Orchid Island Capital, Inc. (ORC) Earnings Call Transcript & Summary

Hello. Good morning, and welcome to the Second Quarter 2024 Earnings Conference Call of Orchid Island Capital. This call is being recorded today, July 26, 2024. 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.

Thank you, operator, and good morning. Hope everybody had a chance to download our slide deck. As usual, I'll be using that for the presentation today. Turning over now to Slide 3, just kind of the agenda, as usual, we'll go through our financial results, and we'll talk about market developments and how those impacted our results and how we see things going forward. and then we'll dive deeper into the portfolio hedging and funding positions. And then a few comments on our outlook for the market and for the portfolio going forward. So on Slide 5, for the quarter, Orchid generated a net loss of $0.09 per share versus income of $0.38 in the last quarter. Book value declined approximately 5.9% from $9.12 to $8.58. Book value as of last Friday, I know that most of our peers have mentioned that, is down about 0.9%, a little under 1% that has to do primarily with just our hedges, which I'll get into later in the presentation. Total return for the quarter was slightly under negative 2%, and we declared and paid $0.36 in dividends. The average portfolio grew quite substantially from a little under $3.9 billion to $4.2 billion. We have been raising capital in the ATM. The portfolio, as we stand today, is about $5.1 billion and repo is about $4.9 billion. Leverage ratio was 7.1 at the end of the quarter, unchanged primarily from the beginning of the quarter. Today, it's a little higher in the mid 7s. Speeds in the portfolio did increase slightly. That's probably due to rates being a little lower and ceasing especially on the discount side of the portfolio. Liquidity remains strong, up slightly and represents little under 50% of equity. Slide 7 just presents our financials. I'll spend time going through these. These are just for your review, the income statement and balance sheet as of the end of the second quarter. Slide 8, as we all know all of our peers is something they referred to as earnings available for distribution. This is common compared to the dividend. We don't publish such a number. This is kind of our proxy. This number is what we call our kind of our economic income, is all derived from GAAP financials. So we are taking all of these numbers from our GAAP numbers. The dividend is based on taxable income, not GAAP. So there are some differences. I just want to walk you through just this presentation and kind of highlight where there could be differences between GAAP-derived numbers and tax. So for instance, just walking down the income statement, the interest income number is slightly different for tax, but I think this is a good proxy. There are minor differences in the calculation of interest income on pass-through portfolios and derivatives, but this number should be reasonable. The amortization of discounted premium, that number is the GAAP number here, that can deviate quite a bit from the taxable number. The main reason is simply the fact that we do this based on changes or paydowns how that impacted the market value at the beginning of the quarter, whereas for taxes from purchase date. And then with repo funding, of course, that's pretty much identical. And then the hedges, we show the impact of the benefit of the hedges that we have in place, which is quite substantial. There is a slight difference between GAAP and tax in that with tax, you have to take into effect hedge positions that are actually closed to the extent they cover the effective the current period. So for instance, if you entered into a 10-year swap 2 years ago and closed it 1 year ago, the open equity at the time of closing would still impact your interest income for tax purposes over the remaining 8 years of that swap. So that can be slightly different and expenses are basically the same. So we're showing this number, this economic income or adjusted income of $0.50. It is a proxy for what our taxable income. I just want to make sure you understand that they're not necessarily exactly the same. And as you can see, it's been fairly stable for the last 3 quarters. So that's all I'll say for that for now. Moving on to the market development, just kind of go through these 4 slides. The first on Slide 10, this is basically just a nutshell what's happened in the economy. If you look back to the end of the first quarter, the inflation and economic data had been quite strong. In fact, we were talking about the rates being higher for longer, even if the potential of the Fed would have to hike again. Second quarter, that all changed. All of the main key data, inflation, jobs, ISM for April, May and June were considerably softer and especially the inflation data is back consistent with what we saw late last year, which is inflation trending down towards the Fed's 2% target. And now the market views the Fed is likely to be on path to cutting rates later this year. And then just kind of fast forward to where we are now in July, and the big change has been the change in the slope of the curve as the market gets closer to pricing in or pricing eases closer. So now, for instance, [ 2s ] 10s as a proxy for the shape of the curve. In late June, that was at minus 50 basis points, earlier this week, it got as low as minus 30. So a big move. It's really hard to discern from these charts if you're looking at the difference between the green and the blue line. But the 2-year point in the swap curves moved over 35 basis points. So a big move, the curve is much deeper. In our view going forward is that, that will continue. And it's easy to have a fair amount of conviction in that because there's really 2 forces that could drive that on the one end, obviously, if the Fed eases, you can get the front end of the curve moving down, it's currently anchored. But also on the longer end of the curve to the extent that we're going to continue to run, for instance, large deficits. There's somewhere in the $5 trillion to $8 trillion of debt that has to be rolled over by the government in the next 1.5 years. And depending on the outcome of the election, say, for instance, if Trump will win, he has talked at length about imposing more tariffs, which could be inflationary. So there's a lot of reasons to think that the long end of the curve may not rally as much as the front end, in fact, it could even go higher. So for these reasons, it's easy to gain a fair amount of conviction on a [indiscernible], and that's kind of how we expect the market to unfold. That being said, to the extent that it doesn't, we are positioned to do quite well even with that outcome. Moving on to the mortgage market. This is a chart on the top. I talk about just the spread of the 10-year treasury going back very far. It's a good perspective. As you can see, we are still in a fairly elevated level. On this chart, we show as the most current rating of 141 basis points spread to the 10-year. Today, that's closer to the 1.35, 1.36. All of that being said, the current coupon mortgage has a duration that's much, much shorter in tenure. So a more appropriate benchmark for today will probably be the 5-year, and that spread