Orchid Island Capital, Inc. (NYSE:ORC) Q4 2022 Earnings Call Transcript

Orchid Island Capital, Inc. (NYSE:ORC) Q4 2022 Earnings Call Transcript February 24, 2023

Operator: Good morning and welcome to the Fourth Quarter 2022 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, February 24, 2023. At this time, the Company would like to remind listeners that statements made during today’s conference call relating to matters that are not historical facts are forward-looking statements subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Listeners are cautioned that such forward-looking statements are based on information currently available on the management’s good faith belief with respect to future events and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in such forward-looking statements.

Important factors that could cause such differences are described in the Company’s 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.

Robert Cauley: Good morning and welcome everybody. I hope everybody has had a chance to download our slide presentation from the website this morning. I do apologize, we did issue our press release last night as usual, but the accompanying and financial statements were not attached. The audit process is taking a little longer than usual this year. And so, the financials were not attached. We will be filing our 10-K probably next week as we typically would do today. This process is running a little late and sorry for the delay but those should be out next week. But all of the numbers that are in the press release, you can rely on, they’re all accurate, unchanged and actually unchanged from what we released back in January when we gave our preliminary results.

So with that, I will kick off with the slide deck. As usual, kind of follow the same outline starting on page 3, with the outline of what we’re going to discuss. I’ll briefly go over the financial highlights, talk about the market developments and how they shaped our performance, and also our results and outlook for the future, and then I’ll go into our financial results a little more detail and then finally talk about our portfolio characteristics, our hedge positions and how we’re positioning and our outlook for the market going forward. So first with the highlights, Orchid Island generated net income per share of $0.95, net earnings per share of negative $0.09 excluding realized and unrealized gains and losses on our RMBS derivative instruments, including an interest income on interest rate swaps.

We had a gain of $1.04 per share from net realized and unrealized losses on our RMBS and derivative instruments, again, again including net interest income on interest rate swaps. Book value per share of $11.93, at December 31, 2022, versus $11.42 at September 30, 2022. In Q4, the Company declared and subsequently paid $0.48 per share in dividends. And since our initial public offering, the Company declared $64.97 per share, at split adjusted, including dividends declared in January, February of this year. The total economic gain is $0.99 per share for the quarter or 8.67% — annualized. I’ll now just go through the market development. Turning to slide 6. I’ll make a couple of comments here. First I would point out that not just include 9/30 and 12/31 numbers, but also February.

We recognize the quarter, and there’s a lot of change such as as well. So it’s been a quite volatile quarter so far. And we shall cash curve is very flat from the 10-year point out and really has been since September 30th. If you look at the swaps curve, while it’s still relatively flat, it’s less so, it’s downward sloping. And that just reflects the fact that swap spreads are negative, SOFR swap spreads and more negative the further you go out the curve, and the ramification for that is somewhat significant, in the sense that if you look at swaps as a hedge instrument, 10-year swaps at about 360 as of close last night is still attractive hedge level, especially for lower coupon securities which have fully extended, it can be quite easily hedged with longer dated swaps.

And yield, even 5 CPR for instance, they could still yield a decent spread above that level. So I just wanted to point that out. That is one of the benefits of an extremely inverted curve and as we speak today, given the data that was released earlier, the curve is even more inverted. Moving on to page 7, just want to not spend a lot of time here, but just point out, if you look on the left hand side, you can see that even through early into this quarter, rates in the long end really haven’t moved a lot, they’re up slightly today, but most of the movement again has been on the front end. And you saw that in the last slide where the market continues to price in more Fed hikes, looks like we’re going to be hiking into the middle of this year possibly.

And obviously, this is driven by the most recent data, but the long end of the curve has not moved anywhere near as much. Turning to page 8, very important slide for us as mortgage investors. This shows the one of many measures that we use to gauge mortgage attractiveness or the like. We’re basically just showing you the spread of a current coupon mortgage to a 10-year treasury. There’s many other metrics you could use. You could use a spread to the 5s, 10s blend, or you could use a spread the swaps. And I think the conclusion that you would draw would be the same if any of them. And I just want to point out a few things. So, on the bottom, we show a very long-term look back. This goes all the way back to the beginning of 2010. And that’s very important for gaining some perspective on where we are today, which of course is to the far right.

