U.S. Markets closed

Edited Transcript of ORC earnings conference call or presentation 25-Oct-19 2:00pm GMT

Q3 2019 Orchid Island Capital Inc Earnings Call

Florida Oct 28, 2019 (Thomson StreetEvents) -- Edited Transcript of Orchid Island Capital Inc earnings conference call or presentation Friday, October 25, 2019 at 2:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* George Hunter Haas

Orchid Island Capital, Inc. - CFO, CIO & Director

* Robert E. Cauley

Orchid Island Capital, Inc. - Chairman, President & CEO

================================================================================

Conference Call Participants

================================================================================

* Christopher Whitbread Patrick Nolan

Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning and welcome to the Third Quarter 2019 Earnings Conference Call for Orchid Island Capital.

This call is being recorded today, October 25, 2019.

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. Sir, please go ahead.

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [2]

--------------------------------------------------------------------------------

Thank you, operator, and good morning, everyone.

I hope everybody has had the chance to download our slide deck or at least view online, as that will be the focus of today's call. As always, I will start on Page 3, the table of contents, just to give you an outline of what we'll be discussing today, and this is the standard format. I'll start off by going over our financial highlights for the quarter ended September 30, 2019. I'll then review market developments during the quarter and summarize at the end and provide an overview of our outlook of the market as we see it going forward. And then, of course, I'll talk about our financial results, portfolio characteristics, credit counterparties and hedge positions, and then a final few words about our outlook and capital-raising activity.

Turning to Slide 4, our financial highlights for the quarter.

Orchid generated a net loss per share on a GAAP basis of $0.14. We incurred $0.32 in losses from net realized and unrealized gains and losses on RMBS and derivative instruments, including net interest income on our interest rate swaps. Earnings per share were $0.18, excluding these same realized and unrealized gains and losses on RMBS and derivative instruments, including net interest income on interest rate swaps.

Book value per share at the end of the quarter was $6.22, a decrease of $0.41 or 6.18% from $6.63 at June 30. During the third quarter of '19, the company declared and subsequently paid $0.24 per share in dividends. And since our initial public offering, we have declared $10.705 of dividends per share. Our economic return for the quarter was negative $0.17 or 2.6%, which reduced the year-to-date return to 1.5%, 1.9% annualized. The company issued 8,771,301 shares during the quarter, the bulk of which were on a follow-on offering of 7 million shares in late July. And I'll speak about that specifically near the end of the presentation.

Turning now to Slide 5. As always, we provide our results versus our peer group. The peer group is listed below in the footnotes. It has changed somewhat over time as firms have either left the space, been acquired or new entrants who fit our -- the makeup of our strategy a little closer have been included in the peer group. We do not have Q3 data, as always, since we were one of the first companies to report, so it's somewhat backward looking.

At the bottom of the table, we show the first and second quarter results for us and our peer group. The first quarter, we trailed the results of our peer group by 1.4%. In the second quarter, we outperformed by 3.4%. Since our inception in February of 2013, Orchid's generated a return of 12.7% versus our peer average of 4.8%. And the calculation methodology is described in the notes as well.

Turning now to market developments, Slide 7. What we observed in the quarter is really a continuation of what's been going on all year. As you can see on the left side, where we show the treasury curve, the nominal benchmark treasuries. On the right side is the swap curve. As you can see, the green line, which is the end of the year; down to the blue line; and the red line, which is the end of the quarter, is a continuation of the inversion of the curve with lower and lower longer-term rates. And as a result, since we are mortgage-backed securities investors, this means that rates available to borrowers have become progressively lower.

This really doesn't tell the full story. Now all we're showing here is kind of the beginning and the ending level of rates. Throughout the quarter, the market was extremely volatile, and for levered mortgage investors, who dynamically hedge, this presented some meaningful challenges, and that's what we had to deal with.

