market has stabilized and we're in a position to do so. Now with respect to the portfolio on slide 23, just going through the column for fair market value on the pass-throughs. Two big changes. With respect to 30-year 2.5s, you know, we took that down very materially. Sold about $941 million, mostly in, again, low pay-up specified pools. We sold over $900 million in 30-year. Same thing, predominantly in low pay-up pools. Our weighted average coupon as a result of the relatively more sales to 2.5 versus 3. Weighted average coupon's a little higher. Went from 2.93 to 3.01.
We did not reinvest paydowns, and so our portfolio has aged by four months. Speeds remain very subdued, you know, high- single- digit, and we would expect them to stay there, if not even decline. We did make meaningful changes to the hedge book. We'll get into that a little in a moment here. If you look at the notional amount of the hedges versus the total mortgage assets, the coverage went from about 45% to closer to 80. That's notional. That's somewhat misleading because the DV01 of our hedges is quite high. In fact, we have a lot of ultras in our swaptions positions and so forth.
If you look, for instance, on the far right column, and you look at our rate sensitivity to ±50 basis point shocks, you can see it's a very flat profile given the size of this portfolio, and that's much flatter than it was at the end of the year. That really is consistent with what we're seeing, even though rates, as I mentioned earlier, have sold off quite a bit in April, and mortgages have widened, our book value's probably down just a few pennies. We really trade pretty much in line to hedges net net, so far. It basically reflects the fact that mortgages have extended, and, you know, they kind of trade in line with the hedges. Even though it's a high-rate environment, it's stabilized.
That reflects the nature of the hedges we have and the assets that we own. Slide 24 is interesting. This is something we used to take great pride in because we've reflected well on our asset selection, our prepayments versus the cohorts. This is of course, you know, backward-looking, so it's our legacy portfolio. As I mentioned, we have not been reinvesting too much. We've done some up in coupon trading, but it also kind of reflects kind of the prior reality that we lived in, which is where premium amortization was the thing you avoided, and everybody was trading at a meaningful premium. Now, obviously we're at a discount. You could see these slides change going forward. Slide 25 is just the same point. The red line or the orange line there is the 10-year Treasury.
This one only goes through the end of the quarter. That number is now at 2.9 or so. The prepayments you would assume in this environment are gonna stay low, kind of like they were in 2013 and 2014. I'll mention on slide 26 our leverage ratio is down. It's actually down a little bit from where it shows here. We're probably pretty much where we want to be. Finally, slide 27. These are our hedges. Just make a few points here. On the top left, we have our Treasury futures, and we've shifted those materially. These numbers are up higher. The five-year sector is up by almost $1 billion and the ultras by not as much, about $50 million.
We have no TBA shorts in place at quarter end, although we have placed some on since quarter end. We have some shorts in Fannie twos. Then with respect to swaps, the belly or the 3- to 5-year has come down. We've moved our swaps out the curve. That was about $950 million. At the end of the year, it's only about $300 million. Then expiries greater than 5- years was about $400 million. Now that's $1.1 billion. You can see the average pay fixed rates. Those have all obviously are very much in the money in this current environment. They are effectively helping us with our increased funding cost. With respect to the swaps and swaptions, I'm not gonna say much about that.
If somebody wants to ask a question or wants detail on that. What I would say about those is that we dynamically hedge those positions. As our strikes move more or less in the money, we take action to ensure that they're going to work as effectively as possible going forward. In this environment, that basically means taking some profits and extending strikes higher. That has worked very well for us and probably explains why we've had the stable performance we've had so far in April. With that concludes my prepared remarks. Operator, I will turn the call over to questions. Thank you.
Thank you. To join the call to ask a question, please dial 1-888-510-2356. We'll pause for 30 seconds to allow time for you to dial in. At this time, I would like to remind everyone, in order to ask a question, press star one. We'll pause for just a moment to compile the Q&A roster. Our first question comes from Mikhail Goberman with JMP Securities. Your line is open.
Hi, good morning, gentlemen. Hope everybody's doing well.
Morning.
Good. Good.
I apologize I missed a good chunk of the call. I had a little trouble getting on, so I apologize if you mentioned if you covered something that I'm about to ask. I do believe I heard you saying that IOs are becoming a bit rich. You've already sold some in Q2 . If that's the case, how much have you sold?
Hang on, I've got some numbers here. I can be a little more specific. In Q1 , we sold roughly $80 million worth of IOs backed by loan balance threes. You know, the profile as of March 31st, those would be out of that. In the last month or this month, I guess I should say, we've sold another $200 million, it's like $35 million market of loan balance three and a halves.
