Good morning, and welcome to the Q3 2021 earnings conference call for Orchid Island Capital. This call is being recorded today, October 29, 2021. 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 to management's good faith belief with respect to future events and are subject to risk 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's had a chance to download the slide deck that we put up on our website last night, because I will be, as usual, following the slide deck as I go through the process of the call. At the end of the call, of course, we will open up the call for questions. First of all, just to give you an outline of how we'll proceed, it's very much the same as it's been in the past. We'll start off with the financial highlights, go through the market developments to give you some background, help you understand our performance and positioning, then go through our results in more detail. Finally, we'll go through the portfolio, hedges and assets and give you a great understanding of our positioning.
With respect to our financial highlights, Orchid Island generated net income per share of $0.20. This was net income of $0.22, excluding realized and unrealized gains and losses on our RMBS assets and derivative instruments, including the interest expense on our interest rate swaps. The loss of $0.02 per share from net realized and unrealized losses in RMBS and derivative instruments does include interest rate swap interest, as I mentioned. Book value per share increased $0.06 from $4.71- 4.77. The company declared and successfully paid $0.195 a share in dividends. Since its public offering, initial public offering that is, the company has declared $12.31 in dividends per share, including the one declared in October of this year.
Total economic gain of $0.255 per share or 5.41% for the quarter. That is not annualized. Moving on to slide 3 and 4. This is as always, we present our performance versus our peers. On the first slide, we show our results using the stock price of Orchid Island and our peers through September 30. We're calculating total return using stock price and dividends paid. At the bottom of the page, we show our peer groups, and they have changed somewhat over time as different entrants have come and gone into our space. The second page just shows you the same numbers, only using book value for purposes of calculating total return. It's the change in book value plus dividends paid.
Again, it's shown with a one quarter lag simply because we don't have all of the results of our peers for the Q3. Although I will add that based on the early results that we have, it looks like Orchid has had a very solid quarter. Again, these numbers are presented both on a look back as of the end of the Q2 and then for each of the various calendar periods. Moving on to the market developments. I just want to pause and just again reiterate why we do this. As opposed to just going through our results and giving a description of our positioning.
The purpose of going through these market developments the way we do is we want to give you a deeper understanding of why we had the results that we had or why we're positioned the way we are and how we see things going forward. That's why we spend time on the market developments, because we need to just give you a deeper understanding about how Orchid is doing. Moving on again to slide 8. This slide is the same slide we use every quarter. Just shows you a snapshot of the various curves, both the nominal or the cash curve on the left and the swap curve on the right. Then of course for Q1 as well.
As you can see on the left-hand side or the right, our rates, at least based on this snapshot, did not appear to move at all. The only movement at all really in this quarter was a flattening of the curve. If you look, for instance, at the five-year point in the curve, you can see that rates increased in the long end flat and went down. We had a meaningful flattening there, and we'll talk about this a little bit more in detail. I want to just say something about this. While even though on a snapshot basis it looks like nothing really happened. If you look on the next slide, particularly the top left, you can see that rates actually for most of the quarter were lower.
Even though we ended the quarter with the rates unchanged, most Treasury benchmarks hit their low yield of the year during this quarter. The result, and the reason is that we had the emergence of the Delta wave of the pandemic. That, of course, was very severe. When it first emerged, nobody really knew just how severe it would be, and the market reacted as you would expect. There was this uncertainty with respect to the impact on earnings. I want to draw a contrast between Q3 and Q4, and I think it's a very important one. When the Delta wave emerged, as I said, there was, you know, obviously it's a very bad development, and it caused a lot of uncertainty.
I would think it's safe to say there was a very strong consensus in the market that once the Delta wave was behind us, and once the various forms of supplemental unemployment insurance and so forth were behind us in September, that the market and the economy was really poised for strong growth. I think there was very strong sense, a belief in that. It was just a matter of time before once this Delta wave moved past us, that we would resume very strong growth, and particularly wage growth. The Fed had talked about the transitory nature of inflation, and they thought that once the pandemic got behind us and we had, the labor shortage go away, that inflation would go away as well. Well, that was Q3. Now let's fast-forward to where we are today.
