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Orchid Island Capital, Inc. (NYSE:ORC)

Q4 2013 Earnings Conference Call

February 20, 2014 10:00 ET


Robert Cauley - Chairman and Chief Executive Officer

G. Hunter Haas, IV - Chief Financial Officer and Chief Investment Officer


David Walrod - Ladenburg


Good morning and welcome to the Fourth Quarter 2013 Earnings Conference Call for Orchid Island Capital Incorporated. This call is being recorded today Thursday, February 20, 2014. 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 - Chairman and Chief Executive Officer

Thank you, operator. Last year may end up being the beginning of the end of the market environment we have (less lifts) since the end onset of the financial crisis in 2008. While no one would suggest it is all as well and our (plums) are behind us, clearly the economy has more, many to do before you’re back to the conditions that existed in 2006 or even 2007.

The Federal Reserve today announced as it begin to remove the combination beginning in January of 2014. This process played out over several months starting in May of 2013 when former Fed Chairman, Ben Bernanke, then the Fed would start to taper it’s asset purchases of the near term if the economy continue to perform as it had recently.

And the Chairman’s words, the economy’s performance was consistent with the Fed’s expectations when it announced the third round of quantitative easing or QE3 in the fall of 2012. The market reacted very strongly to the Chairman’s words and sold off violently. The market started to price – some increases in the Fed funds rate by the end of 2014. The Fed team is surprised by the market’s reaction and they attempted to reassure the markets that had no intention to raise the Fed’s fund rate near future. Nonetheless the markets sold off and the MBS market in particular was negatively impacted.

The market has remained very sensitive to economic data suits and as market participants try to going inside into the Fed’s next move. As we all know the Fed commenced its tapering program in January of this year. The Fed announced another round in reductions through its asset purchases at the conclusion of its January meeting as well. From this point forward absent material erosion and economic data, it appears that Federal Reserve will continue to wind down it’s asset purchases and the purchase (indiscernible) sometime late in calendar year 2014.

From there the economic data will dictate when the Fed ultimately removes the conventional combination – when the Fed ultimately removes the conventional combination begin to increase the Fed’s fund rate. For Orchid Island and (all managers) of levered MBS portfolios, this means we’ll have to look at the market at a new light. We could no longer be assured a funding rate near zero indefinitely and the duration of our assets must be large diligently.

When the Fed initially announced its long awaited tapering program in December of 2013 the market was not terribly surprised. Although there were probably more market participants expecting the first move to come into first quarter of 2014 rather than not December. The Agency MBS market rallied as the current coupon 30 year mortgage tightened by approximately 10 basis points since year end.

The Treasury market on the other hand sold off and the high yield for the 10 year Treasury note to all of 2013 was reached on the last day of the year December 31, 2013. Since the Christmas and New Year holidays fell on a Wednesday trading desks were thinly staffed and market liquidity was very low after the taper announcement. This no doubt exacerbated the move in Treasury market. As the economic data steadily improved over the fourth quarter and rates rose, prepayment activity naturally slowed.

Mortgage bankers refinance index fell below 2,500 in July of 2013 and below 1,500 in late December of 2013. With the seasonal trough typically occurred in late Q4 and Q1, prepayment speeds should remain muted until the March speeds are released in early April of 2014. As a result premium amortization on our pass-through MBS has been muted. With respect to the changes in the portfolio we were quite active. We reduced our exposure to hybrid pass-through MBS by $44 million and redeployed the proceeds into 30 year fixed rate MBS. Our short reset ARM positions were essentially unchanged absent run off and remain a very small percentage of the portfolio. Within the fixed rate sub-portfolio we sold lower coupon 30 year securities and slightly seasoned 4.5%, 30 year pass-throughs and purchased more 4.5%, 30 year securities and some 4% and 5% pass-throughs.

Fixed rate allocation was 69.9% of the portfolio as of December 31, 2013 versus 55.7% at September 30, 2013. Hybrid securities represented 21.7% of the portfolio as of December 31, 2013 versus 36.2% at September 30, 2013. Within the fixed rate allocation, we are more heavily skewed towards 30 year versus 15 year securities as the weighted-average maturity of the fixed rate sub-portfolio was 323 months at 2013 year end versus 310 months at September 30, 2013.

Within the structured securities sub-portfolio, we increased the allocation of our capital by approximately $3.5 million or from 51.1% of our capital at September 30, 2013 to 56.0% at year end. We also made changes to the composition of the interest-only sub-portfolio above and beyond increasing the allocation. We sold two securities that had appreciated in value as prepayment speeds slowed and therefore offered a little additional up-rate protection.

The proceeds were redeployed in securities that simply offered better up-rate protection. In late January of this year we completed a secondary offering of 2,070,000 shares inclusive of their over-allotment option that was fully exercised by our underwriters. We deployed substantially all of the proceeds by the end of January and reported the composition of our portfolio as it existed at January 31, 2014 when we announced our February dividend on February 11. The investment theme is established in the fourth quarter of 2013 was continued with deployment of proceeds from the January offering.

With the Fed tapering its asset purchases and economic data looking stronger in the fourth quarter, the market became very concerned with extensions and securities that offered call protection or protection from higher prepayments or in (low) demand. As a result payouts on these securities declined to the lowest levels we have seen in years. Newly issued loan balance 4% 30 year fixed rate bonds that commanded a payout of north of 126 last spring could now be acquired to our payout of less than 10 fixed. Low loan balance 30 year 4.5% fixed rate bonds, they were not even available last spring we’re trading at payouts in the low to mid 26 range. We purchased many such bonds.