is a little under 1.50, and it hasn't moved as much of late. So it's not tightened as much. So mortgages are still attractive. And we expect going forward that there's room for tightening. The market expects that to the extent we do see Fed easing, we're likely to see the banks become more involved. They have been modestly involved to date. But if they were to become more meaningfully so that, that could be the impetus or the catalyst for some more tightening. I don't know that we're going to go back to the levels we saw pre-pandemic, but it could certainly drive us fairly tighter. And again, that's the kind of market's conventional thinking is that the banks would become more involved if we do get easing. Outside of that, money manager inflows have been substantial. I saw some data published by Nomura yesterday that showed something like $7 billion or $8 billion weekly average to date this year, which is pretty strong. And to the extent that those money managers continue to be overweight mortgages, those are pretty substantial inflows. So they've been supportive in and of late as we know that REITs have been raising capital, and those are kind of on the margin support of the market as well. Looking at the bottom left of the page, you can see the performance of select coupons of mortgages, and you can see early in the second quarter, quite weak performance. April is a rough month. We are still looking at data from March. It was very strong that market was expecting the Fed to be break high for an extended period of time, so mortgages were looking and also appealing. And we had a nice recovery into the end of the quarter. gave up most of that in the last week, which really ended up hurting the returns for the entire quarter, only to turned around in July and kind of rebound, although of late the last week or so, that's turned around again, we're probably close to unchanged if you look back at a 3.31 reference point. On the next slide, we talked about volatility. Volatility is obviously a very big driver of mortgage performance. And this chart on the top shows, if you go back to October 2023 when we are at very high levels, rates and volatility, we've had a nice long rally since although rates haven't started to pick up. And in particular, this week, especially realized volatility has been quite high. And this is just something that we always have to keep an eye on because it is a very big driver of mortgage performance. For now, they're relatively low levels, looking back just a year or so, but starting to build the other way. Slide 13 is kind of our proxy for the housing market and refinancing. And as you can see, as we all know, it's been the same story for quite some time. Mortgage rates are high. That's the red line in the top left and the blue line is the refinancing index, which is basely 0. But just speaking more generally about the housing market. Affordability is very, very low, near record lows. So that impacts a lot of things like turnover, rates, again, near the high level. Prices are high, which these 2 combined drive affordability. And now that we're starting to see our inventory levels build. I know this week, for instance, new home sales were released. The inventory of new homes is over 9 months supply, which is typically associated with recession levels. I'm not saying that we're going to get a recession, but those levels have moved a lot. In fact, I think the absolute level of new homes and inventory is similar to the levels we saw before the financial crisis. So the housing market is definitely weak. There's no question of that. Slide 14 is something I introduced last period. It's just kind of an interesting look at GDP and the money supply. I'm not really going to talk about it, but it paints an interesting picture. You can see that growth has been above long-term trend now for some time since the pandemic. And whether it's causational or not, the money supply would appear to be behind that. And that's kind of associated with the significant deficits that we've been seeing since the pandemic. That's about it all. Now I'll turn to the portfolio. On Slide 16. As I said, our outlook for rates is for the curve to steepen. As I said, there's 2 potential drivers of that. You can have the Fed lower short-term rates and/or longer-term rates could stay the same and/or go higher if inflation and/or deficits continue to stay high. So with that in mind, as kind of the backdrop will probably view the world going forward, not in terms of what we did. Well, the big driver was we had a lot of money to put to work. We used the ATM quite exclusively in the second quarter. We raised about $100 million. And actually in July through the first 1/3 of the month or so, we raised another $55 million. So quite a bit of capital in relation to our size. As a result, we've been deploying that into the portfolio and basically almost exclusively in higher coupons. As a result, our weighted average coupon went from 4.38 at the end of the first quarter to 4.72. The end of the second, which is a pretty substantial move, but it's even higher now. It's at 4.88. So a 50 basis point increase off of where we were at the end of March. Realized yields are higher. I don't have the current number, but it would be higher than what we report here for the end of Q2. And then also, our net interest spread for the quarter went from 2.47 to 2.64 with the additions of the higher coupons and our slight changes to our hedging strategy, which I'll get into in a moment, there's room for that to expand slightly more. And I would just point out, if you look back at our portfolio historically, say, going back a year or so, especially in relation to our peers, we probably had one of the lowest weighted average coupons in the portfolio. And as we employ our barbell strategy and add higher coupons, that's been coming up quite a bit. And so we were in terms of performance for the quarter, our net interest income for June, even though we were negative for the quarter, it was actually slightly positive. I don't have any Q2 figures yet for you, but that's clearly the trend. With respect to the portfolio itself, as you can see on Slide 17, these charts just the bar graphs of our portfolio. If you look at the right, that's where we were at the end of last year. And as you can see, moving to the left, the current positions at 6/30, we have, as I said, been adding to the higher coupons. Just to give you some updates of what we've done since quarter end, 6/30/24. Our allocation to 6 is now is just under $1 billion. So that's grown quite a bit. 6.5, we're now over $800 million, and 7s are almost $400 million. So that's almost $600 million of adds and all of those higher coupons. And the reason we prefer this barbell strategy is we think it does well in either rate environment. So for instance, if we would have a rally on the long in particular, our lower coupons would do quite well to the extent the rates long and in particular, stay higher. These higher coupon security generate lots of income and absent a substantial increase in longer-term rates don't have much extension risk. The belly of the coupon stack is more often than not been quite rich of late. That's another reason why we find these securities to be attractive. Turning to our Slide 18 in our