Good morning, and welcome to the Q3 2023 earnings conference call for Orchid Island Capital. This call is being recorded today, October 27, 2023. At this time, the company would like to remind the listeners that statements made today during today's conference call relating to the 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. The 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. I would now 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, and thank you for joining us today. Hopefully, everybody's had a chance to download our deck. You probably will notice there's some substantial changes made to the deck. Hopefully, you find it more useful. I think we presented the information in a better format that we've been doing up until now. And with that, I will begin. The outline of our talk today will follow the same pattern. We'll go over our financial results for the quarter, talk briefly about our market developments and how those shaped our results and how they form our outlook going forward, and then get into a discussion of the portfolio and our hedging positions and so forth. So with that, turning to slide 5, here are the high-level numbers for the Q3 .
Net income for the quarter was a loss of $1.68 versus income of $0.25 last year. Book value, I'm giving the moves in the market. It was a very rough quarter for mortgage investors. As you can see, our book value was down just over 20% from $11.16- 8.92. Unfortunately, October has been equally as intense and our book's down about fourteen... over 14% through yesterday. So obviously, especially since September first, it's been very challenging mortgage market environment. Total return for the quarter was a very unsatisfactory -15.77%, and we paid dividends again of $0.48, same as the last quarter. The average MBS portfolio did increase over the course of the quarter. We did use our ATM. We raised about $80 million and added to the portfolio.
But given what's happened since quarter end, with the significant move in rates and volatility and mortgage spreads, we have sold assets to maintain our leverage and liquidity positions at an acceptable level, and the portfolio is about $3.65 billion as of yesterday. That's down 18% from the average of Q3. But as I said, that's the average. That's not the 9/30 number. The economic leverage ratio did increase during the quarter as a result of the sell-off and the declining book value. Not terribly so, from 8.1- 8.5, but since then, the steps we've taken this month so far, we've actually lowered our economic leverage ratio to about 7.4. So it's down quite a bit.
Our speeds, given that the portfolio is heavily skewed towards discounts, we do have a lot of seasoning, especially in our lower coupon security. So the speeds are fairly acceptable, 6%. And with the deep dollar price of the securities we own, that's allowing us to increase a fair amount of discount, and that helps with our earnings. Liquidity is right around the low end of our range, then that was driven by the events of late September into early October. Currently, it's in that same range, around the high 30%- 40%, but we are working to bring that up. The next page just shows you our summary balance sheet income statement. I'll leave that for you to peruse. I'm not going to spend any time talking about it. The next slide is something we've been talking about more frequently lately.
This is kind of where we show you kind of our proxy for disposable income. We don't use that term. We use fair value accounting, which makes it challenging for us to present those types of numbers. But what we do here, as we've done in the past, is we show you our interest income and repo amortization or interest expense, but then we also show you the dollar amount of discount accretion and then also the effective hedges that were in place during the quarter. And as you can see, there's substantial numbers there. Finally, we backed out our expenses, and you can see the earnings for the last four quarters, and on the bottom of the page, we just present that in per share. And as you can see, we're running around $0.10, a little more below the dividend.
We were doing so because we were believing the market would turn sooner rather than later, and we did not want to make wholesale changes to the portfolio. But that has not proven to be the case, and we've had to make some changes. Although, you also know we lowered the dividend this quarter, so now it's $0.12, which means we're at a $0.36 run rate, which means we should probably have earnings right in line with the dividend. Going now to market developments. Page 10. You see a very meaningful change in the top left and top right.... For the last year and a half, all we've seen in the movement of a curve, either the swaps curve or the nominal curve, is movement higher in the front end. It just kept getting higher and higher.
The long end, given that the curve was inverted, always had that downward sloping look and was moving up slowly. Well, that's changed dramatically in the Q3 . As you can see, the front end of the curve is pretty much anchored, and I think most market participants expect it to remain that way, maybe go up slightly more if there's one more hike, but that's pretty much it. What we're seeing now is movement on the long end of the curve. It's a steepening in the sense that it's less inverted, but it is a meaningful move and, you know, 100 basis points plus just from late July to where we are now. Another proxy for that is the one on the bottom of the page. This is just a 3-month Treasury bill versus a 10-year note.