And then on the top, you see the same chart only with a much shorter look back, just going back to the end of 2021. And as you can see in 2022, mortgages got quite cheap. In fact, if you look, at the top there, you see — the point that coincides with late September, early October, we got to about 190 basis points spread. That is quite wide. In fact, if you look at where we were in the bottom chart, in March of 2020, we only got to about 160. So, we were quite a bit wider than that. That was when the market was being — to a large extent being driven by the Fed and forced to accept the fact that the Fed was going to tighten much more aggressively and the rates were going to go higher and mortgages sold off. Of course, that was also accompanied by a movement and volatility, which also drove mortgage spreads wider.

And so you saw quite a wide move. And then we started to tighten. But that has since reversed. And that’s mostly been the case in February. And we were at about 160 basis points yesterday and maybe a few basis points wider than that. So, looking at the blower chart, you see a prolonged period where spreads were fairly stable, it’s seven, eight-year period, where those spreads were in the high-70s. And there’s no compelling reason that says we’re going to have to go back to those levels. But it’s reasonable to assume it’s that not likely we’re going to stay at these extreme levels. And all this leads us and most of our peers to conclude that mortgages are attractive, and they offer very attractive total rate of return prospects assuming at least a return to somewhere close to that range.

So, it’s quite a big move if we were to go from 160 or higher towards high-70s, 80s range or even close to that. So, mortgages look attractive to us. Moving on slide 9, this just shows you — chart that we’ve used more in the past, less relevant today, to show you the spread between the 5 and 30-year points on the curve. And as you saw, the slide a few before, that part of the curve is slightly inverted, not meaningfully. So, all the inversion really occurs in the very front end. So for instance, the spread between the 2 and the 10-year or Fed funds and the 10-year, that’s the meaningful inversion. And it’s likely to stay where it is if not even get higher as we move forward until the end of the tightening cycle. Slide 10, this is a picture that moves itself just show you holdings by large commercial banks and the Fed in place and reserve being withdrawn from pace.

We’ve seen this before back in €˜19 when arguably reserves got too tight and caused some problems in the markets. this might happen again, the Fed put in place the second repo facility in the event occur. In any event, I don’t think it’s an issue for the immediate future. But something worth watching and that’s kind of why we have this slide in here. Slide 11 is very important. This is when we’re looking specifically at the mortgage market. And if you look at the top left, what we present here is we normalize the prices for several coupons, Fannie 3s, 4s, 5s and 6s, so giving you a wide range of coupons. And as you can see, early in the fourth quarter, especially as we moved into late October, mortgages and rates performed quite poorly, and mortgages in particular did quite poorly.

But then it started to turn around and we closed the quarter on a big upswing. That’s why we had the book value performance we had. And as you can see in early January, they did very well. And I want to point out and stress here that if you look at the coupon performance, lower coupon versus higher coupon in the period of the quarter, any of these periods when we were rallying, did very well. And there’s several reasons for this, obviously, they have longer duration. But also what we’ve seen over the course of the late fourth quarter, into early first quarter this year, is money managers and the like coming back into the market, most of whom were probably underweight the sector and adding to their positions to get neutral or at least close to neutral.

We don’t have any data for February, so I can’t really say where we think money managers are relative to their bogeys. But we do know, I just read today that bond funds have seen eight consecutive weeks of inflows. So, even to the extent that they’re neutral, the fact that they would try to stay so with bond inflows, it’s beneficial for the sector. And it’s good news for us, because we’ve been on the other side of that equation for quite a while last year. So the fact that money is coming into the space bodes well, particularly for these low coupons. In particular, anybody that runs a portfolio against the index, because the index is very heavily skewed towards lower coupons. Obviously, they were the ones that were produced for most of the last 10 years, in contrast to say Fannie 6s or 6.5s which weren’t even produced until recently, for quite a long time.