Now if you look at Slide 8. Slide 8 just shows you on the left side the changes in these benchmark rates for the quarter, and on the right side with a 2-year look back. I think the 2-year look back is somewhat more illustrative of what happens. You can see, in either case, whether it's in the treasury -- 10-year treasury or swap, over the course of the quarter, you had meaningful volatility. With the case of the 10-year treasury note, the range high to low was 68 basis points, which was quite a bit for any quarter, but the distance traveled throughout the quarter was much more. As you can see, we had a meaningful rally in August and early September, subsequently sold off and then rallied right back, so it's been a very volatile quarter. And as -- again as a mortgage investor, this means that the cash flows of the securities we own, the projected cash flows, can change meaningfully. As you rally, mortgages lose their duration, the cash flow shortened. You turn around and sell off, the opposite occurs. Also, hedge ratios change. And your profile and when you run your shocks can change dramatically as this occurs. As a result, as you tend to dynamically hedge, it can be quite challenging.

We also realized very fast speeds during the quarter, not just Orchid, but across the mortgage universe. And in particular, certain cohort coupons, 3.5s and 4s, especially of 2018 and '19, which paid at 50-, 60-plus CPR. We haven't seen speeds like that in those kind of production coupons since 2003. And they were big drivers of the very poor performance of this sector, the asset class as MBA -- or TBAs did quite poorly.

Turning now to Slide 9. We've had this table for quarters now. It just shows you the slope of the curve as represented by the 5-year note and the 30-year treasury bond. As you can see on the bottom, the green line, this is the spread. Way back in the 2013 year, that was north of 250 basis points. And it hit a trough a little over a year ago, approximately 20 basis points. As you can see, it's only recovered very modestly. In fact, in the most recent quarter, it actually started to decline again. So we're still dealing with a very flat curve environment.

Slide 10, talk a little bit about the performance of TBAs for the quarter. In this case, we're showing 4 30-year fixed-rate coupons. The blue is a 3% coupon. Then the red is the 3.5% and so on. Two things I want to highlight first: The first is the 4.5% coupon, which has been the -- was the star for the quarter, had modest outperformance versus a very low hedge ratio for the 10-year. The blue line is the Fannie 3 coupon. As we were in the second quarter of the year, that was the slight discount coupon. And so to the extent we had rallies in the market and people were chasing duration in this asset class, that would be the coupon of choice. As -- when we got into August and the market rallied, the 3% coupon became progressively higher premium or approached the $102 price and performed quite poorly. And then of course, as I mentioned, 3.5s and 4s did extremely poorly because of speeds.

So really it was kind of a tale of 2 stories there. 4.5s was the upward coupon and was the coupon of choice. Others were shed, so their performance was quite bad.

If we look on Slide 11. The top left, we show these same 4 coupons and total price change over the quarter. As you can see, 3s were up 25 ticks. 4.5s were actually up 27; and the 2 [belly] coupons, 3.5s and 4s, did quite poorly. But keep in mind, over the quarter, the 10-year treasury was up in the neighborhood of 100 ticks, so meaningful underperformance, which we just saw in the previous table, versus the hedge ratio. Since quarter end, market has sold off slightly, and they've given up some performance.

On the bottom left, we show the same 4 coupons in the roll market. Typically, not so much with Orchid but with many of our peers, the roll market is used quite a bit. It's really a source of cheap financing. When rolls are special, coupons can trade at implied financing rates well through LIBOR. That is not the case now predominantly because of speeds. In each of these lines you see here, the implied financing for these coupons is at best equal to repo, in most cases much further above it. And so that really -- that strategy is more or less off the table now in terms of a cheap source of financing for owning mortgages.

As you would expect with the poor performance of TBAs, on the right-hand side, specified pools have done very well. Pay-ups for any form of call protection, whether it's very robust or not so robust and fleeting, those pay-ups have done very, very well and will probably continue to do so.

Finally, on Slide 12, with respect to mortgages. This is a 1-year look back. We're looking at TBA LIBOR OASes. And as you can see, we're at or near the very high end of that range, and this is really just one way of looking at mortgages. If you look at, for instance, the spread of the current coupon mortgage to a blend of 5- or 10-year treasuries or 10-year treasury, the current coupon, even the $102 price mortgage, are at multiyear wides, actually the widest levels we've seen since early 2012 in the case of the current coupon mortgage. So mortgages have very much cheapened down in this quarter.