As you can see, rates were moving up at the end of the Q3. The reason is that because people started to realize that maybe this wasn't gonna be the case as we initially thought. For one, the Delta wave isn't gone, but it's certainly in retreat. All of the various supplemental unemployment insurance measures are gone. The foreclosure moratorium is over, but we really haven't seen jobs really increase. Now, we may see more next week, but so far they really haven't come back as quickly as we thought. Also, just growth in this quarter has steadily, in terms of expectations, declined. At the beginning of the quarter, expectations were that the Q3 would have fairly strong growth. Yesterday morning, we found out it was only 2%.
While there might be some rebound into the Q4 , I think there's a lot more uncertainty with respect to 2022. That was a very meaningful change, I think, in the longer term outlook or medium term outlook, if you will, that's taken place over the course of the quarter. The other thing I mentioned is inflation. The inflation that we're seeing now, including the data that was released this morning, is certainly challenging the transitory nature of inflation. It's starting to look like it's going to. If it is transitory, it's gonna be transitory for longer. It's definitely looks like it's gonna extend well into Q4 and probably into next year.
If you look at, listen to earnings calls, not by mortgage REITs, but by the other companies in, for instance, the S&P 500, they all tend to echo the same theme that they expect inflation to be with us for quite a while. Now in the US, the US is, you know, maybe not exactly the same as the rest of the world. For instance, our energy intensity, which is a measure of how much energy prices impact our economy, has moved down over the decades. Back in the seventies when prices of oil went up, it had a very devastating impact on our economy and caused inflation to go higher. Now cars are more efficient. We're much more energy efficient as a country, and therefore the impact of higher energy costs on inflation in the US are not as severe as they were.
That may not be quite the case around the world. Certainly what we've seen from Australia this week, Canada, England, the UK, central banks in particular there are responding quite strongly to very high levels of inflation. Inflation has definitely become the preeminent story. These, supply shortages of goods and labor are also persisting much longer than we expected, starting to really factor into the growth outlook, not just for Q4, but into 2022. That's important not just for our immediate results, but it does matter for us in terms of positioning, because we view this uncertainty as reason to continue to position the way we are defensively in nature and, basically waiting for the resolution of some of this uncertainty before we, for instance, maybe raise the risk profile of the portfolio.
We'll talk a little bit more about that in a minute or two here. Anyway, that was what we wanted to draw from that. Slide 10. If you just look at this slide, it really just captures the slope of the curve. Really what you're seeing is a convergence between the yield on the 5-year Treasury and the 30. The 5-year Treasury is historically the most sensitive to changes in the direction of rates. In this case, the market is expecting short-term rates to go higher and sooner. You see the 5-year react. Typically, the long end of the curve is most sensitive to inflation, and we certainly see that. Why it's moving the way it is, that's a bit of a quandary. There's two rationales that I've seen floated.
One by an economist that we follow at Cornerstone Macro. The view expressed there was that if the Fed is going to tighten more and sooner, then maybe the terminal funds rate will end up being lower, and that explains why longer term rates have come down. The other one, it may just simply be the massive international global capital flows that we see, especially in the rates market, sometimes can cause movements in the long end of the curve that don't really jive with what's going on with the domestic economy. But these can in fact and do often drive rates. We've seen, especially this week, meaningful moves day in and day out on the long end of the curve that don't necessarily appear to be being driven solely by domestic events.
In any event, whatever reason, we are seeing a flattening of the curve. Again, for a levered bond investor such as ourselves, you know, that gives us some cause for pause. That is, we need to see how this ultimately shakes out. Moving on to slide 11 in respect to the mortgage market. As I mentioned, I just want to remind you that we were defensively positioned coming into this quarter, defensively positioned at the end of the quarter, and will be for now. If you look at the performance of the mortgage market on the top left, we basically just show you the performance of the various 30-year coupons. What we do here is we normalize their prices as of June 30 marked to 100 and just show you the change in their prices over the course of the quarter.