Again, you can see a significant move of late. Turning now to mortgages. This, two pictures here, the first one is the spread to the 10-year, and as you can see, that spread is very wide, very close to the widest levels we've seen since the financial crisis. And when you take into consideration the fact that, you know, as I mentioned, long-term rates have been up materially of late and the spread, again, this is the current coupon, but it's a proxy for the mortgage universe. That spread has been widening also, which gives you an idea with that the yield on mortgages are going up much faster than even Treasuries. So as a result, if you look at the bottom left, you can see this is a normalized price change of several coupons.
So basically just starting at 100 for each coupon on June 30th and showing you what that coupon has done since the end of the Q2 . And obviously, those are very big negative numbers. It's been a very challenging market for mortgage investors, to say the least. Another thing that's been a challenge for us has been volatility. As you know, mortgages are very much impacted by volatility, 'cause whenever you're long a mortgage, you're shorting vol, and if it's going up, then it's hurting you, and that's what we see. These are two different measures of volatility. They paint the same picture, 3-month by 10-year normal vol, and then swap and implied vol from the MOVE Index at elevated levels and continue to remain there as we speak. One last page on the market.
If you look at the top right, this is the primary-secondary spread, and the mortgage originator community is trying to maintain their ability to generate mortgages. And so that's why you kind of see a slight downward trend in that spread. So as rates go up, they're trying to accept less margins in order to get rates to borrowers that they can live with. They only have so much capacity to do that because originators typically will sell all of their origination. And to the extent that the prices at which they can sell their production are going down, that limits how much that they can cut the primary-secondary spread. So I would not expect to see that come down much more.
Otherwise, with respect to this page, as you all know, with rates as high as they are and 30-year mortgage rates approaching 8%, refinancing activity is at an extremely low level. And in fact, we're approaching the late year, early 2024 period, which will be the seasonal slowdown. So speeds will I think they'll go down from here. Moving on to the portfolio in slide 15. These are just the highlights for the quarter. As I mentioned, we raised about $80 million in our ATM. We bought 30-year 6 and 6.5 coupon securities to increase the income of the portfolio in light of the higher rates for longer and the apparent case that they were going to be higher for longer.
The effect of those was to raise our average coupon from 3.83- 4.05, and the realized yield increased even more from 3.81- 4.51. That was impacted somewhat by speeds being a little higher, helped with increased accretion of discount. With respect to our economic interest spread, this is just where we apply our swaps. So there's the GAAP spread, and you can see it increased slightly from 128 basis points to 133 basis points. Slide 16 shows you in pictures what I just was referencing. If you look at the right-hand side of this page, you can see at the end of last year, we had a very, very low coupon bias, and we had no exposure to higher coupons.
But given the fact that rates are as high as they are and apparently going to stay here for a while, our goal now is to try to even out the distribution across the stack. Just to give you a for instance, in September, when rates started to move higher, we saw the lowest coupons really suffer. Presumably, a lot of money managers who are right against the index were reducing overweights, and the lower coupons make up a significant portion of the index, and so that selling caused lower coupons to suffer. In October, it's been more the belly coupons, so 3.5, 4, 4.5, 5, that have suffered. So the takeaway for us is that we need to have greater diversification across the coupons that we own, and that's what we're in the process of doing.
I mentioned that we had sold some assets since quarter end. It's. If you look at the far left, you see our holdings as of 9:30 A.M. We reduced our exposure to the 3% coupon by about 40%, so it's down to about $1.2 billion. That will have the effect of raising our average coupon and our yield somewhat, but we still expect to maintain a bias there, because as I'll say in a few moments, our outlook is we still think eventually there will be a softening of the economy and eventually a Fed pivot, and we think that those securities are the best securities we can own to maximize our potential outcome in that scenario. Now, going to slide 17. This is where we talked about hedging.