Turning now to returns, on Slide 13, across sectors.

At the top, we show year-to-date returns. And if there is a theme here, it's just very much that risk assets have dominated. The highest-performing sectors, investment-grade corporates, emerging market corporates, high yield, S&P 500 have done very well; treasuries, mortgage-agency mortgages, less so. Q3 was slightly different, much more of a -- or less of a risk-on sentiment. While the best-performing sectors, investment-grade corporates and emerging market corporates, have still done well, some of the other riskier assets, like the S&P and emerging market or high yield, have done poorly. In fact, really the star has been the investment-grade corporate market. In fact, most recent data from DTCC, the client positioning data, which is a dollar-denominated measure, the dollar amount [alone in those] asset classes are at 95, 100 percentile ranking. So mortgages obviously were not in that same category.

A final measure, I guess, of the market for the quarter is the vol market, on Slide 14. As you can see, especially starting in early August, vol has spiked and has since come off some, but all measures of vol were elevated very much so in the quarter.

Slide 15. We talk about the short-term rates market. Really I think, at this point, it's being an opportune time to talk about what had happened in the funding markets versus just LIBOR and 1-month Fed funds. This all started on September 16. This is obviously a very meaningful development for us as mortgage investors in a levered basis. As we all know, back in 2017, the Fed began to reduce their bloated balance sheets, taking it down to what they would deem to be a more appropriate level. Nobody really knew exactly what that was, but I think that on or around September 16, we found out, when in fact we had a shortage of liquidity in the market. And we saw overnight funding rates spike in the case of sulfur and repo. 7% overnight repo rates were not uncommon. And really this reflects not so much an unwillingness to lend, which is what we saw during the financial crisis. This was just an inability to lend. Just there was a reserve scarcity. That was an inability of -- to get funding to end-users.

And this is really in a large extent just driven by regulatory developments since the end of the financial crisis. So whether it's a supplemental liquidity ratio; or a high-quality liquid asset test, whatever the case may be; or in the case of the year-end, a G-SIB test, there is really just not an ability to get enough liquidity into the appropriate hands, and of course, funding rates have been risen as a result. The Fed has responded. When this first started on September 16, the Fed had a meeting that week. They announced some measures at their meeting. Since then, on several occasions, they've made announcements. The Chairman gave a speech at the NABE conference on the October 8, outlined some steps they were considering. Those were more formally announced a few days later. Even this week, there's been more steps taken.

So while the fed has been reactive to what's going on, I wouldn't characterize their response as extremely aggressive. They're not appearing to take steps like they did during the financial crisis to get very much in front of this. And so going forward, there is still some doubt in terms of just how effective they'll be. I think I don't see this evolving into a crisis, but I think most market participants wish they were just a little more aggressive in that regard. In terms of what it means for us, it has resulted in elevated funding levels. If you go back to the first half of the year, before the Fed had started their easing cycle, Fed funds was running around 240, 241 basis points. And we were funding, on a 1-month basis points, about 20 to 25 basis points higher. Since then, now the Fed is in place. So Fed funds is somewhat of a moving target, but we're funding levels that are 40, 42 maybe, basis points above that for 1 month. So the spread has increased. So while the Fed has eased around 50 basis points, we've only been able to pick up about 30 in lower funding costs. Going forward, I would assume that, that would stay more or less the same. So in other words, if the Fed were eased a third time and the total reduction were 75 basis points, I think we would still kind of keep that same spread of around 50 to 55. So we still get some benefit, but the net effect is we've effectively lost most of one ease as a result of these developments.