As you can see, mortgages did well. Towards the end of the quarter, rates started to move higher, and it became clear that the Fed was about to taper their asset purchases, specifically at the 22nd of September at the Fed Open Market Committee meeting, when the chairman made it quite clear that a tapering of their asset purchases was on the near-term horizon. You can see Fannie TBAs and 2.5s fell off in price, and that probably reflects a combination of those two factors. With respect to rolls, the top two lines, the red and the blue lines, just show you the strength of the roll of those two coupons. The Fed is still very much involved, and those rolls are quite strong. In contrast, higher coupons are soft. The Fannie 4 roll has been negative.
The Fannie three roll, absent a few spikes, has generally been negative. The key change there is that green line, which is Fannie threes. The perception now is that as rates backed up, that perhaps a 3% coupon will enter the production window and therefore enter the Fed purchase calendar and so forth. As a result, you're seeing a move up in that roll. That has in turn affected the spec market on the top right. I apologize, this chart's cramped. It shows you five years of data. As you can see on the right-hand side, payouts got quite high through the course of 2020 and then collapsed during the Q1, and then recovered during the Q3 when rates were lower and then finally have fallen off at the end.
That reflects both rates being higher and again, rolls, especially in some of the higher coupons, in particular 3s, being a little stronger. As a result, we did see some softness in those payoffs toward the end of the last quarter. Moving on, slide 12, just a snapshot of vol. Looks relatively benign here in the course of the Q3. Over the course of the Q4, it has definitely picked up, with a lot more uncertainty in the market, and especially with respect to central banks, timing of rate hikes and so forth. We've seen vol pick up. Finally, on slide 13, these are just OAS levels. If you notice on the left, you can see the production coupons, 2s and 2.5s are still quite rich.
For us, that just means that, you know, it's not the right time for us to start to meaningfully increase our allocations there. We're, you know, especially with the prospects of not only just tapering, but potentially the pace of tapering could change to the extent the Fed had to alter their plans with respect to rate hikes. That the combination of those two are causing us to stay away for now. I'll just make one comment. If you look at some of these lines here, you can see there's a sharp drop all of a sudden, and that's just because the model that we use, which is Yield Book, updated their model, and it caused a lot of these OAS levels to drop. That's it for that slide.
Just some more bigger picture comments on the markets as a whole on slide 14. Just want to draw a few conclusions from this. The top chart just shows you the quarterly returns. On the left-hand side, you see most of the fixed income markets, mortgages, treasuries, and so forth. You can see the returns for the quarter were very, very modest, basically zero, very much unchanged. If you look at the right-hand side, riskier assets did better. The one that really stands out is the TIPS market. You can see the TIPS market had a very strong quarter. Basically, what this reflects is people demanding more protection for inflation, so they're buying TIPS, they're bidding up their prices.
Yields on nominal Treasuries only increased modestly, so as a result, real yields declined quite a bit, and the breakeven, the difference between the two increased. A very strong quarter. With respect to the year, if you look at the bottom, you can see most of these sectors of the fixed income markets are slightly negative. It's clearly the riskier assets that have done well. I guess the takeaway from that is at least for the first 10 months of the year, risk has done much better than haven assets or, you know, low-risk assets. Moving on to the refinancing activity, which of course is very important for us. The top left, we show the refi index versus the average mortgage rate.
What you've seen here and what you're seeing in Q4 so far is the convergence of those two lines. The refi index has remained subdued, and mortgage rates are creeping higher. The bottom chart just shows you the percentage of the universe that's in the money versus the aggregate refi index, and they both are trending down. Finally, I'll just say the primary/secondary spread seems to have reached a floor. I don't know that there's much room for that to improve. I think that originators have basically extracted all the efficiency they can out of the process, and that spread seems stable. Now going to our financial results, just to go through those in a little more detail.