Okay.
Those, again, as kind of alluded to, they extended pretty much as far as they could. They just get to where the profile's very asymmetric. You know, you don't get much bang for your buck in a future further sell-off, and they have downside exposure. It's kinda like what we mentioned about the hedges. Sometimes you kind of restrike to a higher level. That's probably what we're looking to do there, just have to, you know, find the opportunities to do so.
No, that's exactly right. Unfortunately, I think as Bob alluded to earlier, I don't know if you're on or not, but only 1% of the mortgage universe is refinanceable at this point.
Right
you know, it's tough to find IOs that don't have a great deal of extension already baked in, even if they're paying fast. Just not something we're highly constructive on right now, we've been focused more on doing things in rate derivatives and trying to improve the convexity of our profile through an increased focus on options that will you know, increase in value at an increasing rate into a continued sell-off and have limited downside if we were to rally from here. Whereas the IOs are sort of the opposite of that. They have a tremendous amount of downside into lower rates and, you know, the durations on some of that stuff had gone from negative 15 to 20 down to, you know, negative 4 to 6.
That's not the case in a lower rate environment. They have a lot of value that can be lost at this point. We think it prudent to trim back our exposure there, at least until enough higher rate mortgages have been produced that the CMO machine's turned back on and focused on something that's IOs that can continue to extend.
That's a good point. Just to add two cents to that. Production of new IOs is minimal.
Yeah.
I mean, the CMO machine, as it's referred to, has shut down to a large extent, but new IO creation is very sparse.
That makes sense. You said, like about $200 million sold in Q2 . That effectively kind of zeros out the portfolio almost at the moment.
No, no. That was the face amount. It was 30-
Okay
$35 million market. Yeah.
Oh, okay. I got you. All right.
Sorry for the confusion there.
Oh, no worries. You mentioned on book value only down a few pennies thus far in Q2 , despite the spread widening and the volatility. What would you guys ascribe that relatively strong performance in the month of April to?
Well, we didn't reposition the portfolio meaningfully. I mentioned we've done some modest up in coupon trading, so we basically own a lot of threes. You know, they're very extended, makes them a lot easier to hedge. We extended the duration of the hedges, and we keep restriking in the case of the swaptions or the swaps so that, even with-- I mean, we're down in books some, and that reflects the widening, but it's really the fact that they're just much easier to hedge.
Okay.
Now, part of the reason for what I've. Well, not everyone has reported their earnings yet, but you know, we felt like we had a particularly rough quarter, and a lot of that had to do with the fact that we had such a heavy focus on the specified pools. Whereas a lot of our peer group had a much higher concentration on TBA portfolios. That's, you know. We felt maybe our pain disproportionately in Q2 and have managed to do a little bit better. Again, it's all, I think, attributable to this focus on improving the convexity profile of our net asset hedge book.
Great. Beyond maybe stepping up further in coupon, do you guys see yourself maybe stepping up the 15-year mortgages as well?
No, not materially.
We've done some. We think there's some opportunities in TBA space. We've rolled out of some of the specified pools there that just
Looked fully valued and there's some specialness in some of the 15-year rolls. You know, it could be an area where we add a little bit, but on the margin, that's usually a relatively small part of our build. Yeah. With this curve, this flat 15-year production is pretty light. What's out there has been pretty picked over. I think now the market's really starting to focus, given that we're in a discount environment at seasoning. There's not a lot of trading because obviously we get the cash when all the production lists come out, and you see how new production specs trade. You don't see a ton. Well, put it this way, there are seasoned pools trading. You don't always get the color, so the price discovery is a bit challenging at times.
There's no question that the market is very much seeing the value of seasoned pools, and they pay faster and when they're at a discount. One of the benefits that we have is that because we haven't rolled the portfolio much, you know, the vast majority of it is seasoned, and it has greater value for that reason.
Yeah. Got you. Thank you for that color. That's pretty helpful. That's it for me. Best of luck going forward in a continued difficult environment. Take care.
Yeah. Thanks. Thank you.
Again, if you would like to ask a question, press star one. There are no further questions at this time. I will now turn the call back over to Robert Cauley for closing remarks.
Thank you, operator, and thank you, everyone. To the extent, there are those of you who were not able to make the call, the live call, and wish to call later with questions, we'll be glad to take those. Our office number is 772-231-1400. Otherwise, we look forward to checking in with you next quarter. I hope everybody has a great weekend. Thank you.
This concludes today's Conference Call. You may now disconnect.