So to the extent there’s index, money managers coming into the market, they’re going to be active in those sectors. And those securities have performed well, and we would anticipate they would perform well, if and when the Fed were to pivot and the market would start go in the other direction. In contrast, if you look on the bottom left, you see rolls, other than the Fannie 6, the rolls are all very low, they do not offer much in the way of drop income. With the exception of 6s, it’s been a very technical market in 6s, so that roll can get very special or less special very quickly. The generic — generally speaking, roll market has not been attractive of late. The top right just show specified pools. These are just representative. As you can imagine, as we rallied in January, specs had a decent run, especially with rolls being soft, but now we’ve had another backup in February.

And I suspect that rolls might soften again, but it remains to be seen. We don’t have meaningful data points yet, we’ll get that in early March. The roll market — or the specified pool market given that the market is at such an extreme discount, even in a good day, there’s not a lot of performance to be had there. So, it’s more of a generic or a low payup pools that we heard more desirable to own. Turning to slide 12, we show a picture of volatility. This is just one — one measure, three-month by 10-year normalized vol. And as you can see, it’s been high and very elevated and it remains elevated. Again, we’re showing data through February 17th, which is last Friday. It’s even elevated more as we speak. One point I would make is that mortgage performance and spread levels have been fairly highly correlated with vol as they always are, but it seems even more so over the last 12 or 14 months.

So, vol levels are very important, something we always keep an eye on because they do impact mortgage performance, always have and always will. Just moving on slides — 13. This is — the left side, we show OAS levels. As you can see, they’ve been fairly stable. Different investors put more stock or less than OAS levels. Now, the problem with OAS, if you’re a skeptic, is that you realize that these are the products of models. And given where we are rate wise and the fact that we have almost the entire mortgage universe at a discount, those are — we’ve never seen an environment like this before. And models have built off of empirical data. So, it’s a challenge, I would argue, for the models to be as accurate as they might be otherwise, there’s been frequent changes to a lot of the model, especially on the street yield book and the like.

But that being said, there are a number of investors who trade off of OAS level, so you can’t ignore them. But they would tell you that mortgages are reasonably attractive, not great. And we’ll have a little more to say on that relative attractiveness in a moment. Moving on, just some return data, just so we can kind of gain some perspective and not lose site of the fact that while we’re exclusively MBS investors, we operate in a world of investors who operate across all sectors. And we have three tables here. The top one shows you the Q4 returns. And as you can see, it was very much a risk on, as we like to say, type of quarter. The best returns were generated by the S&P, emerging market, high yield, domestic high yield, et cetera. The lower risk sectors such as agency mortgage has had positive returns.

But that lagged the more risky sectors, which is kind of what you would expect. What you don’t expect is what we saw for the full year of 2022 on the bottom. And this is very much in sharp contrast to historical norms. If you see the numbers here, from the far right, the S&P was down 18%, treasuries were down 12.5%, mortgages almost 12%. Very unusual to see all of these sectors have such highly correlated returns and all negative. That was one of the most remarkable aspects of 2022 is the positive correlation between bonds and in most risky assets, it’s very typically not the case, it’s the opposite more often than not. So, very unusual year. And it just reflected the fact that we had unprecedented things going on, we had the believable removal of accommodation by the Fed in the form of their tightening.

And then also we had seen such incredible monetary — fiscal policy from the government, which was then stopped last year. So, it was basically the withdrawal of tremendous amounts of accommodation. And that’s what led to these types of returns. Slide 15, we just show that quarter to date through February 17th. Nothing much to say here, other than, well, they are all positive, which is good. But it will be interesting to see how this table looks as we move through the year and we approach the end of the year. It could look a lot different. Slide 17, this is more of the same. We’re just showing you spread levels across the fixed income markets across the ratings spectrum. And I’m not really going to say much about this, you can look at this at your leisure.