funding. Well, the Fed hasn't done anything. So not surprisingly, our average repo rate for the quarter was unchanged. All that being said, with the market starting to price in eases, we have extended our average maturity and we've continued to do that and this is why so we can get some benefit of some slightly lower, not meaningfully small, but slightly lower rates further out. With respect to our economic cost of funds, it did improve their amount from 2.56% to 2.41%. And that has a lot to do with changes in the strategy of how we're hedging. We've been using a lot more swaps versus treasuries or futures, and we've been moving those swaps up the curve. So slightly maybe lower notional balance but with more [ DV01 ] further off the curve. And with the curve very, very flat, in effect, our hedge borrowing rate has gone down slightly, and that's what caused the NIM to improve. Now turning to our hedge positions. As I mentioned, we've been moving the swaps out, moving 2 swaps and using longer tenor swaps on almost all 7- and 10-year. And the reason we're doing that is this, we think the greatest potential pain or risk to the portfolio would be a long-end sell-off, which would typically be accompanied by an increase involved. And so therefore, by using 7- and 10-year swaps, especially when we're hedging new purchases, which are higher coupon, lower duration, if those mortgages were to extend, they're extending their duration absolutely close to our hedges, we would dynamically hedge and potentially add to those positions. But it really, I think, is the most sound way to protect the portfolio because that, as I said, I think that would be the greatest source of pain would be a significant selloff in the long end. Also, just more of the statistics on Slide 19. We do cover 84% of our funding liabilities with our hedges, excluding TBAs. Swaps are now up to 72% of that, and our weighted average paid fixed rate is 2.71. If you look at the bottom of that page, you can see our swaps are now a little over $3.1 billion. Corresponding numbers end of Q2 was 2.53. So a significant move of the futures. Those were $842 million, now it's $521 million. In addition to adding to our hedges, we've been moving some of them from futures to swaps and moving the swaps further out the curve. TBA short is essentially unchanged and same with the swaptions, probably just one position. Now if you look at Slide 20, we provide a little more detail on our hedges. And I just want to say a few comments in particular on the top right, our swaps. As you can see, if you compare where we were again on the first quarter versus now, the shorter maturity swaps are the same. So we've been adding to the longer tenor swaps, as I mentioned. With respect to the performance of the portfolio through last Friday, it really was just driven by the fact that we do have a fair number of swaps in a 5-, 6-, 7-year part of the curve, and that's where the markets really rallied. And so it's the reason that we're down side is just because of that, the rally in the swap positions the [indiscernible] mark-to-market to a slightly negative position. Now that being said, I don't know that we're going to change that. But I think as we expect the purpose, we do expect the Fed will ultimately ease, but current pricing is for quite a few eases by the end of the cycle, 200 basis points or so. I don't think we're ready to take the over on that. I don't think we see the economy long about the rule in the recession. And so I wouldn't be surprised if we actually realized less than that. So the fact there's no real reason in our minds to unwind any of those hedges because we think the market may be a little ahead of itself. Also with respect to the swaps, I want to point out that none of our swaps mature between before March of 2026. 85% of our swaps are in place through or mature in Feb of '29 or longer, and 65% in May of 2030 or longer. So these hedge positions are going to be in place for quite a while. The 1 swap that does mature in March of '26 represents less than 10% of our notional balance. So our hedges are here. We're not going to have them roll off. We don't have to refinance those, so to speak, anytime soon. And then secondly, with respect to our balance sheet, as you know, we have no preferred, we have no floating rate preferred. So our balance sheet in that regard is very clean, and we don't have that risk to our net interest margin posed by either a floating rate preferred or swaps that have to be refinanced in the near term. Slide 21 just gives you a look at the portfolio. I would point your attention to the column entitled effective duration. And you can see across the various coupons of those numbers. And then the far right is just our allocation. So basically, if you look at the effective duration column, starting from the top, down to the bottom, that's basically the curve where we're positioned along the curve. So the shortest part of the curve, which would be 1.27 year, our current allocation at the end of June was 7%, those are higher. But basically, this just gives you a sense of how we've positioned the portfolio across the curve. Granted these are static numbers. If rates were to move materially, these duration numbers can change. But as you can see on the far right column, how we're positioned. And just note in the bottom right, the allocations to those higher coupons have gone up. Slide 22 just kind of gives you a sensitivity of our net duration gap or the sensitivity of the portfolio. As you can see, we do a little better in a backup, and that's just because we've added longer tenor swaps primarily. Finally, on Slide 23, our speeds experience. The 1 thing that we benefited from of late I mentioned earlier is that most of our deep discounts, say, bonds with 95 handles are below 4s, 4.5 and so forth. So quite seasoned. And as a result, our speeds, if you look in the very far right column, they're not bad for deep discount bonds. So that's beneficial for us. And with respect to our newer higher coupons, they've been maintained or just basically moderate speeds. We haven't had any issues there. That's pretty much it. Now I'll just kind of turning to our outlook. As I mentioned earlier, a lot has changed since the end of the first quarter. We were looking at higher for longer, maybe the Fed hiking, the data changed pretty abruptly. And now the market really thinks that we're on the verge of an easing cycle. We've been here before. We certainly, if you go back to December of last year, we thought we were on the verge of a big easing cycle and it didn't turn out to be the case. So we are mindful of that. But that being said, to the extent we do get an easing cycle, there's obvious benefits to that as our funding cost decline and our position in the portfolio, which I think is well suited for that outcome. But all that things said, if nothing happens and the data turns around again and we don't get any tightening or easing rather, we just have a status quo. The portfolio is very well positioned. The income and net of our hedges is very attractive. And we think that our hedges are such that we can maintain pretty stable book value throughout. So we're very comfortable positioning where we are. And that's it. Operator, I will now turn the call over to questions.

