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

Good day, and thank you for standing by. Welcome to the Orchid Island Capital Third Quarter 2026 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Melissa Alfonso. Please go ahead.

Thank you, [ Didi ]. Good morning, and welcome to the Third Quarter 2026 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, October 23, 2026. 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'd like to turn the conference over to the company's Chairman and Chief Executive Officer, Mr. Robert Cauley. Please go ahead, sir.

Thanks, Melissa, and good morning, everyone. As usual, we've posted our deck that we will use for the call on our website. I hope you've all had a chance to download it and look it over before we begin. As again, as I've said, we will be using this for the call. We will not necessarily cover every slide in the deck, but we do try to provide as much information as we can, and we will highlight the slides that we think are the most pertinent for purposes of Q3 earnings and our outlook for the markets going forward. Starting on Slide 3. This is just a table of comments and overview. The first thing we will do is just go over our financial results. Jerry Sintes, our Controller, will handle that. I'll then talk about market developments kind of split evenly between a quick summary of what we saw in Q3 and then an equal amount of time looking at what's happened since quarter end and kind of our outlook for the markets going forward. And then Hunter will talk about our portfolio characteristics and hedge positions, discuss some of our trade highlights that we did for the quarter and maybe since quarter end and our outlook, and then we will have our usual Q&A session. So with that, I will turn it over to Jerry Sintes on Slide 5.

Thank you, Bob. I'll start with the financial highlights for the third quarter. Net income, we posted a net loss of $0.90 per share in Q3 compared to net income of $0.44 in Q2. Book value at September 30 decreased to $6.02 per share compared to $7.22 at the end of Q2. Total return for the quarter, inclusive of dividends declared, was negative 12.5% for Q3 compared to a positive 6.2% during Q2. And we declared a dividend of $0.30 per share during the quarter, which was consistent with Q2. Turning to Page 6, the portfolio highlights. During Q3, we had an average portfolio size of $11.1 billion compared to $11.4 billion in Q2. Our leverage ratio at September 30 was 8.6x compared to 7.3x at June 30. 3-month CPR during the quarter was 8.4% compared to 10.9% during Q2. And our liquidity during -- at the end of Q3 was 44% compared to 54% at the end of Q2. With that, I'll give it back to Bob.

