Orchid Island Capital, Inc. (ORC) Q4 2018 Earnings Conference Call Transcript
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Orchid Island Capital, Inc. (NYSE: ORC)
Q4 2018 Earnings Conference Call
Feb. 22, 2019, 10:00 a.m. ET
Contents:
Prepared Remarks
Questions and Answers
Call Participants
Prepared Remarks:
Operator
Good morning, and welcome to the Fourth Quarter 2018 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, February 22, 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. Please go ahead, sir.
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Thank you, operator, and good morning, everybody. Welcome to our call. I hope everybody has had a chance to download the slide deck off of our website. I also saw that Seeking Alpha had it out there this morning. So I will be going through the slides as I normally do. It may skip a few, but I will not go out of order. Many of these slides are slides that we use every quarter, so regular listeners should be accustomed to seeing these slides.
I'll start on Slide 3, which is basically just the table of contents, just run through a quick outline of what we're going to discuss today. We'll start off with the financial highlights of the quarter ended December 31, 2018. And I'll spend some time as we usually do talking about market developments, and this was a significant quarter for the markets, and the outlook for the economy rates going forward. And we will discuss our financial results, portfolio characteristics and then our outlook and strategy.
Turning now to Slide 4, the financial highlights for the quarter. Orchid Island reported a net loss per share of $0.52 for the quarter. This included $0.80 any sense of incurred losses per share from net realized and unrealized gains or losses on RMBS and derivative instruments and including net interest income on interest rate swaps. Earnings per share of $0.28, excluding unrealized and realized gains and losses on the RMBS and derivative instruments, including net interest income on interest rate swaps. We have a Page 18 in the slide deck for reconciliation of that.
Book value per share of $6.84 at December 31, 2018, a decrease of $0.72 or 9.52% from $7.56 at the end of the previous quarter. Total dividends paid for the quarter were $0.24. In 2018, the Company declared and subsequently paid $1.07 per share in dividends. Since its initial public
offering, the Company has declared $10.065 in dividends per share.
Economic return for the quarter was negative $0.48 or 6.35% or $0.80 per share and $9.18 (ph) for the year. The Company repurchased 3,380,536 shares between October 31, 2018 and January 3, 2019, representing 6.5% of the shares outstanding as of September 30, 2018. The Company has repurchased 10.43% of all shares issued since inception.
Now turning to Page 5, our return data. What we see here is our returns broken down by different periods. On the top, we have the annual returns for our Stub year after our initial public offering in early 2013, the years 2014, '15, '16 and '17, and then our more recent six-month return, one-year look back, three-year, five-year, and since inception. And then the quarters for '18 and the total year of '18.
This is also shown versus our peer average. Our peer average is defined at the bottom of the page. It includes Annaly, Anworth, CMO, Cypress, Armour, Hatteras, Agency, Arlington and Dynex. And of course, Hatteras and Cypress were only included for part of the period, as they were acquired at different points in time.
As you can see, after Orchid's IPO in 2013, we've generally faced upward movements in rates and a flattening of the curve and it's somewhat reflected in the results. So you can see the early returns were quite large, and then slowly declined. And of course, 2018, which really represented the peak and the tightening cycle with rates moving higher for most of the year, the results were negative 9.2% total return using book value versus stock price. That's still slight -- slightly better than the peer average, and also for the fourth quarter which we here to discuss today negative 6.3%, so obviously a very rough quarter, but also a slight outperformance versus the peer average.
Turning now to the Slide 7, this is just a snapshot of the yield curve. On the left hand side, we have what we call the cash market or the treasury benchmarks, and on the right hand side, the dollar swap curve. And as you can see, this is a very pivotal quarter. We had a significant movement in the curve. The green line represents the various respective curves at the end of the third quarter; the red line is at the end of the year; and the blue line is through last Wednesday. You can see since the end of the year, rates have not moved much of your swaps or in the cash market. But we did have a very significant move in the fourth quarter.