Obviously, in this environment, this has been critical with borrowing costs rising and interest rates selling off. Our hedge positions exceed our repo liability. I'll get to that point in a moment. What I want to show you here is the effect of the hedges we have in place, and you can see in this chart on the right, that blue line is our economic interest expense. In other words, our, just our economic expense adjusted for the affected hedges, and it's well below our actual funding cost or 1-month SOFR. It did go up slightly this quarter from 2.53%- 3.18%, but given, or, unless we get more hikes, we expect that that's pretty much where it should plateau, and that gives us fairly comfortable NIM.
Obviously, those hedges and the strategy's, you know, very critical in that regard. The next slide just lays out all of the hedge positions we have in place. On the bottom, we have a table with the notional amount and the duration of each. So we have interest rate swaps, futures, swap options, and rate derivatives, which are sometimes floors or caps or other types of structured derivative bets that are designed to give us protection in the event of certain outcomes. Say, for instance, the curve stays flatter for longer, you know, that kind of thing. And then we also short TBAs, and we show you the duration of that. All told, all of these hedges, the notional balance is about 115% of our repo funding liabilities. All of these hedges work in two ways. They're both asset hedges and funding hedges.
TBA is more on the asset side. Swaps are very much both because it does cap your floating rate cost to the extent of the notional balance of those swaps, but they also work as an asset hedge, at least as long as the points on the curve that are moving higher are the same tenors as swaps. In our swaps, we do have a large allocation to longer maturity swaps, so that's been very beneficial and is going to be critical going forward. Slide 19, we just lay out all of the different positions. I'm just going to make a couple of points. The top left, you can see that the Treasury futures went down and swaps went up. Just a more effective hedge in this environment.
It is more capital intensive to own swaps versus futures, but we can lock in pretty low funding. As much as rates have sold off as of late in the last few months, we put a lot of these on prior to a meaningful move. Some of our longer-dated swaps, you can see the paid fixed rates are only 2.84% on our swaps with a maturity of greater than 5 years. Our blended rate is only 2.46%. Very effective and fortunate that we were able to get all this on, and we expect we will have to maintain those for some time. The next slide is kind of new. We haven't done anything like this before, and what I'm—I need to explain to you what you're looking at.
So basically, what we have here are all of these 30-year fixed-rate conventional mortgages, starting with 3%- 6.5%. And we took the price as of 9:30 A.M., and we used Citibank's Yield Book to run the metrics on a generic coupon of each one. So you can see for each one, you see the OAS, effective duration, and convexity. And as you can see, convexity, which is very important for mortgage investors because that kind of drives how you do when rates are moving, and we've had a lot of that lately. The lower coupons have, by far, the best convexity. If you look at how those securities perform in these different scenarios, again, these are just generic Yield Book scenarios, a 50 basis point higher, lower shock, and then a bull steepen and a bear flattener.
There's no question that the Fed may hike some more from the inflation data could stay stronger for a little longer, and we may get a bit more of a bear flattener. But we think if that happens, more likely than not, that just increases the chance that you ultimately get the bull steepener when the Fed does succeed in breaking the economy. And you can see on the returns of these coupons, the lower coupons definitely stand out with the best return potential. And since we still have a bias towards that outcome, although a little less than we did a few months ago, we still view that as the more likely than not outcome, and that explains why we'll probably maintain an overweight to those coupons. On the far right column, we just show the allocation as of 9:30. That, as I mentioned, has changed slightly.
When we report Q4 , those numbers will look somewhat different. Slide 21 just shows you our interest rate sensitivity to portfolio. Not going to say much about this. This should be pretty self-explanatory. Slide 22, our speeds. And what we've included in the slide here for each coupon that we own is the WALA of those securities. And you can see the deepest discounts that we own, the threes, the 3.5s , have very high WALAs, and as a result, they've prepaid fairly well. In fact, for the Q3 , our threes paid at 6 CPR and our 3.5s at 6.3. Those aren't very high speeds, but when you consider the dollar price of these securities, in the case of threes, sometimes they've been under $80.
