Good morning, and welcome to the Second Quarter 2020 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, July 31, 2020. 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 provision 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 that are subject to risk 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. Bob Cauley. Please go ahead, sir.

Thank you, operator, and good morning, everyone. I just want to mention that our slide deck was not put up last night. It was put up this morning. I hope everybody's had a chance to grab a copy so that you can participate with us as we go through the presentation today. As usual, we'll follow the same kind of format. Starting on Page 3, the table of contents. The first item will be just to discuss our results for the quarter, high level. Then, I'll spend a few moments describing the market in which we operated in during the second quarter. Then, I'll go through our financial results in a little deeper detail, and then spend the rest of the time talking about the portfolio positioning changes we made, how we see the market evolving in the future, how we want to be positioned for that. And of course, some discussion of our hedging strategy and leverage and so forth. So with that, turning to Slide 4, financial highlights for the quarter. The first thing I want to mention is that Orchid had a very strong quarter. We generated an economic return of 15.8% for the quarter that is unannualized. As a result, our performance versus our peer group, which I'll describe in a little more detail in a moment using a total rate of return based on stock price and dividends, stacks up extremely well against our peers going back throughout our history and our existence. And finally, we find ourselves finally in a very favorable environment. That has not always been the case. And we've had to slug through a series of Fed rate hikes and the like, but that is not the case now. And the environment that we find ourselves in is very attractive for…

[Operator Instructions]. I show our first question comes from the line of Jason Stewart from JonesTrading. Jason?

So I was wondering if you could opine or share your thoughts on how credit availability may impact speeds that you're thinking about versus models and how that puts you in a position in the portfolio that you have today and going forward.

So when you say credit availability, you're meaning to just borrowers generally?

I'm thinking more in terms of restrictive requirements for -- whether you're seeing that in the GSE world. We're clearly outside of the GSE world that's happening, but whether that's impacting your view on speeds in the GSE world, or there's no change?

This is Hunter, Jason, we really hoped to see and thought we were going to see a benefit in the wake of the crisis and pandemic in terms of job losses equating to slower speeds and the forbearance programs that were rolled out around the time the CARES Act came out. We haven't really seen that show up much at all. It looks like borrowers are quite able to refi into this new environment. And we'll expect that they will continue to do so in the coming months as our expectation is the primary-secondary spreads are going to narrow. We can see mortgage rates drop well into the 2s, and that just opens up an enormous bucket of borrowers who have really never had the potential to refi. And so I guess the short answer is no. We don't really expect to see it slow speeds down. And in fact, we would expect there to be continued robust speeds going into the next several months.

Yes. And I would add to that the GSEs, if anything, have become more accommodative. One thing that was really never seen meaningfully so before was what's known as a property inspection waiver, basically waiving an appraisal. And they're becoming prevalent. The GSEs are really bending over backwards to accommodate the origination of mortgages. It's all part of the government, whether it's the Fed or Congress or the GSE's efforts to just revive and maintain the economy. So borrowers' ability to get loans, especially in the non-bank space -- and we haven't really dwelled on that, but banks, or non-banks, the share of the market has grown substantially. That was a concern with respect to servicing earlier because people were afraid that non-banks wouldn't have the financial wherewithal to service delinquent loans. And everybody assumed, as Hunter alluded to, that forbearances would grow, and how are these services going to be able to make these advances. Well, the GSEs accommodated again, basically said that you only have to advance for 4 months, at which point that GSEs themselves will take over the advancing. We've seen an uptick in agency debt issuance to fund that. And for the most part, they don't expect that pools will be bought out, or delinquent loans will be bought out during the forbearance period, which is initially 6 months, but in all likelihood 12. And even then, the most likely outcome is probably going to be a payment deferral, whereby the unpaid interest and principal is just deferred to the end of the mortgage. So it doesn't even necessarily mean the loan gets bought out then. And even within that, the forbearance, many instances, from what we hear, the borrowers that enter into forbearance often continue to stay current. So the credit element of all of the COVID pandemic outbreak has been much, much less than anticipated, and prepayment speeds every month since April have surprised us and the Street to the upside. So we kind of view that as likely to continue.