The fourth quarter of 2018, as in all respects, an extremely pivotal quarter. It's quite remarkable when you consider what happened over the course of the quarter. So for instance, the very beginning in the quarter, on early October 3, the Dow hit an all-time high. Oil -- WTI oil was at a multi-year high. In terms of economic growth, the outlook is very positive. And in October, the unemployment rate printed at a 49-year low, wage growth was accelerating.
Global growth, while certainly nothing like the U.S. was still seem to be kind of lukewarm; confidence in the markets was extremely high; and in the September Fed meeting, Chairman Powell stated that the Fed was a long way from neutral, and that they may actually pass through neutral. Fast forward to the end of the quarter, pretty much everything had changed materially. With respect to the markets, the Dow and all the major industries had made -- account to a significant correction. We're actually in a bear-market. Year-to-date gains were all gone. WTI oil was down 43% peak to trough, and generally risk assets of all type were suffering mildly.
While the labor market, in terms of economic growth was still positive, the ISM measure, which is a significant metric for the market had a meaningful decline, the largest decline we've seen for one month in the 11 years, and various other measures home sales and new renews had plummeted. Our global growth had peer that changed dramatically. China had each successive quarter of 2018 was lower than the last. The last quarter at 6.4%. Growth for the year was a 28-year low.
Europe is even worse. Many economies reported negative growth of the third quarter including Germany and Italy. Confidence obviously plummeted. The markets hit a year-to-date low on Christmas Eve, which was later on the time the government shutdown was starting. With respect to the Fed, while they had said they were long way from neutral at the end of the third quarter, they now saw themselves at the end of neutral. And in fact at their January meeting they said they were full within the range of neutral, had become data dependent, and the next move could be either a hike or a cut. So obviously a very significant turnaround in the fourth quarter.
Turning to Slide 8, we will discuss through kind of fairly quickly, since I'm sure this is all relatively almost everybody by now, but there are some key takeaways I want to point out. So for instance, turning to Slide 8, where you see the movements in the 10-year treasury and the swap both for the quarter and a two-year look back. You can see in the fourth quarter, we had this meaningful move, but what's noteworthy is that we stabilized since year-end. In fact, both the swaps and in treasuries, we've actually gone into a relatively narrow range. With respect to the 10-year, it's roughly 2.60% to 2.70%, and the market seems to stabilize. But keep in mind, the Fed funds as we speak is at 2.41%. So at 10-year between 2.60% and 2.70% is quite a flat curve. In fact the two-year, three-year and five-year points of the curve were all in the low to mid 2.50%. So, marginally above Fed funds, so quite a flat curve.
If you turn to Slide 9, this is just another depiction of the same basic thing. You can see we've been in a multi-year flattening cycle. The bottom chart shows the green line which is just the spread between the five-year treasury note and the 30-year bond. It has been declining for multiple years. It actually troughed last July, but with all the developments in the fourth quarter it actually started to steepen again. And since the market's view of the rates going forward and the Fed has changed so dramatically, this steep has generally been driven by the five-year, the five-year part of the curve is typically the most sensitive to the path of Fed hikes or cuts, and is usually driven by the market's perception of the terminal funds rate for the next cycle. So to the extent, your economy would soften further, in the market, we start pricing easy. We probably see the five-year part of curve lead the rally and cause that part of the 5/30 curve to steepen.
Turning now to Slide 10, we kind of go back to get to our net of the wage which is the mortgage space. And what we show here is just the relative performance of the various 30-year fixed-rate coupons. In all case, it's Fannie's. The blue line represents the Fannie 3, the red is 3.5, the green is a 4, and then the -- I'm sorry, the grey is a 4, and the green is a 4.5. And this is performance versus hedge ratios. As you can see, it was quite a rough year, and particularly slow in the fourth quarter. What was also noteworthy is that there was clearly a coupon bias, and by that, I simply mean that lower coupons did better, more duration, and as you can see in the fourth quarter, higher coupons did particularly poorly. However, again looking at the development so far this quarter, 2019 has seen stability, and in this case recovery, as these relative performance has actually gone the other way.