On slide 17, as we always do, we show our results decomposed between just the returns of the portfolio, less our expenses, and in the middle column, we show our realized and unrealized gains. Couple comments. You can see that we had some unrealized losses of a little over $11 million on the mortgage portfolio. That really just reflects a very modest movement in rates, coupled with some softness in spec payouts. We still do, as we have since the Q1, have a large allocation to spec pools and no real exposure to TBA rolls. As payouts were soft again in the quarter, that's reflected there. The hedges just reflect a modest increase in rates. The net-net of that is a slight decrease. That's the two cents that we mentioned earlier.
As far as returns for the quarter, as you can see, the pass-through portfolio had a not very strong quarter. NIM did very, very well, reflecting a combination of an up-in-coupon bias and very low realized speeds. I would also note that, and we'll say a little bit more about this in a minute, but our allocation to structured assets, and particularly IOs, did very well this quarter. We are using those for a number of reasons. But one of the benefits obviously is that they generate positive returns, positive carry. It's nice to be able to get positive carry out of our hedges. Finally, last couple more slides here before we get into the real nuts and bolts of the portfolio. Our NIM is reflected on page 18.
I just want to point out it's remained stable. The yield on our assets has declined ever since really the onset of the pandemic and finally seemed to stabilize and bounce a little bit this quarter. Our funding cost, which reflects the effect of our hedges, continues to inch down. The net effect is we've got a very stable NIM, and we have a slight uptick for the quarter. The near term, I think it looks well for the balance of the year. I'll say why in a moment here. Just moving forward, slide 19, really don't need to say anything about this. This is just historical information. Frankly, slide 20 as well just shows you the big picture how we run the portfolio versus our peers.
Now let's get into a little more of the details of the portfolio. If you look on slide 21, this is our capital allocation. What I wanna point out is, you know, obviously we did a fair amount of capital raising this quarter, as a result of using our ATM. As a result, the portfolio increased by approximately 22%. While that did increase, we also increased our allocation to IOs. It increased by approximately 3% in percentage terms, but in dollar terms it increased by almost 50%, 48% or so. So we've continued to add IOs as a hedge instrument. As we mentioned, we see the Fed tapering on the horizon. Some non-zero probability that it could be a little faster than maybe the market expects.
As a result, you would expect mortgages to be a little soft, and we think IOs, one, are a good hedge for upgrades, but also, maybe a little less sensitive to mortgage basis widening, and that's why we have increased that allocation. The right-hand side just shows you the roll forward of the various sub-portfolios. Now turning more to the portfolio, slide 23. You can see that, while we don't have last quarter's slide deck, I will point out that as we've grown the portfolio, increased the size, it's generally stayed the same in terms of this layout in terms of coupons and allocations. The 3% coupon remains our largest concentration. For instance, the weighted average coupon on our 30-year portfolio is 2.96.
It was 2.97 at the end of the Q2, so essentially unchanged. The WAL on the portfolio is actually lower than it was at the end of the Q2. Even though we've had the passage of three months' time, the portfolio is actually a lower WAL, and that just reflects the fact that we've added a low WAL assets to the portfolio, and we have slightly uptick the allocation to specs. One thing I do wanna point out is if you look at that 30-year line, we have nearly $4 billion in market value exposure, and those assets prepaid for the quarter at 7.6 CPR. That's lower than turnover. Very good outcome.
You know, the yield that you derive from that type of asset with that type of dollar price is somewhere in the neighborhood of 2%. Funding costs, you know, even hedged funding costs at, you know, around 50 basis points. That's a very nice NIM. I did mention that we increased the allocation to IOs. We have more line items here, and I'll talk about our hedges in a moment. After the call, Hunter can say in the Q&A, we can give you some more detail on how we've selected the various IOs we have. Slide 24 just shows you the slight uptick in the allocation to specs. We historically have owned specs in lieu of TBAs.
The higher quality assets we've added, generally New York two-story or lower loan balance did uptick slightly this quarter. Finally, slide 25. This is really critical for us to show you, in particular this 3% cohort. If you look at each month presented here, September, August, and July, or the quarters looking back, you can see that our allocation to that sector has done very, very well relative to the cohort as a whole. That's combination of those low realized speeds, and the higher coupons on the asset are what generate the net interest margin that we are able to do, and that really is what drives our economic performance and dividend. Slide 26. Again, it's just more historical information. It just shows you that, speeds, which are the green line, have remained very subdued.