We do show levels at the end of 2021, 2022, current. Current is as of February 9th, and then we show year to date changes. And then one thing we do have here is this one column near the right side, it says 2022 highs. And of course, those levels were all very, very high in 2022. And you can see in the farthest right column. Most of the asset classes have moved in, but not nearly that much. They’re certainly still all above where they were at the end of 2021. So generally speaking, most sectors of the fixed income market are trading at levels much wider than they ended 2021. The next slide, slide 17, not much to say here. The top left shows you the refi index versus the mortgage rate. And as you can imagine, with mortgage rates extremely high levels, the refi index is at multi-decade low.

The percentage of the universe that’s financeable is extremely low, very low single digits. But one thing that is worth pointing out, if you look at this top right, we have the primary secondary spread. And this is really relevant for originators and what we can expect from them. You can see the current level is more or less in the middle of the range it’s been and going back a few years. But one thing we do know and we’ve seen in the past, even going back to the days before the financial crisis that when mortgage originators are in a slow market, they can accept tighter spreads in order to keep business volumes at or — at sustainable levels. And so for that reason, we may see a slight tightening in this spread rates — long end rates were to go up a little bit higher just so they can maintain levels, which means that we may see refinancing activity or purchase activity stay a little more robust than it would have otherwise.

But that all being said, leave no doubt that refinancing activity is still very low, and even purchase activity is at very low levels. Now, we can talk about our financial results on slide 19. And this is a chart that we present every quarter. And I want to spend some time as I did last quarter and talk about the left hand side. As you can see, for the current quarter, our core income proxy is negative. It’s $0.09 negative, obviously with a $0.48 dividend. You wonder how we can cover that. And just as I said the last time, you have to understand that in the right column there where we have these realized and unrealized gains, because of our accounting treatment, some of the things that would normally be components of core income are instead captured in those numbers.

So for instance, unrealized gains on MBS include accretion of discount. Our entire portfolio trades at a discount to par. And any accretion through pay-downs is captured in that number. So that number for the quarter was 6.75 million. So, that’s about $0.1834 that would otherwise have been captured in the $0.09 number. And we also have hedges. Now for the quarter, our interest rate futures and swaps had negative mark-to-market. But that’s just because they went from very, very far in the money to slightly less so. But nonetheless — needless to say, they were all in the money for the quarter. And so, we were receiving more than we were paying out, for instance on our swaps. And that number was about 11.1 million for the fourth quarter, which is about $0.3011.

So, when you add those two numbers to the negative $0.09, you get about $0.395, which I realize is slightly less than the $0.48 dividend. And I’m going to address that, but I’m going to do so in a few moments when I get into discussion of the details of the portfolio. So for now, let’s just hold that thought. We’ll be coming back to that momentarily. Next, I want to talk about slide 20. And this — again, this is historical data that we’ve presented. But I want to point something out very important. If you look at the top chart, you see a solid red line. That represents our economic interest cost, which was 226 basis points for the fourth quarter. Now granted, that’s at a higher level than it’s been recently, but if you look back at where those numbers were in 2019, for instance, even into early 2020, they were at higher levels.

So, our economic interest expense was higher than it is now, even though the benchmark indices are more than 200 basis points higher today than they were then. And this speaks to the amount of hedges that we have in place, and the legacy hedges which we’ve closed, but for tax purposes still are relevant because the way tax accounting works. For instance, if you enter into a 10-year swap and a year later you close that position, whatever the open equity is in that position at the date that you close it is applied over the remainder of that 10-year swap period. So, in this case, it would be nine more years. So for instance, if that swap are closed with positive equity, it would represent a reduction in your interest expense over the remaining nine years.

And we have a lot of legacy swaps, in addition to our current swaps that are going to be available to us for tax purposes, and therefore dividend calculation purposes, for many years to come. And I’ll give you the details of those numbers in a moment. But there is a lot of benefit being derived from those hedges. Just moving through the slide deck, I’m not going to say much about ’21, this is just historical information. But I want to spend some time on page 22. This shows our leverage ratio, on the left hand side. Keep in mind, this is GAAP leverage. So this is showing our total liabilities divided by our shareholders’ equity. We do back out — unsettled security purchases, but those are generally not material. That number was 7.8 at the end of the year, which is on the low end of our range.