Slide 16 just shows you the evolution of the outlook for the Fed. The top right is the kind of the nearing the end of the tightening cycle. And the Fed, at that time, still expected to raise rates up in the mid 3s. The market never really got much beyond additional 2 hikes, and ultimately we -- of course, we know that didn't occur. Now in September of '19, at this most recent meeting, the Fed still sees rates drifting back up slightly over 2%. The market strongly disagrees with that sentiment and has the Fed easing at least 1 or 2 more times. Although, I would say, with respect to the fed going forward, especially next week, there's still a fair amount of uncertainty. I think most market participants are kind of expecting what you would call a hawkish ease. In other words, the Fed will likely ease, but they may provide guidance that implies that they're close to -- they are done for now. And I think this is all driven by some -- a lack of consensus within the Fed. There's 2 schools of thought. One kind of focuses heavily on the domestic economy; the level of inflation, the unemployment rate and so forth, GDP growth, which are still strong. And the other half is a little more global, with global outlook and looking at financial market stress and growth abroad and other factors which can ultimately affect the domestic economy. So the outcome of that kind of remains to be seen.

So to summarize all this, I would say that it was very much a tough quarter for mortgage investors, especially if you were levered and dynamically hedged. As a result, the -- our results for this quarter, our year-to-date return is only 1.5%. However, I think the opposite side of that coin is that I think we are at an attractive point in terms of mortgage valuations. I think most people view these asset classes at the extreme cheaps. There may be some room for additional cheapening. And the mortgage space is cheap for good reasons. We've had speeds at very high levels. TBA performance is poor. Supply of mortgages is $3 billion to $5 billion a day. For those multi-sector asset managers out there chasing duration, mortgages are not a good place to find it.

And the sector is out of form and not -- plus we have some repo issues. But as I said, I think there's a growing sense that we're at or near the bottom and that we're about to turn the corner. I think that speeds -- the bar for speeds to get meaningfully higher is quite high. We've been at low rates, record-low rates, essentially, for quite a period of time, the seasonal effect ahead of us. There's burnout. And I think that -- while it's not necessarily easy to time when exactly it is going to turn, I think the outlook going forward is very asymmetric, in favor of the asset class, coupled with some of the other points I made about sister asset classes, which have done extremely well.

As a result, we feel very comfortable owning mortgages in this environment. As a result of the book value decline, our leverage ratio creeped up a little higher than it had been, but we're comfortable keeping it there, so we've chosen not to reduce the balance sheet and intend to keep it at this type of a leverage ratio for these reasons.

At this point, I would like to pivot and start talking about our results for the quarter.

Slide 18. I'll start with the right side. This is the return by sector. Starting first with pass-throughs: We generated a return in the pass-through portfolio of 3.28%. Speeds were the big driver here. Speeds in the pass-through space were 15%-plus for the quarter. As a result, amortization, premium amortization, was high. Of course, the asset class performed poorly.

With respect to the structured securities, in particular IOs, with the market rallying and speeds very, very fast, this sector did very poorly. In fact, you could argue, at some point around Labor Day, IO class was kind of at a point of maximum pain. We actually got to a point where they were arguably positively convexed, and then since that, they really couldn't get any cheaper. And to the extent that the speeds increased, people just view them as such an extreme level of cheapness that they were desirable to buy. From us as a hedging instrument, we view them as attractive now because they offer very good extension potential, which is what we look at them when we use them as a hedge.

Turning now to the left-hand side. This is our proxy for core income that most of our peers use. We do not present core in the same sense that they do. We just basically take what you see here, which is, if you look to the last column, that's effectively our income statement, and we just parse out the realized and unrealized gains and losses from everything else, which will be interest income and expense and our total G&A expenses. That number was $0.18. The dividend was $0.24, somewhat light, but again it's due to extremely high levels of speeds and premium amortization. And as I'll say in a few months, we don't see this as persisting. I think we're kind of at a trough. I think the worst is probably behind us.

If you turn to Slide '19. This is kind of the same thing in words -- or in picture, several lines here. The blue line at the top is just the yield on the assets. The red line is our economic funding costs, and the green line is our NIM. We've been in the low 2% for a while and in the most 2 recent quarters drifted below that, reflecting the higher level of speeds and excessive premium amortization. But as I said, I think the worst of that is behind us and I would expect this to recover.

Slide 20 is basically the same picture. Here we're showing our proxy for core. It's the same exact conclusion to be drawn from that as in previous page.

21, we get into our portfolio activity. I want to start on the right-hand side. As I mentioned, we did do a capital raise, a follow-on offering at the end of July.