They're much lower than they were even in 2019. Even though we've been in a predominantly much lower rate environment, speeds have been maintained. In the near term, our outlook is favorable, with rates slightly higher than seasonal. I would expect speeds to, if anything, be slightly lower for the next few months. The next slide just gives you our leverage. It does look like our leverage dropped. That's somewhat misleading. Technically, as of 9:30, our leverage ratio was 7.2. As I mentioned, we've been raising capital through the ATM. It was somewhat backloaded in September. We took in a few big chunks of cash towards the end of the quarter and deployed those in the auction, monthly auction cycles in very early October.
We added another term of leverage since then. Really since regs settled for 30-year mortgages in October, our leverage ratio has been around 8.2, so it is still flat. That being said, as I mentioned, we are generally defensively positioned, and given the uncertainty surrounding the outlook, we anticipate continuing to do so. That leverage ratio will probably stay somewhere in the low to maybe mid 8s. Then finally, our last slide is on the hedges. We have had some changes since quarter end. This table depicts simply the look back between June 30 and September 30. Since the quarter end, we have added some TBA shorts. We've added some long end shorts in the future space in the 10-year ultras.
With respect to our swaptions, we did basically restructure some of those, increase them in size, raised the strikes on those, and the maturity dates were extended. We did a lot of that just by taking some profits and building those positions. The hedge book continues to grow as the portfolio does as well. Just one general note, though, I would say that we are relying much more on IOs and swaptions and to a lesser extent, futures to hedge versus swaps. Swaps obviously will have a direct impact on our funding costs in terms of, you know, paying fixed receiving floating until the Fed starts to hike. The hedge allocation's been mostly in swaptions and IOs and to a lesser extent, futures versus swaps. That's about it.
With that, I will open up the call to questions. Operator, we can take any questions you might have.
Thank you, sir. As a reminder to ask a question, you'll need to press star one on your telephone. To withdraw a question, press the pound key. Please stand by while we compile the speaker queue roster. Your first question is from Jason Stewart from Jones Trading. Your line is open.
Hey, good morning. Thanks for taking the questions.
Hey, Jason.
Hey, how are you, Bob? Start with the funding costs and your outlook for the Q4. You know, there's a couple of markers on the horizon, and we typically see a little bit of pressure going into year-end. What's your expectation for just, you know, overnight repo, not considering swaps, but have we seen the bottom here? Do you expect any pressure? Or do you see this pretty smooth sailing through the end of the year?
I'll just say a brief word, and I'll turn it over to Hunter. As we always do when we approach quarter and year-end, always anticipate that pressure, so we always tend to try to start layering in some fundings over quarter end. That's no different than this quarter. I'll give it to Hunter to talk about levels.
Yeah, we continue to see a high amount of demand for collateral. You know, we get tapped on the shoulder every few days or so with counterparties looking for more assets from us that they can put on our repo books. I haven't seen a lot of pressure. I'll say that, you know, just anecdotally, when you're 2 or 3 months from the turn, you know, counterparties tend to try to bake in a little bit of that uncertainty. It's no more than a basis point or 2 right now. You know, if we're rolling something at 12 basis points for 1 month, we could probably do it over year-end for 13 or 14.
Not seeing a lot of pressure and still seeing a lot of demand for assets to repo.
Gotcha. That's great. Thank you for that color. In terms of operating leverage, you know, I know that, you know, that there's a calculation for the management fee. What's your expectation as you continue to grow the equity base in the portfolio for the rest of the operating line items? I mean, should investors expect to see operating leverage, or are you expanding the platform at all? How should we think about that going forward?