The floor is now open for questions. [Operator Instructions] Our first question comes from the line of Jason Weaver from Jones Trading.

I appreciate that market commentary. It's very helpful. I was wondering, could you comment on the pace of deployment over the quarter of the ATM issuance? And if that represents any sort of meaningful cash drag? Or were you able to get that invested relatively simultaneously?

I'll give you my first comment and turn it over to Hunter. We did wait a little bit in June. We raised a lot of money in ATM in June and with the market, especially the mortgage market underperformance late in the month, we did wait, so we didn't deploy most of that until July. So that would cause a slight drag for the first month because we just have less income on more shares. But we then did deploy it. We're, I would say, fully deployed...

Yes, we're fully deployed at this point, although our numbers in June and July would not reflect being fully invested. So with the most recent slot of capital that we've raised, the money will be fully put to work starting in the month of August. So we'll get sort of full month's worth of interest accruals on all those. We raised some capital in the beginning of May, put that money to work relatively quickly and then also did some more rate fundraising in the later part of May and early June. We really waited until towards the end of the quarter to put that money to work. I think it was a wise decision as that last week of June, spreads really backed up quite a bit. So we put some money to work in late June and early July at pretty attractive levels.

Got it. And then just on the macro front, as far as the book looks today, where do you think benchmark mortgage rates or spreads for that matter have to come in for you to begin to get really concerned about your convexity exposure?

What spreads have to come in?

Sorry, where rates have to move before you start worrying about the accelerated prepayment exposure.

I would say, right now, the current coupon is about 5.58 or 5.60. We have a lot of 6s and 6.5s. I think guys mentioned a little under $400 million of 7s. So the 6s and 6.5s are not significant premiums, and a lot of those are New York’s. They're all specs, a mixture of low pay-up and some higher pay-up bonds. They would have to be quite in rally I think for those to become meaningfully in the money and become a concern. Exact number, you're probably looking at, I don't know, 25 basis points or more. And the other thing is that mortgage spreads primary secondaries but I even mentioned that on the thing on the call earlier, but has been kind of sticking to the high side. So I don't know that we would necessarily see them take up with [indiscernible] basis point per basis point.