Turning to Slide 11, four charts here which kind of just give us a little deeper dive on the same thing. Again the top left, we're just looking at the price of a Fannie 30-year (ph) 4 and 4.5. As you can see, they've actually stabilized and tightened somewhat. That's somewhat misleading because there are a lot more going on. The bottom left chart shows the rolls for the securities. And it captures the fact that they have plummeted something we've seen now for several months and that is a change in the TBA deliverable, in other words, what is being the kind of the cheapest to deliver collateral that is delivered in the TBA market, and it's been very uniformly poor in quality.
And the reason it's so poor is several fold. One, the spread between the gross WAC and the net WAC on all of these has grown far above norms, and in some cases approaching 90 basis points and 100 basis points. The average loan balances are higher and FICO scores are higher. So as a result, the characteristics, the convexity securities has deemed to be very poor.
So what's bad for the TBA market is good from specified market in the top right. You see the payup for certain key loan balance pools, and they've certainly recovered and we continue to see that into 2019. Bottom right, just shows the payup for new pools and consistent with what we've seen in the deterioration in the TBA deliverable, those levels are essentially zero.
Turning to Slide 12, and this is rather a key especially for the outlook. So, as I said it earlier, higher coupons tend to deploy in the fourth quarter, and really throughout the year. What we're showing here is the LIBOR OAS by coupon over the course of the fourth quarter. But in this case, the higher coupons are wider, which just makes sense, because their performance was worse, their spread was widening, but the LIBOR OAS that they offer is quite high and very attractive.
So these securities now going forward represents very good value to us and good sources of carry. On the left hand side, we're just looking at the TBA. On the right, we are looking at specifically, the 4.5% coupon, but various specified pool buckets, and as you can see these numbers are very attractive, and that is very key for us from our perspective going forward.
Turning to Slide 13, I won't spend a lot of time here. These are the -- what used to be the Lehman Aggregate, now the Bloomberg Aggregate Index returns for the year. As you can see, on the left hand side, these are absolute returns. The aggregate itself generated a return essentially zero, mortgages were a slight positive 1%, the start for the year by far was non-agency MBS, which was 3%.
On the right hand side, we show the same returns versus treasuries. The aggregate had a slight negative return as the mortgages, but again non-agency mortgages did very well. And just wanted to make a point here, early on I talked about our returns and how we did versus our peer average. Now we will remain a fully all agency portfolio, so while over the course of 2018 and '17 for that matter, non-agency credit did extremely well. We've been able to generate returns consistent with our peers, in some cases better without any credit, and so to the extent moving forward that the economy would roll over and the consumer were weakened, and the credit would be somewhat exposed. We are very well positioned, since we have no exposure whatsoever to any of those risks.
Finally on Slide 14, this is volatility. We're using a three-month swaption on a 10-year. There are three lines; one represents at the money, the other two are slightly out. In the case of the red line, it's 25 basis point out of the money receiver swaption, and the green is a payer. But what I want to point out is you can see the spike in volatility that occurred at the end of the year, but now how much it's fallen off since. Now it is stabilized, but it's stabilized at a really low level. There's an index you can pull up on Bloomberg called the MOVE Index, which is similar to this, and it's at or near an all-time low. So for mortgages, that's a good thing. We like to see low volatility because we are short to prepayment option in all cases.
Slide 15 just shows you our rates, whether it's LIBOR or Fed funds. The simple takeaway here is that we are probably at or near our peak. And this is more evident on Slide 16. What we're showing here, in all four slides, there are two lines. The red line represents the Fed's dot plot as of the respective meeting and the blue line reflects market pricing of Fed funds going forward. It's derived from the Fed funds futures market.
So for instance, on the bottom, if you look at the September '18 meeting, the red line was well into 3s, nearly 3.5%. So in other words, Fed hikes at least based on Fed expectations were far from where we are today at 2.40%. The market was approaching 3%. By the end of the quarter, you can see the dramatic shift. Fed expectations were much less and the market has gone from pricing in close to 3% to essentially pricing in a modest probability of a cut moving forward. So a very crucial quarter. And as we turn now into our financial results, this will become clear why we think this is so favorable.