I would say that, with respect to the platform, I can't really say that we have any plans for that. Otherwise, you know, I mean, we should continue to benefit from scale. I mean, we have two variable costs. The biggest one by far is the management fee, and the second one is just our repo funding cost, which is much, much smaller. But we can, you know, we continue to benefit from it, as we grow. We're at a point now where the management fee is at 1% fixed, basically from now on. Every dollar of capital we raise, our weighted average management fee should come down. Most of the rest of the cost structure is fixed, so it gets diluted.
We should see continue to see a dilution of the you know the cost structure as we grow.
Now almost all the capital we raised in this period was done at that lowest marginal management fee rate. We don't really anticipate our fixed costs increasing materially. You know, those two things will contribute to operating leverage going forward.
Great. Thanks for that. Last one for me, and I'll jump out. I didn't hear a book value update. I heard the update on the hedges, and it looks like based on my math, you closed them out to nice profits. Do you have a book value update for us quarter to date in 4Q?
We don't have a hard number, but I would say it's down somewhat. That would reflect, you know, the increase in rates and spec softness.
Yeah. The softness that Bob referred to on the slide 11 in specified pools resulting from in his comments he was discussing the threes specifically, which we have a lot of exposure to. We've continued to see weakness in specified pool payoffs for the first few weeks of the new quarter. A little bit of a giveback there attributable to this crazy roll market with Fannie 3s. You know, it's tough to comment on book value this early in the new quarter because things can change so quickly, but we're down very marginally.
Yeah, it'll be very important to see how we do next week. You know, as we get into November, we have the auction cycles. Because we really haven't seen as much trading activity in the second half of October we've had for the last really year. We've got into a cycle where you have a typical auction cycle at the beginning of the month. Then you get a mid-cycle list, and occasionally you even get some, you know, Fannie cash window list in the last week of the month, rather. We did not get that. So there is some uncertainty on the level of payoffs. So the market will be very keenly dialed into next. I think the cash window is going to be Tuesday next week, so we'll see where those levels are, and that'll give us an update.
I would say based on what we've seen today, though, our book is down. I don't have an exact number, but I'm guessing it'll be, you know, probably 1%-2%, but I can't give you anything more specific than that.
That's perfect. Thanks for the color. I appreciate that. Thank you.
Yeah.
Your next question is from Christopher Nolan from Ladenburg Thalmann. Your line is open.
Hey, guys. Hey, Bob.
Yes.
On your comments in terms of the overall yield curve environment, is it fair to say that your expectations are for a flatter yield curve?
Yeah, that definitely looks like it's gonna continue to be the case. It's easy to explain what's going on in the front end of the curve. The longer end of the curve is much more of a challenge. I tried to give my best guess at what's going on right now during my comments. This week in particular, every day it just seemed intra-day we get big moves. When you walk in and New York, you know, hasn't opened yet and, you know, London hours the market's flatter and then it turns around and goes the other way, and then Europe closes, and we go back the other way. Very challenging week.
Going forward, I think that inflation continues assuming it's going to continue to persist, you know, stretch the bounds of transitory, if you will, that's gonna keep the front end of the curve soft. What goes on in the long end is who knows, but it's hard to imagine the curve not doing anything but, you know, stay pretty flat. By the way, I didn't mention it in my prepared remarks, but the spread between fives and thirties at one point was north of 150 basis points. It's less than 75 as we speak, so it's likely to continue to do that.
There seems to be some contagion between what's going on amongst other central banks and what's going on with the Fed. It's great that we have a meeting next week, so we can get some clarity in that regard. You know this week that the Bank of Canada stopped QE, and they're gonna raise rates. Australia was amazing. They have yield curve control there, they just stopped participating. Apparently, they're ending that program. They've done nothing to stop the run-up in yields. I was just checking yesterday, the yield on the Australian two-year, which was slightly negative in mid-September, is approaching 50 and moved meaningfully again today, I understand. Then the same thing in, you know, the UK
You know, it's moving rapidly, and it seems to be influencing market expectations here, which again, all these forces are just gonna drive the curve flatter.
Should we expect an increased capital allocation for IOs in the Q4?
We had soft targeted 25. I think we're at 21 and change. I would say we're probably gonna continue to move in that direction.