The $80 level, that means a lot in terms of discount accretion, so that has been a very beneficial, fact for us. And really, that's kind of it. The next slide is just kind of a wrap on what we've experienced and what we're going through. Obviously, the market is very challenging. We expect it to be challenging going forward. So our focus now is to just diversify the portfolio across coupons, try to avoid, excessive concentration in any point on the curve. We're going to maintain our hedge levels as high as we have in the recent past, just because of where funding costs are. We're going to keep our leverage ratio at the low end of the range.
I mentioned it's down from 8.5- 7.4, and we're going to have to keep our liquidity as high as we can just to get through the balance of this episode. We don't really know when this period will end, but we know these are the steps we take that are going to give us a high, high level of confidence that we're going to get through this period okay. And at the same time, allow us to be positioned in such a way that we can do very well when the market turns, assuming we do get the outcome we perceive. If we don't, the portfolio positioning is at a point now where we're covering the dividend, we think, and we can get along just fine here.
But we think if we do get the outcome of a bear-a- bull steepener, that we could be poised to do quite well. So that's a rundown of our positioning in our portfolio and all the market developments. And with that, operator, I will turn the call over to questions.
Thank you. To ask a question, please press star one on your telephone keypad. Your first question is from Matthew Erdner of Jones Trading. Please go ahead. Your line is open.
Hey, good morning. Thanks for taking the question. So you mentioned the diversification of, within the coupon stack. Are you looking to kind of spread out evenly across coupons, or are you going to favor the belly more so than current production? Obviously, the reduction in the 3% is coming, but, you know, what part of the curve are you really looking to diversify into?
Well, we'll still have a slight down in coupon bias, just won't be as pronounced, just because we just, we like the characteristics of those assets, the convexity, the return potential in the event we do get a, a bull steepening, which we may not. The problem with the higher coupons, they do well in times like this, at least most of the time, and they carry well, but they have a lot of risk, a lot of extension potential and a meaningful sell-off, and in a rally, they will, you know, may not perform well. And one thing that we didn't really dwell on, but if you look at new production, current coupon mortgages, the gross WACs on them are typically 95-105 basis points above the coupon.
So a Fannie seven has a gross WAC of 7.95, 8, and loan balances are very high. And what that means and what it predicts is when we do get a rally, if we do get a rally, that those are going to be prepaying very, very fast. Hunter, you want to throw in a few extra words on that?
Sure. I, I think that the, there will be a little bit of a focus on higher coupons, maybe not as quite as extreme as 7s, but just like we did a continuation of what we did in the Q3 , 6s and 6.5s are quite attractive from a carry perspective. They, you know, fit that part of our portfolio, where, you know, if we're in a higher for longer environment, but not necessarily higher rates and higher for longer, you know, there's some extension risk on the upper coupons. But if we are kind of topping out somewhere in, let's say, 5%-6%, ballpark for 10-year rates, I think that those higher coupons can do quite well.
They have a lot of current carry, so that's the portion of our portfolio that's going to carry a little bit better, but not necessarily do well on the wings, big rally or big sell-off.
Gotcha. That's helpful. And then from a technical perspective, it seems like when money managers went overweight, they've kind of sold off in the recent months. What do you think will tighten spreads from here, and who do you think is going to be the purchasers of this MBS?
Well, that's the million-dollar question. You know, the reason that mortgages have done so poorly is that you really have no sponsorship from any large investor base. You know, obviously, the Fed's long gone, banks are not, money managers are very overweight, and may be having redemptions, and that's really what keeps mortgages from tightening anytime soon. There just isn't. You really probably need the curve to uninvert and banks to come in in a meaningful way or something like that because it's just not out there, and that's why we expect that we'll probably be positioned the way we are for some time, because you can get some tightening, but, I don't see a meaningful tightening with the market the way it is. It's gonna- something's gonna have to change, and probably it's gonna be the shape of the curve.