But keep in mind, this is GAAP leverage ratio. And like many of our peers who use TBAs, typically they’re long TBA, so their economic leverage ratio, as we referred to is typically higher than their reported GAAP. In our case, we’re short TBAs, we’re not long. And so, our economic leverage ratio was actually 6.3 at the end of 2022. So, it’s very low relative to our historical norms. And it’s about 6.4 today. So, our leverage ratio, in view of our typical range, which is maybe six to nine, we’re at the low end of our range. So, we have quite a bit of dry powder that we can deploy when and if the market — the Fed pivots, so the market turns around, and we start to see prospects for a meaningful rally in rates, especially on the front end, and the potential for mortgages to tighten back towards historical norms.

We have dry powder. It could be as simple as buying back our shorts. So for instance, if the market starts to rally and mortgages start to tighten, we have a lot of TBA shorts that we could unwind that would allow us to benefit and realize this leverage ratio you see here versus the true economic one we have today. So it would be beneficial to us. Page 23, I’m not going to say much about this. Our allocation on the left to pass-throughs is higher, simply because IOs with rates as high as they are, basically tapped out. I mean, they can’t go up in price anymore, speech can’t go any lower. In fact, what we saw for the latter half of 2022 is very mediocre performance from the part of IOs because there were really a lot of investors selling and trying to take profits.

So price appreciation was limited. And we don’t see any benefit. There’s nothing — there’s more downside in owning IOs today than upside. So we’ve been moving into a much more heavily concentrated exposure to pass-throughs. Now slide 25, we can talk about our positioning here and kind of how we’re positioned and why. If you look at this page, I’ll just highlight a few things. If you notice that — for instance, I’m going to start with our coupon. Our weighted average coupon at the end of the year was 3.47%, it was about 3.3% at the end of the third quarter, and it’s about 3.55% today. So from the end of the third quarter to today, it’s gone from 3.3% to 3.55%. It’s not that much. We still have a very heavy lower coupon bias. And that might be in contrast to our peers who have gone to a much larger extent up in coupon in an effort to generate current income and to cover current funding costs.

We have not done so as much as they have, in fact, much, much less. One thing I will point out here, if you look at our position on 30 years, pretty much 30-year 3, 3.5, 4 and 4.5, most of those positions did not change over the course of the fourth quarter other than pay-downs. But we did add about 400 million to our position in 5s. And since the end of the year, we’ve added to our exposure in 4s by about 150 million, and we added about 160 million to 5s. So, we have brought the coupon off, as I mentioned to 3.55%. But it still has a much lower coupon bias. And then, I would also mention that the total portfolio is up about 400 million. With respect to our hedges on the bottom of the page, we have TBA shorts of 675 million. That’s the number I was referencing when I said our economic leverage ratio was lower than our GAAP.

We’ve added to that since year-end, it’s now about 875 million. So, we have a lot of dry powder in the form of TBA shorts that can be unwound, in the event that the market turns. And so now, just kind of giving some more color on why we’re positioned the way we are, and with this lower coupon bias. Two things that really mitigate the negative, if you will, ramifications of owning these lower coupons. I mentioned the fact that we had a lot of hedges, both legacy hedges, in other words, hedges that were closed, and existing hedges that can be used to offset increased funding costs. And these numbers just — or these hedges really started to come into the money in the second half of 2022. And like I did today, and like I did in the last quarter, I showed you these numbers that we received in the form of an offset to our interest expense.

Going forward, those numbers are even higher, so they’re higher than they were, in the future than they were in 2022. And what we did is to kind of do some analysis around this, we looked at all of our closed hedge positions, and we calculated or tabulated the contribution to interest expense in the future. And then, we took the second step of taking all of our hedges that were in place at the end of 2022. And assuming they had been closed that day, and then determine what benefit we would derive from those over the remainder of the hedge periods and underlying them, and then just tabulated them across time. And I can give you some numbers. For instance, in 2023, we have about $58.5 million available to offset interest expense in the current year.