Yes, the strategy has been, especially in the 6.5% and 7%, even more so as you go up in rate has been to stay sort of close to TBA. So we recognize that convexity risk, and we monitor our hedge ratios as they change from day to day on that front. So we're trying to stay on top of the convection into a rally. We did mention that our barbell strategy. The other side of that is we have a lot of really high-quality specified pools that are lower coupon. And so because they're so far out of the money. At this point, there pay-ups aren't all that high, but we would expect those pay-ups to accelerate at an increasing rate if we were to have a really big rally. So on the opposite side, the high coupon portfolio, because it's relatively low payout. If we were to have that big sell-off, I think as Bob alluded to in his comments, we would expect those assets to do quite well. And we've really seen that as we've bounced around the rate range. We have a big sell-off, we'll see 6.5 and 7 TBAs do relatively well. lackluster performance down lower in coupon. That market is a lot more technical, less predictable as rates rise and fall, but the production coupons tend to do well into a sell-off and tighten up. So we like the way we're positioned for that reason.

Our next question comes from Jason Stewart from Janney.

Maybe start with the current cash ROE of the portfolio and what you're seeing in terms of incremental capital deployment on current cash ROEs?

Well, we've seen, we were at 150 for quite a while now or getting closer to 200 over, especially as we've been using more of the longer dated swaps. I don't feel we've published the numbers but yields on the new acquisitions that Hunter just alluded to, were in the very, very high 5s on average, and using a combination of 7- and 10-year swaps, therein depending on when we put a mini to the low 4s or even high 3s. So I don't know if we're 200 over, but they're quite high. And with 7x leverage, 7.5, those that's pretty decent ROEs, and I don't think that's being very aggressive with respect to leverage. So they're very, very attractive. I think the 1 thing we do think about is, what's going to be the big driver if you're going to get the big tightening and we haven't seen that yet, obviously. I don't know that we're going to see it in the immediate term unless you really start to see the banks come in.

And I would just add, just a comment, 1 thing we've seen, since you don't have the Fed doing QE, you don't have banks buy is the mortgage market has become very relative value driven. No coupon outperforms for more than a day or so. If the belly outperforms today, then you know it's not going to perform tomorrow kind of thing. And so performance has been very volatile in that regard on just rich cheap basis. But that being said, we've been able to generate very decent yields in this kind of stationary market and taking advantage of the funding or hedging strategy, we've got very attractive ROEs. Now depending on the point in time where we as alluded to earlier, some of the early May settles were done at slightly tighter spreads from both an OAS and yield perspective. But it's 180 to 200 over positive cash flow versus funding today's repo funding levels just in terms of carry. And then one of the benefits of hedging these a little bit further out the curve is if and when we do get those Fed eases, we have immediate room for NIM expansion on some of the unhedged portion of the assets. So yes...

Yes, no, it does. So like mid- to high teens and all cash carry with room for improvement. It's sort of the bottom line there, right?

Yes.

Yes.

Okay. And then just a technical question on the pay-ups. When you look at hedging, sort of that spread duration of the pay-up, does that change your hedging strategy at all? I mean, we've seen some pretty aggressive refi programs out there. It seems like a lot of the mortgage market is going to be very quick to refi some of the new production. Just maybe talk a little bit about how you're looking at that spread duration and hedging risk on the pay-ups?

Well, we've seen that be very painful in the past. I mean as we all know, there's been some gut wrenching episodes early in '23, where those payoffs can move a lot, and you experience that spread duration. What we've done is basically just basically stick to more low pay-up stuff. As I did mention, we owned some New Yorks, but those are in 6s. So their payoffs aren't that high. Generally, it's been higher loan balance or FICO or Texas or Florida or LTV. So try to avoid that as much as we can. We have not been buying all loan balance 7, for instance.

Yes. And those pay-ups are a little bit different than the traditional pay-up stories where you might say, like a low loan balance or something where you're really paying up for this superior convexity. A lot of times, the pay-up that is embedded in some of those less expensive stories is really kind of months to breakeven sort of play, right? So are they going to build outperform generic TBA deliverable type of collateral by a handful of ticks per month and the market kind of works ample the breakeven is for that. They do have, in all cases, better than and cheapest to deliver convexity or S curves, but a lot of times what you're really paying for is just a month to breakeven type of approach. So it's been a good strategy. They do carry a little bit better than worse to deliver. We don't expect them to defy gravity into a huge rally. That's why we're focused on the lower pay-ups, and they have relatively low negative convexity. And so we think into a volatile market, they can do well.

And that's also part of the barbell strategy. We still have a lot of 3s. We don't expect a huge rally on the long end. But if we do, they're going to do very, very well even despite the fact that some of these higher coupons may not do as well.