On Slide 18, we show our results for the quarter. The left hand side is where we try to show -- this is our kind of proxy for core income, which many of our peers produce. It basically just represents our income, absent mark-to-market issue or gains and losses. And as you can see, it foots (ph) to $0.28, but we did have significant mark-to-market gains and losses and the predominant one was the movement in interest rate futures.
As I've been saying, mortgages had a rough year and it's particularly quarter versus our hedges. And in the case of -- by the fourth quarter, they were the driver of our overall performance. Mortgages did OK in just going up in prices, it's particularly pass-throughs, but the hedges over well in performance and that's really reflected on the right hand side. This is our typical table where we show results by sector, where we allocate capital. The first column is the pass-throughs. As you can see, the derivative losses were material. They drove the results for that sector to a negative 7.7% return. IO has had a negative return simply because of the market rally. Our inverse part did very well, had a 9.8% positive return, but because of less capital allocated there, it did not offset the other sectors, and as a result net for the entire portfolio was a negative 6.5% return.
Now I'll turn to Slide 19. I think this slide is very important from respective not just where we've been, but where we think we are going. As you can see here, over the last five years, our net interest spread, as the curve has flattened, has been slowly eroded, and for the last few years, our NIM has been in the low 2% range. So we've had a very long tightening cycle that accelerated in 2017 and '18. As a result, we had to position progressively more defensively, add to our hedges, more specifically, our front end hedges, and as a result, it put a lot of pressure on our earnings.
However, prior to that period, before the tightening cycle had intensified, we were issuing capital through our ATM program, because the shares were trading above book. Since we've had to make cuts in the dividend as you see in the bottom part of the table, the stock has traded below book and we've been aggressively buying back shares. As I mentioned, we've bought back almost 10.5% of all shares issued, and this is a key part of our strategy to maximize our book value performance by either selling above or buying below, and it's part of the reason that our returns are where they are.
Now, what I want to point out here, this is really key going forward, if you look on the far right part of the page, you can see stability. With respect to the NIM, it's been running in the low 2s, but it's done so for several quarters. Our dividend has been at $0.08 all the way through February of this year.
Going forward, we think the Fed appears to either be done or close to being done, and we have excellent carry in the assets we own. We talked about that earlier, and we talked about the various higher coupon securities we typically own, whether it be LIBOR OAS, or any other measures of carry, they look very attractive. And we have no credit exposure. To the extent that there is any kind of a downturn, we will not be exposed. So given all of that, we feel that returns going forward should be stable, and actually there may be upside to the extent the economy softens further and the Fed were at lower rates.
Before I wrap it up, I would like to just go ahead and say a few things about our capital allocation, portfolio composition and our hedge coverage. I'm going to skip ahead to Slide 21. This on the left hand side shows the allocation on the capital. As you can see, over the course of the quarter, the pass-throughs, for instance, went from 65.2% to 58.5%, where that structured increased. But I want to point out, this was not much of a -- it was a combination of the strategic decision to shift away from pass-throughs, but also because of the book value per share ending leverage we had to reduce the size of the balance sheet. That's also reflected on the right hand side, and most of the reductions were in the area of the pass-through portfolio.
So -- on the right hand side, you can see, the market value at the end of the last quarter was nearly $3.4 billion and now it's little under $2.9 billion. The increase in capital allocation to the structured was modest, but simply just kind of gain on a relative basis through attrition because the pass-through part of the portfolio is where most of the declines took place.
Jumping ahead to Slide 23, this is just the composition of the portfolio. Again the changes were more driven by what was reduced versus what was added fixed rate CMOs and 15 years increased modestly versus the end of the third quarter, simply because they just didn't decline. Most of the sales were in the 20-year and 30-year bucket, and so those two buckets reduced slightly. But also keep in mind, the coupon distribution is still very much the same. As we said, those coupons, while they had a rough quarter, are pose to do very well going forward to offer very good carry.