Great. Then I guess on page 23, you have a in the portfolio characteristics your asset sensitivity. Are you planning to position this a little bit more where you have a little bit neutral sensitivity towards a 50 basis point rise in rates?
Yes. The short answer to that is yes. I would say that, you know, one of the things we've been raising capital, it's been coming in quickly this, particularly this last quarter. Sometimes we add assets and, you know, we try to do so uniformly but get a little ahead or behind on one or the other. We will continue to add IOs, as I mentioned. Since quarter end, we have increased the hedges. I mentioned we added to our Treasury shorts Ultras. We added some TBA shorts. We added some IOs, and we repositioned some of our swaptions. The profile will look differently today than it did at quarter end. Yeah, the short answer to your question is yes.
Great. Thank you. I'll get back in the queue.
Yes.
Your next question is from Mikhail Goberman from JMP Securities. Your line is open.
Hi. Morning, gentlemen. Thanks for taking my question. A few of my questions have already been answered, but I just wanted to get your thoughts on what you're seeing for agency MBS spread widening or tightening going forward, and how you're thinking about positioning the portfolio. Assuming ceteris paribus, we putter along the way we are now, although we've obviously seen quite a lot of volatility last week, as you mentioned. Assuming you expect a flatter yield curve going forward, and also in maybe a more volatile scenario where you have a massive, not massive, but heightened, perhaps, spread widening. Thanks.
I'll take that. I would say that, well, I'll turn it over to Hunter in a second. One thing is to keep in mind is that, we certainly see the good days and bad days for mortgages and, you know, we pretty much have a pretty good feel for that. That'll tell you know, what we expect. The thing you have to keep in mind is that, everything else is very rich also. To the extent there are many, multi-sector asset managers out there, which there are, they, you know, are relative value traders. Mortgages, as by nature, can never typically get too rich or too cheap for long. That's just an overriding principle. Yeah, mortgages are rich, so is everything else.
Tapering is on the horizon, the market knows that. But we also have, you know, bank demand, which tend to be and represent an additional floor, if you will, in addition to the Fed, simply because as the Fed pumps reserves into the system, they find their way to banks, and banks have to invest these reserves. You know, just the opposite of where we were in 2019 when they were depleting reserves, and we couldn't get repo because the banks were all up against their liquidity ratios and so forth. Now it's the exact opposite. They have too much cash, so they're buyers. I mean, I would say tapering is key next week. If they give us something that's different than what the market expects, you're going to see a knee-jerk widening. What happens? You know, it just represents a buy opportunity. That's the way I look at it. I don't know.
No, I totally agree with that. I think that every buying opportunity has been well received over the last year or so, I guess. You know, obviously, we were in a state of free fall right after the pandemic outbreak. You know, Fed stepped in, shored up the market. Since then, any marginal widening has been met with buying. On the, I think, the yield front as well, every you know, we definitely see yield-based buyers step in every time rates increase marginally. Those are, you know, typically unlevered money stepping in, and then levered money stepping in when things widen out on a spread basis.
As to your question, I think if we continue to gyrate around in this range, I don't think things will change meaningfully. I think we'll continue to see slow emergence of burnout in the portfolio. I think if we do have some an inflation scare or something that, you know, for us, I think that's what we are most concerned about is a breakout to higher rates, caused by something like inflation. That seems to be on the back burner right now or less of a concern for the market, but something that we always have to keep our eye on.
The nature of the way we're positioned in premium MBS specified pools in that type of situation, I think the portfolio does relatively well for the next 25 or 30 basis points. We could see spreads tighten on our assets just due to the fact that a refi incentive is disappearing. We increase that exposure or through the use of IOs as well. We've been really focused on positioning in the cuspy mortgage assets that are, you know, going to really have a dramatically reduced incentive to refi in the next, you know, 20, call it 25-50 basis points. That's why a lot of times you'll see our profile skewed a little bit where it'll look negative to the up 50.