And they're fully extended at this point. So they have very low convexity for the opposite reason.

Yes. Absolutely. Okay. That's helpful. And last question for me. On Slide 8, Hunter, maybe this one for you. If I look at the 2Q '24 number, say, $29.5 million of gains on funding hedges attributed to the current period, how much of that is coming from closed swaps, really what I'm trying to get at is...

None of it. These are all from currently existing hedges.

Okay. So when we look at these numbers relative to the dividend and book value, there's a mark-to-market impact, obviously, that's been realized in the book, and it's going to change as rates move around. And some of this is going to come out of book value. So it will be a return of capital and the dividend.

Right.

Okay. I got it. I'm thinking about the right way.

Our next question comes from Eric Hagen from BTIG.

How are we thinking about the range for your leverage right now? Can you remind us kind of the historic range that it's been? And what you think might get you to take it up to kind of the higher end of the range versus raising more capital?

Yes. The range is 7% to 8% be the range, maybe a little less than 7%. We're about 7.5% now. We were right around 7% and 7.1% at the end of the last few quarters. I would say at the moment, I don't see a reason to take it meaningfully higher, I would say, quite comfortable with 7.5...

Yes. I think that this fall could be very volatile. We're not really in a position where we're thinking about hiding and taking cover, but we're also, I think, there's a lot of black swans flying around right now. So we're content to sit at this level for the time being.

Yes. All right. That's helpful. So how are we also thinking about repo rates in light of higher volatility. I think you guys mentioned a lot of government debt coming to the market pretty soon. Should we expect...

You started to see that. I was just reading this morning about our in-house repo trade has been in the industry for 30 years. We spent a lot of time talking about this. So if you look at software, Today, I think it said it's 34, it's above Fed funds. I don't want to get over my skis, but my understanding is that software, it's the average of weighted average of third-party repo, GC repo and then I don't remember what the third component is. But what we've been seeing is that the banks, the Wall Street firms have been using sponsored repo more for balance constraint reasons. As a result, the blended rate has been driven higher, so less third-party, more sponsored repo, which is at a higher rate. And so you're seeing that drift higher. It's actually quite a bit higher now than the RRP, which is why the RRP usage has been coming down, money markets and moving funds into there. But that's been higher. I don't know that that's not a function of deficits. That's just funding levels and QT and things like that. Our focus on the deficits and things like that is more of a long end story with so much debt to be refinanced over the balance of the next 2 years, obviously at much higher rates. We think that's going to pressure longer-term rates. And that's why the effect we're playing for a steepener, we think it's going to be more front end driven than long end. And then depending on the outcome of the election, as I mentioned, Trump talks a lot about sanctions and the like. He's not known as a deficit hawk. So I don't think you're going to see inflation come roaring back down to the low 1s. So all those things are going to keep pressure on loan end I think...

Yes, in spite of all the volatility and record, the builds markets and everything that's rolling off there and the index rates bouncing around, and there's a lot of noise there, repo rates have been remarkably stable. And now finally, just starting to roll into that period where we're taking longer term, putting on some longer-term repos or 2, 3 months, every day that passes start incorporating more of that September rate cut that's baked into the market. So spreads may widen out a little bit, but I think we'll see the nominal level of repo rates come down.

Good perspective. I appreciate you guys very much.

Our next question comes from Mikhail Goberman from Citizens.

If I could just jump in with a question. If you can flesh out perhaps a little bit further. Your idea is about book value and the swap portfolio. Given we're going to probably get some Fed loosening here in the next couple of months and quarters, are you guys thinking about book value stability or book value growth in a lower rate environment?

Stability versus growth. I don't know that we have that in quite an outlook. I think as I said, I'm going to see the curve steeper on the front end. So obviously, the swaps are going to suffer there. But if you look on the asset side, especially with large allocations of 3s, I think a lot of that can be offset. So I guess, without thinking out too much, it would be stability, but there is certainly room for growth. That would be more mortgage tightening. Like I said, we're trading depending on your benchmark between 135 and 150 off. If we do get a meaningful easing cycle, which I don't think it's going to be that meaningful. But if we do when the banks come back in and they're more buyer the space, you can get spreads tightened 10 or 15, that's probably where the book value would come from...

I'd add that we have from a tax perspective, we had a little bit of an over distribution earlier in the year. So as the NIM expands, we have some latitude to think about preserving a little bit of below. That's in a very short term, just really kind of through the end of this year. And then 2025, we'll be more tax driven in terms of whether or not we can distribute or retain some excess profit.

Good luck going forward.

Our next question comes from the line of Christopher Nolan from Ladenburg Thalmann.

Bob, your comments on the bank staying out of the MBS market. Is this any sort of anything related to the fallout from the Silicon Valley Bank [indiscernible] where suddenly the Feds are...