The prepayment waivers, in particular, are something that are cause for concern within the way we manage our assets. And Bob alluded to the fact in his prepared remarks that we are migrating down in coupon. So there's been a proliferation of Fannie 2.5s that have hit the market over the course of the last few months since rates have come down, but those loans still have gross WACs often into the low to mid 3s. And so I'm particularly skeptical about those in the coming months. If and when we do see that primary-secondary spread decrease, that could just be very low-hanging fruit for the mortgage, especially like the non-bank lenders who are getting more and more aggressive every day.

I would expect just at this point, just to reemphasize, as we move through the balance of the year, and let's say the primary mortgage rate moves below 3, the paid's going to be felt in the more recently originated 2s and 2.5 because, as Hunter said, they have high gross WACs, fresh docs, they're very low-hanging fruit. Conversely, the higher coupons, the more seasoned pools, they just go from 200 in the money to 250, and they will start to exhibit some burnout. So I would expect a lot of the higher coupons, and especially seasoned bonds, would do commensurately better in that environment. One thing we didn't mention, I mentioned that payoffs on spec pools had risen, but what I didn't say was that you've seen a huge gap between new issue and seasoned. And the reason, initially, was well-founded, and that is that seasoned loan balance in the like pools paid quite fast and, therefore, much faster than new. And so the pay-up changed dramatically. Actually, it probably got too big. And I would expect, going forward, if what we just said is true, and you start to see more and more burnout amongst those pools, that that gap would narrow. And therefore, those securities would be behaving quite well. So if you did own the seasoned loan balance, you could see some pay-up appreciation and speed decline. And so the returns there, we feel are very attractive. And we're more leery of the lower coupons, absent the roll, of course. As long as the Fed's buying, the rolls should be strong. But if you own those in pool forms, I think those are very vulnerable pools.

We've been focusing on purchasing. What we have purchased in lower coupons have been those that are either stories that have such a low dollar price that we could quickly deliver them into a TBA if and when they start paying fast, or loans that would not qualify for the inspection waiver, like investor properties and different unique collateral types that would not qualify for that type of refi.

Right. Well, and kudos to a nice view on positioning in the agency book. You took a very convicted view and have paid off, so kudos on that. But if we pool way up, and then I'll jump out here, do you have a thought on yield curve control and what that means for mortgage?

Well, I think if they do, there's a large variance of opinion out there. If they do, I think it's probably just going to be in the front end of the curve, maybe out to the 3-year point. I think the market, to a large extent, is behaving as if they already are. I checked today. The 2-year is about 2 bps over Fed funds; 3 years, not much more. I wouldn't expect, whether they do it or not, it to have a meaningful impact. It's more the long end. And what you're seeing now with this flattening, from what I hear, is the dollar has been weakening, and Asian investors view the long end of the curve is very attractive. They've been investing in the long end of the treasury curve on an unhedged basis. So when those kind of dynamics are at play, that's really outside the Fed, per se. It's just driven by more market dynamics. And that may persist for some time. Yield curve control probably just -- if it does come, it's probably just going to be on the front end of the curve, and I would argue that the market's almost acting as if it were in place already.

Thank you. [Operator Instructions]. I show our next question comes from Christopher Nolan from Ladenburg Thalmann.

On the ROE, you're talking about low to mid-turn returns. Is that for the second half of the year? Or is that for a full year?

I do have a specific period. I would just say that's what's available today. The higher end of that range is going to be predicated on better speed performance. We just mentioned on Jason's question. We think lower coupons in pool form are a little more vulnerable, so returns there are going to be on the low end of that range and some of the higher coupon, especially seasoned pools, probably going to be more on the high end of that range, unless we're wrong and speeds do accelerate across the board meaningfully, and then, in which case, those returns probably won't be there. But if we can manage speeds, I think those returns are very doable.