In 2024, that number goes to $70.2 million. In 2025, it’s $77.2 million. And it stays relatively high through the balance of the decade. The total is about $417 million over the remaining lives of those hedges. So, that’s a big mitigant in our minds, and is why we are not comfortable trying to chase current income in the form of premium mortgages today. We feel we have a lot of this hedge benefit that we can utilize. And the second reason is that as we do always, we look at these investment opportunities from a total rate of return perspective, so not solely focused on current income, and we make — the lower coupon securities which are very easy to hedge because they’re fully extended. We have longer tenor hedges in place. And we’ve seen already in the fourth quarter and earlier this quarter in a rally they do very well and we explain why we think they would continue to do so.

The fact that mortgages are wide and the fact that money managers tend to run against indices, which are heavily weighted towards these coupons, we think they offer very good total rate of return opportunities. And that’s why we want to favor these. On the other hand, we view current coupon mortgages as quite unattractive. And while they might offer current — high current income, they would probably exhibit extremely poor convexity. In a rally, they’re going to perform poorly, because they’re going to short, because they are — the mortgages are going to be the most readily refinanced. These are newly originated loans, they have fresh documents, they would be the lowest hanging fruit and prepay fast. In the event of our sell-off, they’re going to expand.

As a result, with that horrible convexity, they’re very challenging to hedge, and the cost of hedging would be high. So again, when I talk about their apparent current carry, you have to realize that when you go to hedge that, it materially eats into the cost. And we don’t have similar costs with respect to the coupons that we own. And that’s for — we need to have even better total rate of return prospects, coupled with our legacy hedge interest — benefit. And we are very comfortable maintaining the positioning that we have in place and we probably continue to do so going forward. One final point on the positioning, and this is in a somewhat related vein, with respect to capital raising. We were very constructive on that in early January and early February, still somewhat, are, maybe a little less so and we will probably recognize that carry in this environment’s a little less than legacy assets.

But that being said, as I mentioned, if you can buy deep discount mortgages that are fully extended and hedge them with, for instance, 10-year swaps or a forward starting swap, you can still lock in pretty attractive spreads. And in conjunction with the total rate of return potential of those securities, you still get returns in the double-digits. So, they’re attractive. And capital raising is certainly something we would consider. And with the most recent cheapening we’ve seen the last two or three weeks, they even look more compelling. So, there’s definitely benefits to new capital being deployed today. Just moving on, slide 26, this just shows our speeds. On the bottom right, you can see that our speeds relative to the cohorts as we move through 2022 kind of converge.

So, they’re more in line with the cohort. That being said, speeds in the cohorts are all much slower and will probably stay that way for some time. So, there’s no question that speeds generally speaking are very low and likely to stay that way. Going through the balance of the this deck, slide 28, we show our funding costs in the blue line versus the red line, which is just our aggregate cost of funds, and you really can’t quite see it, but we also have one month SOFR there, they’re pretty much on top of each other, the red and the gray line. But the blue line, you can see that gap is large and growing. And as we’ve moved into 2023, it’s continued to expand. And that again leads to the benefits of both, our legacy and current hedges which are very much in the money.

And so, that’s pretty much it. One last slide on the hedging positions. The top left are our futures. They are mostly unchanged through the end of the year and early this year. We did roll them. One trade we did do is unwind some of our futures and replaced them with a forward starting swap. With respect to our swap agreements, other than the one we just added, those were unchanged over the course of the quarter. And in the bottom right, we show our swaptions and rate derivatives. That’s where we do most of our dynamic hedging as the markets move. So the positions there do change more rapidly than the rest. But those are ways but we can be kind of nimble, and take advantage of opportunities as they present themselves in the market to kind of enhance our overall hedge effectiveness.

And then finally, I just want to conclude with kind of our outlook, and how we view the world. Obviously, with what’s happened of late with the data turning around and going in the opposite direction, which it had been, we’re seeing inflation start to reaccelerate, we’re seeing wage, nonfarm payrolls are very robust. So, I’m not sure when the tightening cycle is going to end. It’s hard to have a lot of conviction. But one thing you can have conviction is the fact that assuming that the Fed is going to do as they say and continue to tighten, eventually this cycle will end. And there will be a pivot. We’re not sure when but we are very much looking forward to that because we think we’re very much very well positioned to take advantage of that in many ways.

