Orchid Island Capital's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Nov. 6.13 | About: Orchid Island (ORC)

Orchid Island Capital Incorporated

Q3 2013 Earnings Conference Call

November 6, 2013 10.00 AM ET


Robert Cauley - Chairman of the Board, President, Chief Executive Officer

Hunter Haas - Chief Financial Officer, Chief Investment Officer, Secretary, Director


David Walrod - Ladenburg Thalmann


Good morning and welcome to the First Quarter 2013 Earnings Conference Call for Orchid Island Capital Incorporated. This call is being recorded today on Wednesday, November 6, 2013. At this time, the company would like to remind the listeners that statements made during today's conference call, relating to matters that are not historical facts are forward-looking statements subject to the Safe-Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Listeners are cautioned that such forward-looking statements are based on information currently available on the management's good faith, 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

Thank you, operator and welcome everybody to our third quarter earnings call. As a very volatile second quarter in which the 10 year note rate increased by close to 100 basis points and MBS places sold out materially, the third quarter started off in the same fashion. The market reacted violently to the Federal Reserve's hint that that they will begin to taper their assets purchases by yearend in May and June and suddenly been stopped until late in the third quarter.

The economic data release early in the third quarter was generally strong or at least the employment data which par with the Fed's contention that there has been material improvement in September of 2012 when QE3 was announced. This development was to be the basis for the beginning of at least wind down their asset purchase program as the quarter progress the MBS asset prices continue to sell up and MBS duration extended.

Shortly before the nonfarm payroll report for August was issued on September 6, the yield on a 10 year U.S. Treasury note briefly surpassed 3%. When the Fed met later that month and market was fully exciting to Fed to announce the initial tapering of their asset purchases. The market was dead wrong. The Fed did not announce any changes to their asset purchase program.

In fact, the Fed decided to cancel these through options to the economic activity that might occur if Congress and the administration were unable to address the pending exploration of the continuing resolution, there was plenty [indiscernible] on a temporary basis and the related need to increase the country's debt ceiling. They were quite pathetic.

The government shut-down for over 20 days while the power that be in Washington [hang it] over the terms of resolution to the mini crisis. Economic data has also soft and now the market is now expected to fairly start to taper its asset purchase program until well into 2014. After the Fed announced on the 18 or non announcement, the rate markets rally and MBS follow suit even tightening as the MBS asset prices rose well in comparable duration treasury.

If someone had left their office on June 28, 2013 and not come back until September 30, 2013, they might assume very little had happened in the rates market over the quarter. After all, while the long end of the curve moved up slightly -12.4 and 18.5 basis points in the case of the 10 year note and 30 year bond respectively, most points on the curve were close to unchanged.

This was certainly not the case, however. Thirty-year, fixed rate 3.5% coupon mortgages traded in four point range over the course of the quarter yet ended the quarter only 14 tics higher in price. We ended the second quarter with essentially the same balance sheet size and repo balance that we started it with. This was the case again in June 3; our repo balance was down only little over 2% on the quarter. We did make some adjustment to the portfolio over the course of the quarter. But importantly, we do not have to shrink the portfolio and the earnings power of the portfolio has been maintained.

We announced the monthly divided for October of $0.135, matching the monthly dividend in the previous seven months since our IPO. Our year-to-date distributions are essentially equal to our year-to-date taxable income. We will have our final taxable income figures for the year in early 2014. As the market sold off as well as after the rally when the Fed opted not to taper on September 18, we made minor changes to the composition and profile of the portfolio.

We have reduced our holdings for the fixed rate pass- throughs from 61.8% of portfolio to 55.7% and deploy the majority of the proceeds in hybrid arms which has stiffen dramatically. We also repositioned to fix rates on portfolio into higher coupons especially after the market rally with the Fed did not announce the tapering of their asset purchases on September 18. Our average coupon on the fixed rate cash to hold is increased from 3.35% to 3.62%.

We have continued to move our fixed rate holdings up in coupon after quarter end. The structured securities portfolio was reduced only modestly and now represents 6.3% of total portfolio assets versus 6.5% at June 30, 2013. Within structured portfolio, we increase the average coupon of the IO holdings from 3.93% to 4.32% in an effort to re-strike our exposure to rate if you will.

The coupons on our IO holdings are now centric at or just above the current coupon rate. They have the greatest potential to expand if rates rise further. We also deployed more capital into inverse IOs from 0.6% of total assets to 1.6%, as yields available are now much closer to lever pass-through position and offer some extension protection as well. Our leverage ratio is up slightly from 6.5x at the end of the second quarter to 6.7x at the end of the third, reflecting a slightly lower equity base offset partially by slightly lower by 2.3% repo balance.

The portfolio is now more defensively positioned than it was when we entered Q2. We expect the economic data to remain on the soft side for the next few months and the Fed too [indiscernible] on tapering until late in Q1 of 2014. But regards of what may begin to taper, we are very confident they will ultimately to do so. Our sense is that most market participants expect the same and we have seen evidence of this at late when softer economic data was released but was not followed by rally in the rates market.