Thanks, Jerry. I'll start on Slide 9. And as I said, just give you a quick overview. I'm sure since we're kind of the last of the peer group to report this week, you've heard quite a bit of this already. And obviously, the big story in Q3 was this material sell-off in the rates market that occurred right at the end of the quarter, driven by many, many factors: inflation, capital with AI and sovereign debt issuance driving up borrowing costs and risk premium and several other factors. I don't need to dwell on that too much, but we did see a very substantial sell-off late in the quarter. And since quarter end, we have actually changed. First off, I think we stabilized. We saw evidence of that last week. Probably driven by the fact that the market positioning [ had ] gotten extremely short. A lot of the selling we saw in the market was driven by mortgage investors such as ourselves, hedging convexity related extension of the assets that we own. I think that all kind of ran its course, and the market just seemed to stabilize. I think we just basically were collectively so short, really good. It was hard to have an impetus to drive further selling. In fact, last week, we had very strong CPI and PPI data that came out, which would -- 3 weeks ago would have caused another leg lower in the market, but we did not have that at all. This week, we've kind of had a pretty meaningful change, not only has the market stabilized, but 2 things stick out. One, we've seen this very high correlation between oil prices and rates where oil -- higher oil prices lead to higher rates. That broke this week and particularly yesterday, where oil was up quite a bit and rates rallied quite strongly. The other thing that we've seen this week, which is a change from what we've seen really for the last 2 quarters is kind of the safe haven status of the U.S. treasury market, where a lot of the turmoil that's taking place in the Middle East, in Europe and so forth has led to people buying treasuries. So like I said, yesterday, there was a lot of AI-related issues in the equity markets and credit markets. We had oil higher. We had political unrest in areas in Europe and then developments in the Middle East, and treasuries rallied very strongly. No doubt, a lot of that was short covering. In fact, color today from the market would imply that CTAs are a lot less offsides, if you will, no longer have the extreme positioning they had. CTAs are commodity trading advisers that trade in futures very actively. They tend to be kind of a form of fast money, if you will. And they were very active in the market yesterday in all likelihood, covering short. So we had a very significant rally. It since petered out today. Don't know what will happen in the next few days. But we've definitely seen a change in the rates market from what we saw at the end of Q3. So that's a very significant development. Slide 4 -- or Slide 10, rather, I don't need to spend a lot of time on this. Just looking at the mortgage market, I'll just make one observation. This is just a proxy for the attractiveness of the asset class, the current coupon mortgage spread to the 10-year treasury. And obviously, in the period after COVID, we had this several year period where the mortgage market performance was driven by the Fed, either it was QE or QT, and that's ended now. And so I think it kind of -- we have enough data points, if you will, since that ended where we can look at mortgages relative to the period prior to that. And if you look at this chart, you can see the period up to COVID where we traded in a relatively stable range for a large number of years, and we're now north of that. So I think the asset class does look attractive. We'll talk more about that later in the call. We have had some tightening this week, but they still look attractive, and returns in the market are still quite attractive. Moving on to Slide 11. As you can see, we've had another spike in vol associated with the sell-off late in the quarter and the meaningful mortgage underperformance. And if you look down below that, you can see we tend to have a lot of these episodes. They are obviously very detrimental for mortgage performance. The current one seems to be abating, but it seems that we're only a few months away from the next one. The next slide, I think, is pertinent for us because when we get into a discussion of what we did with respect to the portfolio, we, like our peers, opted to not do a lot of widespread selling. Instead, we had modest selling and let the prepayments run off and instead address these sell-off by adjusting our hedges, both the notional amount of the hedges and the duration of those hedges. Obviously, we all know, as rates sell off, mortgage cash flows extend, the duration of the asset extends. So when we added to our hedge position, we did so with longer duration assets. But also, if you look to the left, it's not as evident here how much has happened in the swap spread market. We saw swap spreads widening. But if you look back a little further, they're kind of at the wider end of the range that they've been in. And as a result, we wanted to do our hedging in the futures market more so than swaps just because swap spreads have widened so much. So if you look at the right side, you can see that the mix, the orange piece of the pie, if you will, which represents futures, has grown quite a bit. So we opted to change the mix in the hedges somewhat. We also took the hedge coverage from a pretty high 91% going into the quarter to 99%. But as I mentioned, most of the change was in the futures market, less so in swaps. One -- next slide, 13. Just one quick point. If you look at the top right, the primary, secondary spread, we see a pretty significant tightening trend there. And I think what's driving that, if you look at the left side chart, you can see, one, the red line, that just is mortgage rates. As we all know, they're up in the mid-7% range. And not surprisingly, the refinancing activity associated with such a high mortgage rate is quite low. So it seems to be that mortgage originators may be giving up some profitability in order to maintain origination levels. As we enter into the typical seasonal slowdown with very high mortgage rates, very low affordability. It's a challenging market for that sector, for the originators. We did see last night, for instance, President Trump, signed an executive order, another step taken to try to reinvigorate the housing market, which has been struggling so much in the current rate environment and also not to downplay at all, but affordability, housing prices are quite high. So the combination, money is expensive, homes are expensive, and that makes for a very challenging market. That's pretty much it. For the macro outlook, I'm going to turn it over to Hunter, and he can go through the portfolio developments, and then we will go to our Q&A. Thank you.