That was more of a last year's story, maybe earlier this year. They're not present. They're just not in a big way. The conventional with them is that they're waiting for the Fed to ease. And once they do that, they'll become meaningful buyers. And that was what I was trying to get at earlier the comment and the 1 question I was answering is that we had QE back in the day, the Fed was just an indiscriminate buyer, and banks were flying too because the Fed was pumping reserves into the system. So even though people didn't talk about it at the time, if you looked at bank holdings of mortgages, they are going up in lockstep with Fed holdings. So you had these 2 huge buyers of the space. they're pretty much both gone. I mean the banks buy some and I just said, but so you don't really have this huge indiscriminate buyer, so now the money managers buy it, they're very much relative value driven. So they'll buy mortgages if they think they're cheap versus, say, corporates or versus treasuries, whatever. But so there's mortgage trading now is all relative value driven. So nothing stays rich for long or cheap for long. And so you haven't seen mortgages gap wider or tighter much. There's no real potential for that, but that could change if we get banks back in. So we'll see the regional banks, I think were the biggest culprits when it came to the underwater how the maturity accounts, the Wells Fargos and JPMorgans of the world, I don't think are in that position as much or at least, if not at all. They still have legacy portfolio of issues to work off. And the accounting classifications that they use them and how much they can sell at a loss and redeploy at wider spreads. And so it's just going to be a matter of time or in the case of there have been some large bank portfolio movements, and those have been sort of one-off in nature that related to selling some profitable arm of the business and then using the gains from that to offset selling lower coupon mortgages and loss and then redeploying in the higher coupons. So Fed cuts will definitely accelerate the amount of time that they're sort of in the penalty box from having to work off those losses before they can redeploy into more profitable strategies. So I think there'll be present at an increasing rate, but I don't really expect a monumental shift any time soon.

Okay. And then turning to capital management. What was the average share issuance price for the ATM in the quarter?

I don't have that in front of me. It did vary quite a bit. I would say in the second quarter, we were probably around 97% of book on repo we are selling, what was moving around. Obviously, that number is higher. We weren't starting for long in July, but it was at a much higher percentage of book, but I think the last sales we did were even in the 8.60s gross, but the stock has since fallen back. So we traded in quite a range probably 8.25 to 8.75 throughout the second quarter and the selling price tracked bulk more, like I said, it was kind of 97% of book of gross, maybe 97.5%. And so just depending on the day where those prices were. I don't have that in front of me.

Yes. So given that you're raising equity capital, which is dilutive to book value, how much of the swing in book value in the second quarter was due to these capital raises?

About $0.09, and here's how you get to that number. We had GAAP earnings of negative $0.09 and we paid dividends of $0.36. So if you don't issue any shares, the change in your book value is just going to be earnings less the dividend, right? So minus $0.09, minus $0.36 gets you to minus $0.45, but we did issue shares and book was down $0.54. So that delta is $0.09. It was attributable to share issuance.

And final question. Given that, should we expect further book value dilution from the capital raises you've done quarter-to-date?

Well, we did those at a much higher percentage of the book. My rough estimate is about $0.01 quarter-to-date. And that's because the last sales we did were almost at book, essentially at book, and so there's very little dilution in those...

Maybe worth noting also that something that makes us a little bit tough to get your hands or on your mind around is that as I alluded to earlier, some of the capital that we raised, we did so when book was higher and then put the money to work when book was lower. So not to confuse the matter too much, but we did save some capital and put it to work when spreads were sort of at their quarterly wides.

Our next question comes from the line of Jim Fowler from Kingsbarn Capital.

I just wanted to ask a bit, refer to a couple of tables, 1 in the press release, 1 in the deck, if you could rather see if I'm looking at this properly and ask the question. So I've noted that the last 2 quarters, strong economic income relative to the dividend distribution if you note on Page 8 and which you also provided detail on the largest contributor of that has been the hedges in the current period, of which about 60% is related to the net swap benefit in those swaps. You have a very enviable position of not having maturities until 2026, and then they're much longer. So when I look at the economic income for the quarter of $29 million, and I look at that as a return on the average capital allocation of the quarter of $405 million from the press release, I get an economic income return on average invested economic capital of about 28% for the quarter. And as you articulated earlier, I think the marginal cash ROE is in the 19% to 19.5% range, leverage 7.5x. So if all of that seems reasonable to you and is accurate. I guess the question that I have or the observation I'm making is that this is now a convergence situation, how long will it take for the portfolio economic return of 28% on average invested capital to converge onto the marginal investment return on the cash ROE of approximately 19%. That would seem to be a very long convergence cycle unless a significant amount of capital was being raised and invested at that margin with that marginal cash ROE that would cause that economic return to converge more rapidly. And here we are in the second quarter on into July, raising lots of capital. I think share issuance in the quarter was up quarter-over-quarter, about 22%. So I'm wondering how you think about that vis-a-vis the relationship of economic income versus the current distribution and if that economic income on the margin gets declined closer to distribution, the distribution rate because of [indiscernible] raises, does that obviate any opportunity to adjust the dividend upward and could potentially pressure the dividend?