I want to focus here on the -- on the right-hand side, the 2 lines securities purchased and sold. And as you can see, all the activity was in the pass-through side, so all the marginal capital was deployed into the pass-through portfolio. We did not buy any IO securities. And in fact, if you look at the IO, interest-only, column, you can see that a combination of return on investment and mark-to-market losses reduced the allocation in that space. As a result, when you look to the left-hand side, you can see that the pass-through allocation, capital allocation, increased from 66% to 75%, reflecting the combination of the fact that the marginal capital was invested exclusively in pass-throughs and the runoff of the IO portfolio.

Now turning to Slide 23. This is the outline of the portfolio versus a snapshot where the portfolio was at the end of the quarter. With respect to ARMs and 15 years, there was no -- 20 years, no meaningful changes. We did do a few changes in the 30-year space. We shifted some 30-year 3 exposure into 3.5s, but it wasn't so much of a duration call as a relative value trade. And we added to 4s and 4.5s. Again, there was marginal capital deployed as a result of the capital raise. This is mostly relative value trading in attempts to increase the call protection of the portfolio. And as you can see, the allocation to IOs was 2.07%. That just reflects the runoff.

When we did do the capital raise in July, we had put in place some swaps. As you see, our swap position increased this quarter. And we also put on some 5-year treasury futures, which I'll say another word or 2 about in a moment. And we no longer have any TBA hedges. Since quarter end, we've done a few more trades, again trying to add call protection to the portfolio. And some of the addition was through subtraction by just parting ways with some higher-paying, lower-yielding assets. So we think going forward the portfolio is positioned to do better in this low-rate, high-speed environment.

As I mentioned, our leverage ratio, Slide 25, is at the high end of our recent range, approaching 10.

And then finally, on Slide 26, just a few words about our hedge positions. As I mentioned, the swaps, we put in place some new swaps when we did the capital raise. Most of the capital raise was through that follow-on offering. We did run our ATM program in July, but the incremental capital through that capital raise, we put in place a $410 million notional swap at about 1.77%. The notional amount of that swap essentially reflected all the marginal borrowing. So in effect, we have locked in the funding costs of the marginal borrowing and in doing so more or less locked in the NIM on the marginal capital at about 125 to [30] basis points. So it is an accretive capital raise and not affected by the term on the repo market since we did lock in the funding.

And we also added some Fed Fund futures positions, as you can see on the top right. We chose Fed Fund futures because, at the time, you had the most amount of fed eases reflecting in the futures market. As you can see, the blended rate there is 1.49%. And the contracts themself reflect about 50 basis points of additional easing. So we'll see what the Fed does. They may be done after next week. They may not, but we've locked in a fair amount of funding.

And then just finally, a few words on the cap rates. We did this at the end of July in anticipation of a Fed easing cycle; didn't really see what was going to happen starting in August, with the turmoil in the market, but, fortunately, we were able to deploy the proceeds very quickly, 2 or 3 days. And as I said, through the swap position we entered into, we were able to lock in a NIM that was modestly accretive to earnings. So we -- even though the timing wasn't quite as fortuitous as we hoped, because we're able to deploy the proceeds and lock in the funding quickly, it was an accretive capital raise.

That's basically it, operator, for my prepared remarks. At this point, we can turn the call over to questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Your first question comes from the line of Christopher Nolan from Ladenburg.

--------------------------------------------------------------------------------

Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [2]

--------------------------------------------------------------------------------

Bob, the -- on Page 10. You're showing -- they're hedge updates. And you're showing that the 4.5s were outperforming. Could you explain that a little bit? I found that surprising.

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [3]

--------------------------------------------------------------------------------

Well, I think it's -- to a large extent, it was the desirability -- I'll just give my answer, then I'll let Hunter speak. I think it was the less of evils. 3.5s and 4s during this quarter behaved very, very poorly. They were basically shunned in 4s. This is versus a hedge ratio, and 4.5s have a very low hedge ratio versus the 10-year. And it was more of just, would you want to call it, a people ran from the other coupons to these. 3s did poorly simply because they went from being the convexity play when they were at a discount to a premium and did poorly. So it was really just the lesser of evils. I don't know, Hunter, if you want to add to that.