Thanks, Bob, and hello, everyone. I'd like to add a little more context to Bob's comments regarding the performance of our portfolio and the hedge book during the third quarter and October month-to-date. Following a strong second quarter when we generated 6.2% total return, performance in July as the [ 10-year rose ] about 20 basis points, and our book value declined roughly 5%. We continue to see a familiar pattern in that month in which higher rates, wider spread environment and type of environment we've experienced over the last several quarters during those types of moves, we tend to see [ belly ] and lower coupon mortgages underperform and premium coupons outperform on a relative basis, although in July, both sectors widened relative to our hedges. Performance improved in August as interest rates were largely unchanged. Mortgage spreads recovered a little bit, and we regained approximately half of July's book value decline. As we moved through August into early September, the 10-year treasury yield broke above its recent trading range, climbing into the 4.70s and approaching 5%. Throughout this period, we steadily extended the duration of our hedges, particularly through longer-dated treasury futures, as Bob alluded to, as the duration of our mortgage portfolio increased. This allowed us to maintain a relatively flat interest rate risk profile despite substantial extension in our underlying mortgage assets. The sell-off remained relatively orderly through the first 10 days of September. That changed with a sharp increase in rates and volatility, combined with significant widening in the mortgage basis, triggered some convexity related selling -- or convexity related hedging, I should say, and forced selling by some of the more highly levered investors. Specified pools had held in relatively well until that point, supported by strong demand from dealers creating new CMOs in the preceding months when rates were lower. However, as rates moved higher and selling pressure increased in the CMO floater market, that source of demand slowly -- slowed considerably. This put additional pressure on higher pay-up specified pools, particularly low loan balance in New York geographic collateral, where we saw a meaningful decline in pay-ups relative to TBA. During this period, we made some moves. We executed a 15-year, 30-year coupon swap. We unwound our 3-month into 5-year payer spread swaption trade that we put on in the prior quarter, near max value, realized approximately 200% return on the premium paid. And we added short positions in 7-year, 10-year and even 30-year treasury futures. Market conditions remain stressed into the second week of October but have since begun to improve. This improvement has been reflected in our performance, with book value increasing approximately 4.5% month-to-date through yesterday, October 22. Since quarter end, we've made several adjustments to the portfolio and hedge book. We've replaced $1.6 billion of short-dated swaps with an equivalent amount of DV01 and the 10-year treasury futures. We've sold some low pay-up 30-year 5 specified pools against a TBA short position that we had established at the end of the second quarter when implied funding levels on the rolls were quite higher. And we bought back our 1,500 contract ultra 30-year treasury future position that we had sold in September -- or that had matured in September. Throughout the third quarter and October month-to-date, our primary focus has been on maintaining liquidity and a relatively flat interest rate profile. At the same time, we repurchased 6.62 million shares since the end of the second quarter, taking advantage of the substantial discount to book in the stock while maintaining a competitive expense ratio and avoiding dilutive equity issuance. Looking ahead to the fourth quarter and next year, we'll continue this disciplined approach: We expect to reduce hedges as rates rally, add mortgage assets as market conditions and leverage normalize and look for opportunities to improve portfolio carry as relative value opportunities emerge. Our taxable income estimates remain in line with the dividends paid year-to-date. More recently, a modest increase in asset yields has contributed to some improvement in our taxable net interest margin. While the recent repricing of mortgage assets negatively affected book value during the quarter, it has also improved the prospective returns available in the market. At current leverage levels, we believe the portfolio is capable of generating returns on equity in the high teens with somewhat higher prospective returns available through new investments or selective portfolio rotation. Our economic returns on shareholders' equity for both the quarter and the year have rivaled those at the top of the pure agency peer group without the benefit of any accretive equity issuance. With our shares trading at a discount of more than 20% to estimated current book value as of October 22, we continue to view share repurchases as an attractive use of capital alongside opportunities to invest in additional mortgage assets. And with that, I'll turn it back over to Bob.

Thanks, Hunter. Very good summary. I think, with that, we can turn the call over to questions. Operator, Didi, you can field the first question.

[Operator Instructions] And our first question comes from Doug Harter of BTIG.

I just wanted to clarify the book value update that you gave and how that factors in kind of accrued earnings or the accrued dividend.

4.5% through yesterday, and it does include or exclude the dividend, if you will. So it reflects the dividend -- I'm sorry. It reflects the accrual of the earnings, the dividend.

So that's like an economic return number?

Yes, yes.

Okay. Appreciate it. And then can you just talk about your thought process and kind of how you weigh the decision to buy back your stock at a discount, which you guys clearly did last quarter? And how that compares to the attractiveness of kind of buying additional assets?

Well, we always -- it's just a number, right? You're looking at returns on marginal investments versus returns on buying back the shares. We're at such an extreme discount now. As Hunter mentioned, we're comfortably below 80% of book. So it's a pretty attractive return. I mean, that being said, we did 6.6 million shares. That's not a huge number, and it was something we will continue to do. But I think, as Hunter alluded to, I would think, going forward, given what happened late in the quarter -- and by the way, the number we quote, a lot of that share repurchase activity had occurred before the last, whatever, 5 or 6 days of September. So we have done some in the fourth quarter. I think it's about [ 1.7 million ]. That's just when the stock was extremely cheap in the midst of all the turmoil. But the sector is attractive, and we'll probably -- as I think we mentioned, we had not reinvested paydowns during Q3. We will cease. We will start reinvesting paydowns. And we may actually add some assets just to kind of take advantage of the additional -- the changes to the hedge book, I think we can accommodate that. So I would probably -- it's going to be a mix of asset acquisition and share buybacks just depending on what more -- looks more attractive at the time.

I would just chime in that...

Sorry, go ahead.

Sorry. No, I was just going to chime in that there's certainly some assets in the portfolio that look more attractive than others, and there's still a few things that are on the tighter side. And so we have a little bit of room to -- we have room to shed some of the tighter things and either reinvest the proceeds from that in stock buybacks or reallocate or rotate into asset classes that are -- or coupons really that are more attractive. And I just wanted to clarify on the book value question, the dividend has been removed from shareholders' equity. I got a little confused in that one.