Going forward, we may actually add slightly to the duration, simply because of (inaudible) as we said so far in terms of our view, it does look like the Fed is at or near the end of its tightening cycle, and we would expect if and when they ultimately do ease that we would see declines in rates and therefore we will have a more significant positive duration gap.
The final slide I'll refer to is Slide 26, which shows our hedges. As you can see, we have all these different hedge products. The top left is our Eurodollars. On the right hand side, we have swaptions which now are actually gone. TBA positions and swaps. The swap positions with -- in conjunction with our Eurodollars effectively cover all of our funding costs, repo balances that is so to the extent there are more Fed hikes we've essentially locked in a rate as reflected on this page, 2.51% in the case of the Eurodollars and 1.70% in the swaps. But as I said, we do think that we're at or near the end of the cycle, so that we would think over time that the percent of our repo funding that hedge will decline. So whether it's through growth, if we were able to access the market through the ATM program for instance, or just trading that that coverage would slightly come -- will start to come down.
And with that, operator, I will conclude my prepared remarks, and turn it over to questions.
Questions and Answers:
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Thank you. (Operator instructions) Our first question comes from Christopher Nolan of Ladenburg Thalmann. Your line is open.
Christopher Nolan -- Ladenburg Thalmann -- Analyst
Hey, Bob. Looking at the portfolio allocation, I'm on Slide 23, that you highlight. By the way, thank you very much for all the great commentary. And I thought you guys lined up on the 30-year 4.5s. Is that sort of a indication by expectations for you that prepays are going to start spiking up in general?
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
I would -- I'll say a few words and I'll turn over to Hunt. I would say, no. We've actually had the benefit for the last few months of being in the seasonal trough, and we have seen a rally in rates although that has since kind of abated. We are coming out into the -- where we typically see a pickup. We've been adding forms of payup protection, typically lower payups. So, even if we do see some modest uptick, the combination of fact that we're still at relatively higher mortgage rates and we do have forms of call protection, we would not expect to see a spike. I'll let Hunter say more about that.
G. Hunter Haas -- Chief Financial Officer and Chief Investment Officer & Director
Yes. A lot of that Chris just had to do with the fact that, as Bob alluded to, we were both trying to manage our leverage in a pretty choppy market in the fourth quarter. And we were also aggressively buying stock back and shrinking the equity base. So we were selling 4.5s because that was the biggest and most liquid part of book. So the 15 years that we owned, we've lightened up on this a little bit into the first quarter. Those are largely loan balance. So into the rally, we're typically best to hang on to those. Te CMOs were not something we really wanted to sell in the fourth quarter, because they're not as nearly as liquid as the pools that had a TBA back stuff, so it was really just sort of a hodgepodge of two different varieties of (inaudible).
Christopher Nolan -- Ladenburg Thalmann -- Analyst
All right. Thanks, Hunter. And talking about buybacks, I see you guys are pretty active in the quarter, what's the thoughts further buybacks going forward?
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Well, we're not going to change to the extent that the stock trades materially below book. We have unofficial level of about 90% of book, but that's not issuings done (ph). We will buy back shares. And when the bottom fell out of the market in December and the stock traded down appreciably with all other pretty much everything else, we got very aggressive, and as I said, we brought back 6.5% of the shares that were outstanding. At the end of the third quarter, we are an externally managed REIT, and I don't think that's typical -- that type of aggressive buying back of shares, but it helps drives returns, because we're doing so adding to book value in the course of the fourth quarter, when book value is being plummet, you're kind of netting some of that out by buying back shares accretively.
G. Hunter Haas -- Chief Financial Officer and Chief Investment Officer & Director
Yes, Bob alluded to the fact that risk markets behaved pretty poorly in at least the second half of the fourth quarter, but I guess if there is a silver lining in all that, it was that equity was in particular Orchid stocked traded abysmally as well, so we were able to liquidate some mortgage assets that had double limit better than our stock price on a relative basis and buyback pretty aggressively some shares.