As the market rallied into late January, early February, these payouts increased by approximately 10 fixed. If the market were to continue to rally from here these payouts would likely increase further, if not the bond still offer attractive yield at such modest payouts. With the deployment of the proceeds essentially completed as of January 31, 2014, the allocation to pass-through MBS was 94.4% of our assets versus 93.1% at 2013 year end. Fixed rate pass-through MBS was 78.5% of the portfolio at January 31, 2014 versus 69.9% at year end. Hybrid MBS was 14.9% at January 31, 2014 versus 21.7% at year end. Finally structured securities were 5.6% of the total MBS assets at January 31, 2014 versus 6.9% at year end.

In summary we believe the portfolio has constructed as of January 31, 2014 offers more income potential as a result of the combination of higher weighted average coupons and potentially slowed prepayment speeds. We’ve retained adequate up-rate protection, but are also cognizant of the potential for a rally in rates and the risk such an event poses. The markets still appears quite convinced that rates will move higher into 2014 and when markets are overwhelmingly positioned for one outcome the opposite can and often does happen.

In closing we are fortunate to have managed our way through this significant market move that occurred last year but are having to reduce our leverage will materially out through our hedge positions. This allowed us to maintain the earnings potential of portfolio. Further we’re also fortunate to raise additional capital to deploy and certain that pass-through MBS asset was targeted was trading at much lower pay-outs at comparable (NYSE:CBI) securities in relation to where they’re traded over the past several years. We believe our investment strategy which was designed for these types of market conditions has served us well.

That concludes my prepared remarks. Operator, we will now open the call up for questions.

Question-and-Answer Session


(Operator Instructions) And our first question comes from the line of David Walrod with Ladenburg. You may proceed with your question.

David Walrod - Ladenburg

Good morning.

Robert Cauley

Good morning, Dave.

David Walrod - Ladenburg

Just want to clarify a couple of things. You – when did lended the secondary offering in January closed?

Robert Cauley

It closed in two tranches, the first close on the 20th and then the (indiscernible) was exercised and closed on the 29th.

David Walrod - Ladenburg

And you said that the assets were largely deployed by the end of January that’s fully levered or deployed?

Robert Cauley

Yes, substantially completed 100%.

David Walrod - Ladenburg

Okay. Now in the fourth quarter you took that your capital allocation somewhat significantly towards the structured portfolio. Was that an anticipation of doing a deal or how should we think about how the capital was deployed now going forward, is it more closer to the 50:50 range or is it still favor the structured portfolio?

G. Hunter Haas, IV

Hey David, this is Hunter. We did shift a little bit towards the end of the fourth quarter. We found some securities that we would like than more interested and we had a little more cash on hand than sitting idle than we typically care to have. So when we made that investment we had sense gone with the deployment of the proceeds would really come back to closer to where we were prior to those acquisitions. So a little more balance kind of 50:50 range. We have a little dry powder still left in the derivative structured securities and are just looking for opportunities I guess.

Robert Cauley

I’d just add what Hunter talked about some of the opportunities that we saw. Some of the inverse IOs we found that we could acquire very attractive yields, David, that we can see earlier in the year and so we could kind of replicate structured pass-through rates with the inverse IO rate.

David Walrod - Ladenburg

Good, good. And then you gave us some good color on where book value was at the end of January. Can you just give us an idea of how that’s trended in February obviously not down anything specific?

Robert Cauley

Well a pretty good number as of January 31, it is now the market had rallied all the way through January and I believe Monday the 3rd was the low rates – recent low. Since then we have backed up some, these backup starts. My sense is that book value would not be materially different from where it was at month end. Rates have not moved much, mortgages had also tightened so when rates rally we had this best of both well where rates were rallied, mortgages were tightening, so really going up in price and kind of go a little choppy. So as we backed off you’ve seen them IOs have had a pretty decent run. So net-net I don’t know it will be materially unchanged.

G. Hunter Haas, IV

Absolutely tightening as Bob alluded to as rates came down in the first part of this year, the first month and a week or so of this year. Absent the tightening we probably would have leaked off a little bit of book value because we are and have been at least empirically so hedged in such a way that we’re very much still braced for higher rates. But we’ve had some things go our way as well. Bob mentioned in his prepared remarks the specified pool pay-ups much of the proceeds we deployed in January and some of the portfolio turnover in the fourth quarter were used to buy those types of assets, they have had a great run and IOs continue to do very well which is part of the reason why we’ve taken a little time now from and staying slightly under invested from that front. So we have the portfolio I think where we wanted to be right now.

David Walrod - Ladenburg

Okay. That’s great. Thanks. Thanks all. I appreciate it.

Robert Cauley

Thanks, Dave.


Thank you. (Operator Instructions) And I’m not showing any further questions in the queue. I would now like to turn the call back over to the speakers for any closing remarks.

Robert Cauley - Chairman and Chief Executive Officer

Thank you, operator. We appreciate everybody taken the time to listen in to the extent somebody is going to listen to the replay and therefore maybe have a question later we will be available all day tomorrow, please give us a call in the office, number is 772-231-1400, otherwise we appreciate your time and we will talk to you again at the end of the first quarter. Thank you.


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

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