Yeah, it's been pretty-
Okay.
It was very disappointing, Q3 . You know, we leaned, we leaned into the basis a little bit at the end of towards the end of the Q2 , when spreads were sort of at their wides during the Q2 , in the wake of the regional bank crisis. You know, those lists went off so incredibly well and so much faster than we expected that, you know, there was definitely a more positive, firmer tone. But as you alluded to, the money managers, you know, quickly got overweight and, you know, the quantitative tightening continued, and as rates just grinded higher, you know, there was really that lack of a marginal buyer. So, optimistic, I guess, but seeing some signs of life from the banking sector.
I don't think they're quite ready to come in in full force, but, you know, there was a couple of reports out in the last couple of weeks about banks being able to unload some of their lower coupon assets and supplement their income with some better earning potential in higher coupon mortgage space. So, you know, it's not anywhere near them becoming the, you know, quote, "the marginal buyer," but, you know, it's certainly starting to see some signs of life. So it'll probably be grind for the next, you know, couple of quarters and will be volatile. But we're also having those days when we see, you know, just the slightest glimmer of hope in mortgage spread space really brings in an influx of participants.
So the basis is incredibly volatile, but on those days when it's green, it's very green. So, that's been a little bit of a welcome change over the past, you know, 4-5 weeks, you know, that we've really just seen show up in the last handful of days.
... That's helpful. Thanks for the call, you guys.
All right. You're welcome.
Your next question is from Chris Nolan of Ladenburg Thalmann. Please go ahead. Your line is open.
Hey, guys.
Hey, Chris.
Bob, have you guys received any margin calls on the repo funding this quarter?
This morning. Oh, we get them every day. Yeah, I mean, we, margin call activity is very robust. Yeah, we, we get calls both on the, hedges and on the assets every day. And we've internalized that. We used to outsource that to AVM. We hired Pat Doyle from AVM, and we brought in our own systems, and so now we can manage that whole process entirely on our own. And yeah, I mean, the margin call activity keeps Pat busy several hours a day, in and out, so absolutely.
Thank you. And then also a follow-up. What sort of flexibility do you have on the dividend? Because I know you need to, to distribute a certain amount of your taxable income, but given all the moving pieces here, what sort of flexibility do you think you might see on how you readjust the dividend if you do that?
We brought it down into kinda line with what we were earning. You know, we were under-earning, over-distributing, thinking that the market was gonna turn, and we didn't want to take the steps to reposition the portfolio. We had to adjust some, and we did, but I, you know, that $0.12 seems fairly well reasonable. I mean, the big picture view on the dividend, trust me, we've spent hours discussing this. The market does tend to punish you if you change it too often, and they also punish you if you over-distribute too much, and the tax laws keep you from under-distributing. So, and we track our taxable earnings. We have a pretty good sense, generally, as we go throughout the year, where we are in terms of over-under distribution.
There is some latitude, but it's not boundless.
Great. Thank you.
Your next question is from Mikhail Goberman of JMP Securities. Please go ahead. Your line is open.
G uys. Good morning. Hope everybody's doing well. Could you guys give an update on where Book Value stands right now? And also, I believe you mentioned economic leverage is down to 7.4 now from 8.5. Is that right?
Yes. Yep, it is. And book, I did mention it's, we're down about a little over 14% through yesterday.
Okay. Thank you. Sorry if I missed that. All my other questions-
Yeah
... were kinda touched on by the other two questioners. So good luck going forward, guys. Thank you.
Thank you.
Thank you.
Thanks.
There are no further questions at this time. I will now turn the call over to Robert E. Cauley for closing remarks.
Thank you, operator, and thank you for taking the time to listen to the call. If you have any further questions that come to mind after the call is over, feel free to call us, or if you listen to the replay, have a question, you can always reach us in the office. The number is 772-231-1400. Otherwise, we look forward to speaking with you at the end of the Q4 . Thank you, everybody.
This concludes today's conference call. Thank you for your participation. You may now disconnect.