I think that's because empirically we've observed that those assets, the types of assets that we typically hold, do well in that scenario. That's also why we've tried to not play chicken with the Fed, being in production coupon TBAs, a little bit unique in that regard. We have been trying to resist the allure of the drop market in Fannie 2s and 2.5s, just on a relative value basis of horribly negative OASs. Our concern is that those are going to be the first assets to widen into a taper.
Yeah.
That was my thoughts.
I would just one other thought I might add is that, in terms of a vol event, something that the market doesn't see coming. If you look at the market pricing and compare that to what Powell said at the September Fed meeting, when he basically implied that tapering will be done midsummer. If you look at the Eurodollar market or the, you know, Fed Funds futures contracts, you see that that initial tightening right after that. You know, obviously, that's very much in contrast to the last cycle when there was a long pause from when QE ended to the first hike. The market is very much at odds with a repeat of what happened the last time. you know, who knows how it plays out.
Let's say, for instance, that, you know, inflation continues to get worse, whatever, and the Fed concludes that they have to bring forward their tightening. We would presume that they don't want to be tightening, raising the Fed funds rate at the same time they're buying assets. They would then accelerate the tapering. In that event, that's not what the market's currently expecting, in spite of the fact what the Fed funds market's telling you. I think in that event, you would see the production coupons soften quickly. For investors, you know, they might just say, "Okay, we're gonna just sell these lower coupons." They may leave the space or they go up in coupon. That's how we're positioned for that to happen.
I don't think there's a chance that they're gonna not taper or extend the taper, you know, unless, you know, the economy does something that is not currently on, you know, visible. I think the risk is that they're forced to accelerate the tapering, in which case you would see the production coupons probably soften up. That would benefit us.
In that type of environment, we are in a fairly enviable position to the extent that our leverage ratio is lower than it typically is. Not as low as some out there that are waiting for this buying opportunity moment. We definitely have another turn or so of leverage that we could quickly add in a buying opportunity type of moment. Perhaps more importantly, we have been pretty successful lately in raising capital and would definitely use that leverage, so to speak, as a way to add cheaper assets in the event we saw that type of scenario play out.
Got it. Thank you, Hunter. That's very, very helpful.
Thanks for Mikhail
Your next question is from Kevin Jones, investor. Your line is open.
Hello? Hello, Kevin?
Yeah. I didn't have a question. I just called in to listen.
Oh. Well, glad. Thank you for doing that. Well, anything comes to mind, feel free.
I'm at a loss for words.
All right. Well, thanks for calling and have a great weekend.
Keep doing what you're doing. Thank you, guys.
All right. Thank you.
All right.
Thank you.
Again, to ask a question, please press star one on your telephone. Again, that's star one on your telephone. We do have a follow-up question from Christopher Nolan from Ladenburg Thalmann. Your line is open.
Hunter answered my TBA question. While I got you guys, what's the management perspective on doing additional equity raises?
Well, the TBA, the ATM, is something we, you know, we wanna continue to use. We've done secondaries probably, you know, obviously, as you know, we don't do a lot of those. We have done them. There are benefits to the ATM. The cost of capital is cheaper. You get the money in, you know, slowly over time, so it makes it easy to invest. You don't have to do it all at once. You know, if the stock, you know, our basic mantra is when, you know, the stock is trading above what we consider raising capital. When it's trading below, we consider buying it back. We always factor in market investment opportunities at the time in both cases. Today, the investment opportunities are okay. They're not spectacular.
The stock had been trading at a premium to books, so it was accretive. In that instance, if that were to continue, we would probably be still inclined to continue to use the program.
All right. Thank you.
To ask a question, please press star one on your telephone. That's star one on your telephone. There are no other questions at this time. I will turn the call back to Mr. Cauley.
Thank you, operator. Thank you, everybody. I appreciate you taking the time to join us, and we certainly enjoy all your questions. To the extent you all have additional questions that weren't answered, you'd have to listen to the replay. If you want to call, please feel free to do. The office number is 772-231-1400. We'll always be glad to take your questions. Otherwise, we look forward to talking to you next time. Thank you.
This concludes today's conference call. Thank you for participating. You may now disconnect.