Orchid Island Capital Inc (ORC) 2018 Q1 法說會逐字稿

Good morning, and welcome to the First Quarter 2018 Earnings Conference Call for the Orchid Island Capital. This call is being recorded today, April 27, 2018.

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 under management's good faith, belief with respect to future events and 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. Robert Cauley. Please go ahead, sir.

Thank you, operator. I hope everybody's had a chance to download our slide deck off of our website. As we have in the recent past, the earnings call basically consists of me walking through the slide deck, and then at the end of the -- of those comments, we'll open the call up for questions.

I'll start with Slide 3, which is a table of contents. This is basically an outline of how I'm going to proceed today. As is always the case, we'll start with just a quick overview of our financial highlights for the quarter. And then to really give us an understanding of what happened to -- in the markets, what happened to us for the quarter, how we see things going forward. We'll discuss market developments. Then we'll briefly go through our financial results. We'll touch on the portfolio characteristics, our hedge positions, our funding positions.

And then we'll go through an outlook and strategy section. I'll give a very brief overview of our history simply because I think it's meaningful at this juncture. And then we'll take a look at how we see things going forward and how we're positioning for what we see on the horizon.

Turning to Slide 4, our financial highlights. We had a GAAP net loss of $0.31 a quarter -- per share for the quarter. As usual, this includes our mark-to-market gains and losses. We had losses -- net losses of -- for the quarter of $0.72. This includes premium loss due to paydown under our accounting treatment. We do not use a straight line amortization method. We take all of the amortization of premium through gains and losses and that was approximately $0.093 for the quarter. The net of all this is an earnings per share of $0.41, excluding these realized gains and losses. Book value for the quarter was -- at the end of the quarter was $8.09, that's a decline of $0.62 or 7.1%. We paid dividends of $0.31 for the quarter and this resulted in an economic return of minus $0.31 or 3.6% for the quarter, negative 14.2% annualized.

Now to understand why these results were -- we realize these results and to get a sense of what this meant for us in the market and how we position going forward, I would like to go into the 2 primary markets that affect mortgage portfolios. The first is the rate market, interest rates and swaps; and, of course, the second one is the mortgage-backed market itself.

Starting on Slide 6. On the left-hand side of the page, though this points to one of the two primary developments that took place during the quarter. As you can see, rates were both higher. The red line represents the level of rates on the treasury curve at 3/31. The blue line is at year-end 2017. So you can see that rates moved higher in the case of the 10-year treasury approximately 35 basis points, but that rates were higher on the front-end. If you look at the swaps curve, you can see this development was even more pronounced, especially on the front-end. Some of this was due to some developments in the short-term funding markets. We'll discuss that a little more in a few minutes, but, obviously, rates were higher for the quarter.

Looking more specifically at the 10-year point of the curve on Slide 7. On the left side, you see what happened in the quarter, both in the U.S. treasury -- 10-year U.S. treasury and the dollar swap. Obviously, both were up in the quarter although they both finished below their peak, which occurred in February. But in order to get a little more perspective, we've included slides on the right-hand side of the page, which go back 2 years. And 2 years is a very convenient time period because it shows a lot of meaningful developments that have taken place and gives you a good perspective of where we are today.

In the case of the treasury, as you can see in the middle of 2016, after the surprise Brexit vote, the 10-year treasury closed on June 23rd at the lowest level ever. That's a meaningful statement made for a very challenging market at the time. That started to change in the fall of 2016 with the surprise election result, the Trump Administration came into power. Rates sold off meaningfully. There was a lot of optimism and enthusiasm for the markets. Trump was assumed to be very pro-market. This enthusiasm waned as we moved into 2017, primarily because the Trump Administration did not have much success. Their first legislative agenda item was health care reform and it failed. However, later 2017, things turned around. They passed a tax package and then a funding package early in 2018. The bottom line is that interest rates have moved an awful lot, close to 100 basis points from the low of 2016.

Now let's turn to the Slide 8. We can talk about what I consider the most meaningful of the developments in the quarter, especially so for levered fixed income investors. What we see here on the top chart are 2 lines. The top one is the 30-year treasury and the second one is the 5-year treasury over the 5-year period, basically, the 5 years of our existence, but also a very interesting time frame when you consider what's happened.

Looking at the bottom, you see the spread between those 2 rates. If you go back to 2013 on the left, that's the time of the taper tantrum. The spread in the curve was substantially high, almost 254 basis points. Fast-forward to today, at the end of the third quarter, it's 41. Today, it's much less than that, we're in the 30s. That's a meaningful development for fixed income investors, especially levered investors. That's a decline of over 200 basis points. And developments like that have ramifications.