We can get through this environment, as I mentioned, for the reasons we just discussed. And we like the upside when and if that happens. We have one, potential for NIM expansion if to the extent that the fed eases; we also have all of our substantial hedge positions, which are going to support our NIM, which would do so even more in the event of a Fed tightening — or easing. But we also have book value expansion potential. The current coupon mortgages are wide. We don’t know how much they can tighten. They may or may not get back to historical norms, but they are very wide relative to those. And also vol could normalize, which again would be helpful in bringing spreads in, the vol is very elevated. The other thing is — second point would be our exposure to fully index, extended low coupon mortgages, which we think can do very well in a rally.

And the fact that we have a low economic leverage ratio, which we can easily increase by 2 or 2.5 turns to take advantage of that. And we don’t have any exposure to high coupon premiums, which we think would be formed very badly when and if the Fed pivots. So for all of those reasons, we think we have the potential for very good book value performance and NIM expansion. And then, one final minor point, I would just say that, to the extent we do have a downturn in the economy, you would expect agency mortgages to perform on a relative basis quite well, just because we have no credit exposure. And you could see some credit widening in other sectors. So for all those reasons, we are cautiously optimistic on the market. As I said, we don’t really know when the market is going to turn, when the Fed’s going to pivot.

But the more they tighten, the more they have to constrain economic activity, just kind of increases the chances that it will ultimately turn over and they’ll be successful. And when they do, we stand to benefit from that environment. So, that’s kind of it. Operator, with that we can open the call up to questions.

Q&A Session

Operator: Our first question will come from the line of Jason Stewart with JonesTrading. Please go ahead.

Jason Stewart: Thanks for taking the question. And I appreciate all the comments on the portfolio, especially on the coupon stack. Do you have a thought on where natural turnover is in the market today?

Robert Cauley: It’s, I would say, single digits. The one thing that I’ll say about that is that in the past when someone asked you that question, you would look to whatever discount security there was, and there typically would only be one, maybe two, and say, okay, what is two or three-year old, Fannie or Freddie X. And what’s it prepaying? And that’s my proxy for turnover. Well, now, the entire universe is a discount, and we have seasoning. But it seems that everything is tending towards mid to even low-single-digits. Some of the low loan balance pools that are seasoned, as discounts can prepay around 10 — 8 to 10. But that’s the range, I would say, call it 3 to 10, depending on security, but very low.

Jason Stewart: Yes. Okay. And then, when you take that into — going down the coupon stack, and related to capital allocation, what’s more attractive, the dividend, stock buybacks? How should we think about that equation in your mind?

Robert Cauley: Well, we did do some share buybacks in the fourth quarter, about 2.5 million shares. Weighted average price was like 9.30. So, when we’re at a 90%, that’s kind of our threshold book. When we get below that, we start thinking about buybacks. I think when we did those, we were closer to 80%. So, 90 to 100 is the gray area. If we’re in the high-90s and the investment opportunities are very good, we may even issue shares. Obviously, for above book and the investment opportunities are decent, we will issue shares. And then, we get below 9, then we start thinking of buying back shares. But we think the lower coupons, even 5 CPR for life, which you may not realize for the next six months, but for life, the yields on those are still 100 over bridges 10-year swap or more depending on which coupon you buy, 3 or 3.5 or 4.

So, those are not bad returns, with decent potential for price related performance. So, you can get total returns in the double-digits. It may just not be all in the form of current carry, but you may realize that carry down the road just won’t be front loaded.

Hunter Haas: And with tremendous upside to the extent that rates move, they’re much easier to hedge into a sell-off. And to the extent that we rally and spreads tighten even further, which we would expect, a lot of that spread duration is going to play out through a longer cash flow and we would stay and see a potential benefit there as well.

Operator: Our next question will come from the line of Mikhail Goberman with JMP Securities. Please go ahead.

Mikhail Goberman: Good morning. I hope you gentlemen are doing well. Those extensive comments pretty much covered all the questions that I had in the question of buybacks versus share issuance was just covered as well. I just have a question about if you could provide a current book value estimate. That’s it for me.