Christopher Nolan -- Ladenburg Thalmann -- Analyst
Yes. I wish some other externally managed companies I cover were as aggressive buyback stock as you guys were. Okay. Thank you very much for taking my questions.
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Thanks, Chris.
Operator
Thank you. (Operator Instructions) Our next question comes from David Walrod of JonesTrading. Your line is open.
David Walrod -- JonesTrading -- Analyst
Good morning, guys.
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Hi, Dave.
G. Hunter Haas -- Chief Financial Officer and Chief Investment Officer & Director
David.
David Walrod -- JonesTrading -- Analyst
Could you give us an update on where book value is either today or at the end of January?
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
It was up slightly. At the end the January, it has actually come back down. It's probably more or less in line with where it was at the end of the year.
David Walrod -- JonesTrading -- Analyst
Okay.
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Most of the recovery we saw was in January, and we've since given back some of that.
David Walrod -- JonesTrading -- Analyst
All right. And then you know, both from an asset allocation standpoint and a leverage standpoint, given the decline in equity, given your share repurchases as well as the market conditions, your leverage has picked up, your asset allocation changed as you noted, how should we think about that going forward? Where are you putting runoff today and how should we think about leverage, given the current equity levels?
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Yes. First of all, the leverage we put in the slide deck, I think was 9.1%. There were some unsettled sales, so kicking off slightly, then that plus the TBA short. So it is actually somewhat lower than that. That's closer about 8.4%. We're probably going to stay at or near that kind of level. We were so defensive for so long with the tightening cycle. It seem like it was never going to end. And they may resume tightening, but that's -- I think it's a stretch to think there is a meaningful amount of tightening still to go.
So going forward, you would expect eventually to go the other way, who knows when exactly that will occur, but it seems like we're probably be in range bound here for a while. So, we don't have overly concerned with having that risk. We're very fully hedged, may be too hedged, and so we'll probably take some of that off, and then it gets down to the securities yield too. The IO securities (inaudible) Hunter says, but there's a lot of two-way risk in those, so they actually add some true hedge benefit to them. So --
G. Hunter Haas -- Chief Financial Officer and Chief Investment Officer & Director
Yes. No, exactly, and the fixed rate securities and themselves have much lower hedge ratios at this point in rates. So there is less need to hedge. So we would expect just to curtail some of those positions. With respect to the portfolio allocation, as we've alluded to, the percentage allocated to mortgage, derivative, CMOs and 15 years increased really just because we were selling -- we were selling 30-year fixed-rate.
So it'll probably be the focus, we will level the portfolio back out more in line with what you saw probably in the third quarter, maybe even larger skew toward fixed rates, getting or shying away from some of the hyper prepaid sensitive coupons like 5s and 4.5, and maybe going down a little bit in coupon, but I wouldn't expect to see meaningful changes just sort of redistributing the allocation back to where it was prior to the buybacks and deleveraging.
David Walrod -- JonesTrading -- Analyst
Okay. Very helpful. Thanks a lot guys.
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Thanks, David.
Operator
Thank you. And this concludes our Q&A portion. I'd like to turn the call back over to Mr. Robert Cauley for closing comments.
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Thank you, operator. Again, thank you everybody for taking the time to listen. To the extent, anybody has any additional questions or only had a chance to listen to the replay, please feel free to reach out to us at the office. We will be here all day as usual. Our number is 772-231-1400. Otherwise, we look forward to talking to everybody at the end of the next quarter. Thank you. Thank you, operator.
Operator
Ladies and gentlemen, thank you for your participation in today's conference. You may disconnect. Have a wonderful day.
Duration: 32 minutes
Call participants:
Robert E. Cauley -- Chairman of the Board of Directors, President & Chief Executive Officer
Christopher Nolan -- Ladenburg Thalmann -- Analyst
G. Hunter Haas -- Chief Financial Officer and Chief Investment Officer & Director
David Walrod -- JonesTrading -- Analyst
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