Let me take a crack at that. So the convergence, if we were to get an easing cycle...

Let's not talk about easing at this point. I'm just talking about the marginal capital raised or invested at 19% when you have a balance sheet and hedge structure right now, that's it's obviously above market, mostly driven by the swap benefit, but I don't want to introduce anything with the Fed at this point. I'm just looking at static balance sheet, the raising of capital on the market that at a cash ROE that is diluted to the economic ROE.

So if I'm following you correctly, so you're saying it's diluted because the legacy ROE is higher than the marginal ROE, right?

Absolutely right. Yes.

Right. But the rationality for doing so is that if you look at it purely from the perspective of a NIM in your framework, it doesn't make sense. But the way that we would look at it is not just from the perspective of NIM, but the valuation of the assets. So we think that the NIM that you allude to, the 19.5%, that is, if you think of total return is the sum of price appreciation and income, that's purely income, right? So that's assuming no price delta. And the rationale for us in doing so is the expectation that there's the potential for a fairly meaningful price return because we're putting the money to work at assets that we view as historically cheap. That may not come. So let's say that mortgages don't tighten at all for the next 2 years. in which case, you're right, as we raise capital, we will continuously dilute the return, the NIM. That being said, there is potential for price return, and that would cause the marginal return to be higher. And I guess that would be our justification for continuing to do so. We view ourselves as putting money towards. And that's really the reason getting back to the last question, why would you so stop slightly below book. And that's why you think that you have the potential to generate capital price returns that will more than offset any potential dilution from issuing stock.

Just to add, I think there's 1 oversimplification here in that said these gains and losses attributable to the swaps, for example, as you alluded to, the swaps have already been mark-to-market. So those mark-to-market on the swaps that are in the money is going to go from whatever it is now to 0 over the life of that swap, right? So it's going to accrete or it's going to amortize back out of book value. That's, I think, one of the missing pieces to the 28% number is just on a total return basis.

Right, they're going to accrete to 0. The market value impact will accrete to 0 as they approach maturity.

Right.

And that's why I was going to bring up the Fed, not because I'm making a call on the Fed. But if the Fed were to ease to Hunter's point, the value of those swaps would decrease, right? Because there's what the Fed doesn't look at markets pricing of the Fed to do. If you look at the curve, the swap curve, where's the 10-year swap yield? Well, it's a hell of a lot lower than Fed funds. Now the 10-year point on the swap curve is 4%. So the market expects 6 eases on average over the next 10 years. So just the fact that the Fed eases may not do anything. But potentially, if you do get more eases than expected, those swaps start to lose value, but your return on marginal equity goes up because as Hunter alluded to earlier, the NIM on the unhedged position grows.

So I look at that as being a geographic change on your economic income schedule. I mean NIM increase and the swap benefit will decrease and the net benefit to the bottom line should approximate no change. Yes, I was just looking at this and saying, I was looking at the first quarter number where it was such a strong performance, the economic income was such a strong performance relative to the distribution. And then in the second quarter, it was even slightly better, thinking that, that was indicative of the opportunity to address the distribution. But then with the capital being raised is going to cause on the margin that delta to decline in the third quarter and in the fourth quarter. So I just wanted to see what your view on that thinking was. But I appreciate the insight.

I think you might hung up, but just 1 more point on that. And that's the legacy portfolio is largely a lower yielding portfolio. And so what we've actually seen is if we think about marking our portfolio and our hedges to market every day really as far as that goes, but every quarter, our mix of assets want mark-to-market, it doesn't fall out of line with that 180 to 200 basis point economic return that gets us to that sort of high teens type of number. And so as we have added higher coupon production coupons, those have come at a slightly wider NIM than the legacy portfolio. And so if we just think about moving from one quarter where we were marked both on an asset and hedge basis to the next quarter, the recent capital raises have actually increased our blended income earning capacity of the portfolio. Operator, next question... Hello. Operator, are you there? All right. I seem to have lost the operator. I'm assuming that we don't have any more questions. Okay. I'm told that the operator is still on. We just can't see and hear them. In any event, we appreciate your time, thanking for joining us today. To the extent that any other questions come up and because of these apparent technical difficulties you're unable to ask, please reach out to us at the office. The number is (772) 231-1400. Or for instance, you don't get a chance to listen to the call live and listen to the rebroadcast, if you have any questions, you can use that same number to call us. Otherwise, we look forward to speaking to you at the end of the third quarter. Thank you.

And that does conclude today's call. Thank you for attending.