--------------------------------------------------------------------------------

George Hunter Haas, Orchid Island Capital, Inc. - CFO, CIO & Director [4]

--------------------------------------------------------------------------------

Yes. I will just -- I think in particular we use -- the hedge ratios that we used for that slide are from a firm who modeled 4.5s to be very, very short. So I don't remember off the top of my head what that was at the beginning of the period, but I want to say somewhere around like 12% to 15% of a 10-year. So you have the 4.5 going up in price by...

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [5]

--------------------------------------------------------------------------------

5 or 7 ticks.

--------------------------------------------------------------------------------

George Hunter Haas, Orchid Island Capital, Inc. - CFO, CIO & Director [6]

--------------------------------------------------------------------------------

Yes, where is it?

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [7]

--------------------------------------------------------------------------------

On the next page. I think it was 27...

--------------------------------------------------------------------------------

George Hunter Haas, Orchid Island Capital, Inc. - CFO, CIO & Director [8]

--------------------------------------------------------------------------------

27 ticks versus the 10-year going to -- up...

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [9]

--------------------------------------------------------------------------------

100.

--------------------------------------------------------------------------------

George Hunter Haas, Orchid Island Capital, Inc. - CFO, CIO & Director [10]

--------------------------------------------------------------------------------

100. So that seems consistent with that math.

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [11]

--------------------------------------------------------------------------------

Yes.

--------------------------------------------------------------------------------

George Hunter Haas, Orchid Island Capital, Inc. - CFO, CIO & Director [12]

--------------------------------------------------------------------------------

We're using like a 15% hedge ratio.

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [13]

--------------------------------------------------------------------------------

And I would just add that, when you get into periods like this, you can see a large disparity in hedge ratios that people use. The fact of the matter is, a lot of times, the empirical durations shrink very, very low. So mortgages just don't behave well in a sharp rally or sell off generally, but in this case it was a very meaningful rally. And there was a psychological significance too. In late August, early September, we were getting very close to the all-time low in 10-year yields. And when people are chasing duration, they're not looking to mortgages. And therefore, they -- that's why they can typically, especially the lower coupons, behave so poorly. And I think the higher coupon really just benefited from the math, as Hunter alluded to, just the fact that the hedge ratio was so low.

--------------------------------------------------------------------------------

Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [14]

--------------------------------------------------------------------------------

Great. And then on Page 23, I'm looking at your interest rate sensitivity in the lower right-hand corner, which has changed dramatically from the last quarter. And is it fair to characterize that you guys are basically not baking in any possibility of a rate increase on your hedge position? You're -- just looking at that.

--------------------------------------------------------------------------------

George Hunter Haas, Orchid Island Capital, Inc. - CFO, CIO & Director [15]

--------------------------------------------------------------------------------

Yes, we definitely try to add duration to the portfolio. We think that the bar for rate increases is -- or at least dramatic ones, is fairly low right now. So we're trying to flatten it out as much as we can. We're delta hedging the portfolio to a certain extent. So a lot of times, when we get to the upper end of the range, we'll try to add a little more duration. It was, quite frankly, very hard to come by last quarter. There was mortgages widening on a spread basis and then volatility increasing. So even if you -- so we were wider in term -- in OAS terms, and we were also lower dollar price because volatility was increasing. You had the speed dynamic at play, which was more of an income event for us, but then also a -- you had, also, the funding squeeze. So that coming in at quarter end certainly didn't help our marks out. So we're at the higher end of the range. I think we feel comfortable trying to flatten that portfolio out. We tend to perform a little better than modeled in the down shock scenario. That's just because in the -- on the models, some of the higher-coupon assets and some of our more seasoned IOs perform -- empirically have performed better than models in those down scenarios. So I would think that we're actually a little bit flatter than what is suggested here. So anyway, I think the goal is, yes, to have less exposure to sharp moves downward in rate and willing to take on a little more of a flat profile into a rising rate environment.