The TBA's a great alternative, as well, for us if we become overly concerned with the potential performance of the pools. Buying TBAs is a great option. The rolls are great. The Fed is going to continue to buy production coupons, and they're going to trade special for the foreseeable future, in our opinion.

And I'm just sort of doing back-of-the-envelope on the new dividend of $0.06 per month. That equates to roughly a 14% of book value, so that sort of falls within that range. Is that a fair way to look at you're setting your dividend consistent with your view in terms of ROE?

Yes.

And then, I guess the other thing is really everything just sort of turns on speeds. By the way, very nice quarter, but that is the key question here. I just want to make sure that's the key takeaway.

Yes absolutely. And we tried to make that point as strong as we could. And you saw how so far we've behaved versus the cohorts, and it's how you position in terms of what spec pools you own or what vintage you own. TBA, of course, always offers attractive returns. You see that, especially a lot of our peers use the TBA market more than we traditionally do. But in those coupons the Fed's buying, implied financing cost is very, very low. And if you listen to the Fed, it doesn't sound like they're going to back away from the market anytime soon. But it does create opportunities for everybody.

We just go back to that Slide 23 here. We're sitting at over 80% of our portfolio in what we would consider to be very high-quality specified pools. That's especially true of the higher coupons that we own. So the 3s, 3.5s, 4s, 4.5s -- apologize. I'm not used to call them 3s high coupons quite yet. But it's all $85,000, $100,000 max, $110,000 max, a few $125,000 and 150,000s. And then some New York, predominantly in 3s and 3.5 space. So we feel pretty good about the quality of the portfolio. We've sat on these assets and watched their pay-ups go through the moon, but we have a good cost basis in them. And so, while we could grab quick profits by selling them, we'd just be left with the replacement problem. And so I think we're going to sit on them for a little while. And as they pay down, we'll venture into lower coupon space and make sure that we're in safe territory there, as well.

Yes. And we did also own some 15-year TBAs as well, too. That trade, we actually got in and out of that trade a few times, has done very, very well. So there's a lot of opportunities in the marketplace today. That's for sure. And funding looks like it's readily available. We didn't really dwell on this. We're in the mid-20s, and we can even term that out, if we like, in most cases, at around the same level or very, very modest increase in rate. And we don't have any of the issues that some of our credit peers do. We didn't have to go through any forbearance or anything. We maintain adequate liquidity throughout. And so that allows us to be nimble to the extent we want or need to be. And we've got the leverage ratio back up to the high end of the range. That was not a challenge to do so, and we're not going to go higher, but we see very comfortable maintaining it at that level, as long as the recent returns are available.

I guess on the question of leverage box, I guess your lenders are assuming that the Fed backstop will not allow another liquidity trap like we saw in March.

Yes, I think that's safe to say. I mean, the Fed -- go ahead.

Yes. And if that's the case, and if you're really dealing with a one-dimensional risk here, which is namely prepayments, why not take the leverage as high as can bear?

You need a lot of conviction to do that, and it would be very costly if you were wrong. I guess the one thing that would drive me away from that is that a lot of people have the view that we do, that rates are going to be low for longer. And there's no reason to think they won't. It's just that, whenever you get the market so offside on one view, it can be very painful when the market goes the other way. It doesn't have to be a meaningful move. It just has to be enough to trip a few people to shift, and that in and of itself can drive the market higher. So that would keep us from doing that.

[Operator Instructions]. I show no further questions in the queue at this time. I'd like to turn the call over to Mr. Bob Cauley, Chairman and Chief Executive Officer, for closing remarks.

Thank you, operator, and thank you, everybody, for joining us. As always, we appreciate you spending the time with us. To the extent you aren't able to, you want to listen to the replay of the call or you just want to call in with questions, we are more than happy to take your calls. The office phone number is 772-231-1400. Otherwise, we look forward to talking to you next quarter. And our next dividend announcement will be out in mid-August. I hope everybody stays safe, and look forward to talking to you next time. Thank you.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.