Robert Cauley: Yes. I meant to mention that. Using the mark-to-market on the portfolio and hedges, we were up about 10% at the end of January. So obviously, we had a good run in January. We had a lot of low coupon exposure. But with the sell-off, since then we’ve given up at least half of that. My most recent estimate, again, just using mark-to-market of the portfolio, it’s not a purely GAAP number, we were about 4% year-to-date. So, we gave back a little over half of that. We’ll see what the future holds. But so far, we’re up on quarter.

Operator: Your next question will come from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Christopher Nolan: Hey Bob. Could you give a little detail as to the logic behind the increased TBA short position, please?

Robert Cauley: Yes. What we did there was, as I mentioned in January, like the very earliest days of February, lower coupons had a really good run, performed very well. And we just it was kind of a way to lock in some gains, if you will, pretty much. Hunter, do you want to add to that? But that was kind of…

Hunter Haas: No, I think that’s the tool that — a lever, I guess, that we’ll use to the extent that we think a certain coupon, just the TBA in general has had a outsized run, we will put some duration related hedges on in the form of TBA shorts, and in lieu of other rate hedges. So it’s really more of a basis trade. And with our high exposure to Fannie 3s, it’s just something that — I don’t expect to be there forever, but mortgage, like we said, mortgage did great in the fourth quarter. Even, it continued — that continued into the first quarter. And so, we lagged in a little bit more to our bases hedge. And to the extent that we see things gap wider, which we have, we may reallocate to rates.

Christopher Nolan: Okay. I guess my follow-up question turns on the dividend. I know it was decreased this quarter. And given that the market has been — I mean, the interest rate market has been so topsy-turvy and everything else. Given that and given your comments in terms of all the taxable carry forward you have, what’s your thinking of the sustainability of the current dividend?

Robert Cauley: We see it as sustainable, and as I mentioned. We were a little short in fourth quarter, but that’s just purely on an income basis. The portfolio’s total return was much higher than the dividend because we had the price appreciation that we had. And I also mentioned that the hedges really started to kick in, in the second half of 2022. They really do so this year. So, we’ve got that significant tailwind, so to speak at our backs. And even with these lower coupons, while they not cover the dividend in and out of themselves, in conjunction with the benefits of the hedge — legacy hedge asset and the fact that they have such great total rate of return potential, even if there’s a modest shortcoming — shortfall in the near-term, which I’m not sure that would be, we still view this as much more desirable.

I think it’s — Hunter mentioned, it’s very challenging to try to — in my mind, be myopic and try to just go up and coupon and capture more interest income, because that’s fleeting. It’s really not what you think it is, because those assets are extremely hard and therefore costly to hedge with poor total rate of return prospects.

Hunter Haas: Yes. I think, just to chime in on that, I think this is just an environment that’s more complicated than just looking economic income or NIM. There’s a lot of income that is not quantified in under that more simplistic way of looking at things. For example, in the deep discounts, in our portfolio, all of the pay-downs to the extent that they are 12 to 14 points or accretive to us in fair value terms, that’s really to me — when I think about these assets, that’s an income component, but it shows up in a fair value adjustment. So it’s really hard to disaggregate those changes in market value. A lot of that — book value appreciation that we saw in January and year-to-date and in December, comes from the fact that there’s a positive roll up component in our hedges, there’s a pull the par and our deep discounts that we own. So looking at things through the traditional lens of just NIM or economic income is a little bit challenging in this environment.

Operator: We have no further questions at this time. I’ll turn the conference back over to management for any closing remarks.

Robert Cauley: Thanks, operator, and thank you everybody for your time. To the extent additional questions come up, please feel free to call us in the office, or to the extent that you aren’t able to listen to the call live and want to call us afterwards, after listen to a replay, the number in the office is 772-231-1400. We’re always willing and able to take your questions. Otherwise, have a good day and have a good weekend. Thank you.

Operator: That concludes today’s meeting. Thank you all for joining. You may now disconnect.