In sum, we still see the risk profile is skewed towards higher rate. It's more questionable when not if. If we are wrong, the positioning of our portfolio such that we will likely be negatively impacted by higher prepayments should they occur, because of the positioning of our IOs and fixed rate assets. We've also taken a net duration of the portfolio down since quarter end; however, we are quite comfortable with its positioning. This is because risk management and protection of book value are the focus of our investment strategy.

By positioning as we did going in Q2 and Q3, we are able to preserve book value and importantly, we haven't to de-lever our balance sheet. This is allowed us to retain our income generating potential; this is not the case with all of our peers. If rates still continue to move higher over the next few years, we will succeed by retaining our book value as best we can, as book value provides the basis for generating attractive risk adjusted returns. As it rose so does the income generating potential of the portfolio. And that's it for my prepared remarks. Operator, we will now turn it over to questions. Operator?

Question-and-Answer Session

(Operator Instructions)


Our first question is from David Walrod. Your line is open. Please proceed with your question.

David Walrod - Ladenburg Thalmann

Hi, good morning.

Robert Cauley

Good morning, David.

David Walrod - Ladenburg Thalmann

Kind of a conceptual question, a lot of your peers given all the volatility have been taking down leverage and increasing their hedging, and I am just curious if given the way you can be somewhat nimble with your portfolio. You broaden your allocation to pass -throughs to about 49% from 52%. Does it make sense given your commentary about rates being, the press forward extended period, does it make sense to up the allocation to the pass -throughs for maybe two three quarters and maybe reduce the hedge a little bit in order to maximize earnings and then maybe reallocate.

Robert Cauley

A very good question, good thought. I will give a comment and then I will turn it over Hunter. One thing I want to stress is the fact that we do not have to shrink means that our earnings potential didn't shrink obvious statement, but more importantly, we moved up in coupon, we have restructure the IOs to higher coupons so what that really mean then is that our earnings potential has been enhanced somewhat while the market -- they have been surely been reflected in the dividend and I won't say anything about the dividend for the balance of the year and 2014, but in essence, we are benefiting from the backup and seething up the curve, and we really have the potential to increase our earnings without doing anything to the hedge. The problem is to your point is that, yes, maybe if I had a crystal ball and I said the Fed is going to start tapering again a new pull sell off in May, it would make a lot of sense to do that. But you don't have, and you might have sense it we are not going to do anything but if you are wrong, you can get really caught out. And we saw to some extent that happened in the second quarter. So if we have the ability to maintain or slightly increase our dividend without having to offer our hedges, I think it's most prudent to do that. And therefore if you are wrong or if the market, if the Fed goes a little sooner than rather later, you don't get cooperate, you don't get caught out and have to de-lever and basically decrease your earnings potential. So I think we are quite comfortable being able to do what we are. Hunter, if you want to add to that?

Hunter Haas

Sure. David, what we are trying to focus on here is sort of having our cake and eating it too I guess, and that the market is provided us with an opportunity to take some gains on some buyers by virtue of the fact that have extended since we purchased them. Some of them were up or down little bit versus the prior mark which shows up in our GAAP reporting, but generally speaking, we're welling the money on those purchases and rates have moved a long way. So what we have been able to do is improve our risk profile by going up in coupon those IOs and still sort of have the same capital allocation to that space with more coverage. Similarly on the pass-through side rates finally came back and after we were comfortable shedding a little bit duration without appearing that we are going to get which side too bad and so in the third quarter, we sold a lot of asset classes pass-through space that had done what we thought exceptionally well, so there is lot of buying activity in 15 year threes, we took advantage of that and sold it little bit. We took advantage of some of this stress in the hybrid arm market by buying into that. And also for the first time in couple of months, the market presented us with an opportunity to buy higher coupon for the year fixed rate by 4s and 4.5. So in general what we try to do is as rates have moved gradually, higher from the taper announcement, since it had moved lower from the non taper announcement, we have lighten up on some of the high duration 30 year fixed rate products and ended some lower, some lower duration assets like 4s and 4.5 versus say 3s and 3.5, so we believe that, back to your original question, so I think what we are doing here is we are improving the profile of the portfolio and also increasing the income earnings capacity on the margin. So hopefully that's beneficial in the coming few months.

Robert Cauley

Yes, actually I have one final point to that note that we've been able to as we flatten our profile a little bit without increasing the hedge. So the hedge is basically the same by moving up in coupon and fixed rate and up in coupon and IOs, we now have kind of same protection from operate, we didn't have to increase the hedge, you follow the peers and you know the buy increase in the hedge it became very much a big issue with respect to earnings power, because current rate stiffen, so if you hedge up the curve, you are paying say for instance stakes on swap is very, very costly so do not have to increase the hedges very beneficial in terms of future earnings, and also as I said the other market generally speaking is offering service better return and have been the case to the most of the year.


(Operator Instructions). I am not showing any further questions. Please proceed with any further remarks.

Robert Cauley

Thank you, operator. Once again I appreciate everybody's time, to the extent somebody is just a little shy or listening to the replay of the call and has questions further to what was discussed today, please feel free to call us in the office, our number is 772-231-1400. We will be very glad to field any more questions. Otherwise we look forward to speaking to you next quarter. Thank you.


Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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