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [16]

--------------------------------------------------------------------------------

And also I would add, Chris, and I tried to make the point earlier, was that the volatility in the market was really extreme. When you went -- it kind of all started right after the fed ease on the 31st. And following day, there was a tweet by President Trump that [basically] escalated the trade war with China. And August was very chaotic. It's very sharp rally. And by the end of the month, mortgages pretty much lost all their duration. And when you're trying to maintain a relatively flat profile, you've got to find a way to do so. And then we had this sharp reversal in early September. We sold off, I think it was, 44 basis points on 10s in like 8 days. And then on Saturday, whatever, September 14, we find out that they've attacked oil fields in Saudi Arabia and the market turns right around and rallies again. And so when you're trying to adjust your hedges with rates whipsawing that fast, it gets very challenging. That was really a lot of the reason for the pain in the quarter. And then going forward, when you get these extreme low levels of rates, the -- what you're seeing in this table on the bottom right is the model is basically telling you that if you have a meaningful rally from here of 50 basis points, mortgages are going to underperform. And the sell-off, the way we're positioned, we would probably do better in a sell-off. I mean obviously it's not a large positive number, but, again, I think that we're at a point where, at least from a speed perspective, I think it's just very asymmetric going forward. Yes, you could see speeds get a little faster, but I think the bar is pretty high. I think in all likelihood they may be a slow trend lower, but they really can't -- I just find it hard to believe they could get meaningfully faster from here.

We've taken steps in October also to flatten that out even more on the down rate scenario. So we've sold some of the really short, low-yielding assets, and we've added some quality call protection that exhibits more duration.

--------------------------------------------------------------------------------

Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [17]

--------------------------------------------------------------------------------

So is it fair to say that, given all that, it sounds like you guys are sort of a -- and it sort of reflects Bob's comments, speeds to start slowing down a little bit, maybe some of this volatility settling down and that's the reason for going out for the 4.5 30 years, which is a change of strategy from the last couple quarters?

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [18]

--------------------------------------------------------------------------------

Yes, we were definitely adding to the duration in 3s and 3.5s, and a lot of this is just relative value. Well, 2 things: relative value in the sense that the longest-duration mortgages got extremely rich because everybody was trying to add that duration. And two, this is kind of a nuance, but when we talk about the performance of the TBA over the last 1.5 years, we haven't really -- -- I didn't speak at all about it today, but -- part of the reason is what we've seen are these very high-gross WACC pools. So in other words, historically when I went out and bought a 3.5% mortgage, the gross WAC was around 4, give or take. So normally the spread was like 50 bps. Now it's 80 to 110. So Fannie 3s have a 4% gross WACC, so they prepay like about 3.5. So it's like you've shifted the S curve, so to speak. And not only that, but they tend to have higher average loan balances and very high FICO scores. And so TBA pays at extremely fast speeds. Some of the major pools that were produced even this year -- there's a -- one pool, I think it's a 4, that it paid 55 CPR in the first month and 58 and 59 or something like that. They've been terrible, but what we did finally find recently were some originator bid lists where the gross WACC was 3.40 on a 3 year or a 3.90 on a 3.5. And those are very attractive. So that's, to some extent, what attracted us to those, it wasn't an explicit desire to add that coupon. It was where we could find value. And that's -- that -- like I said, that was more relative value-trading-driven versus duration chasing-driven, if that makes sense.

--------------------------------------------------------------------------------

Operator [19]

--------------------------------------------------------------------------------

(Operator Instructions) There are no further questions at this time. Please continue, sir.

--------------------------------------------------------------------------------

Robert E. Cauley, Orchid Island Capital, Inc. - Chairman, President & CEO [20]

--------------------------------------------------------------------------------

Thank you, operator. And thank you, everyone, for taking the time to listen in, or to the extent you're listening in on the replay. If you do have questions that come up, come to mind after the fact, please feel free to call us in the office. Our number here is (772) 231-1400. We'll be very willing to take any and all questions. Otherwise, we look forward to talking to you next time.

Thank you.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

Ladies and gentlemen, this concludes today's conference. Thank you for participating. Have a wonderful day. You may all disconnect.