Turning now to Slide 9, we'll look more specifically at the mortgage market. In the top left, you see Fannie 4s and 4.5s. These were and have been for some time our 2 primary holdings. And as you can see, there were significant price movements. In the case of 4.5s, they went from a mid-$106 price to a high-$104 price. So in our parlance, we say there was a handle -- 2-handle changes, from 106 to 105 and 105 to 104. That's a lot for a quarter. In the case of Fannie 4s, similar developments.

The bottom left, we show the dollar roll market. As you can see, dollar rolls have become quite healthy at the end of the third quarter. This basically reflects among other things the fact that these 2 coupons, while previously being very high coupon premiums are now the production coupons. As a result, there is a lot more focus in the coupons, the cheapest to deliver is of much greater concern to the market, and those rolls reflect that. There are some other developments which affect the dollar market as well, get to those in a moment.

On the right-hand side, we see the pay-up for specified pools. As you can see, it's quite volatile, but one thing I do want to point out in the top right in the case of 85k Max pool is that even though rates at the end of the third quarter were at or near the high of this 5-year period, these pay-ups are not. They've been quite resilient. And they reflect the fact that prepayment concerns are still, these people are willing to pay for them even if realized speeds are quite low. On the bottom right, we see the pay-up for a new security, and this is just really here to give you some perspective of the range and pay-ups for the various forms of call protection from the worst, which would be the new to the highest, which is 85k.

Slide 10, we'll go into some developments in the quarter, specifically. The top, this was a very interesting development that occurred. That was in the short-term funding markets. You see 2 lines there, one is the green line, one is blue. The green line reflects the spread between 3-month LIBOR and 3-month OIS. OIS is overnight indexing swap. It's a proxy for Fed Funds futures. So basically, it's the market's pricing of expected -- the movements in Fed Funds. Typically, these are highly correlated, and the spread is relatively stable. As you see, it moved quite substantially in the quarter, crested at near 60 basis points, has since come off to around 53. And the reason it just did so was there were short-term funding pressures which impacted not just all the short-term funding markets, but mortgage investors as well.

The reason we had so much pressure, several factors were mentioned. On the one hand, the most recent tax legislation resulted in corporations repatriating funds that had been stranded overseas. Those funds were a source of supply of cash into the short-term funding markets to the extent they're repatriated and not lent out anymore, you've decreased the supply of cash. At the same time, the treasury, because of the tax package, is running larger deficits.

The government has opted to fund a lot of that in the short-term treasury bill market, so you had substantial supply of bills or demand for money. In the case of March, it was very high. Most of the bill auctions in March were the largest ever. Of course, that's March. When we move into April, the government is now taking in funds through tax collections. Those bill auctions have shrunk in the short-term -- that one source of short-term funding pressure is removed.

That was very beneficial, the movement in LIBOR for us because we use a lot of Eurodollar shorts, payer swaps and swaptions. And we received 3 month floating back. So that was very beneficial for our hedges.

The second line there is our funding cost. That's repo. As you can see, it also spiked around quarter end. And that had an impact on the mortgage market obviously, because that's how people such as ourselves fund our positions. It crested over quarter end, it's also year-end in Japan, has since come off, never quite got to the extreme levels that we saw in the LIBOR market.

Turning now to the bottom of the page. If you look at the performance of 30-year fixed-rate coupons, 3s, 3.5s, 4s and 4.5s. The data we have here is their performance versus their hedge ratio, using JPMorgan's hedge ratios. As we mentioned, the curve flattened substantially. Shorter-duration mortgages, which are the higher coupon mortgages, did very poorly against our hedge ratios. On the other hand, longer-durated mortgages did much better, in the case of 3s, as you can see. They still had mediocre performance in that they underperformed their hedges, but they did far better than higher coupons.

So what is this -- what is the consequence of this? Well, using data from Goldman Sachs, the agency mortgage market had a return for the quarter of minus 1.6%. That's the first quarter result -- worst first quarter result in over 20 years. We also had a spike in vol during the quarter. Volatility is, obviously, a bad thing for mortgages because we're short a prepayment option. So you had mortgage widening, a flattening of the curve and an increase in funding cost. All these conspired to impact in a very negative way, the mortgage universe.

Now I'll touch on our financial results, Slide 12. On the left-hand side, this is just a decomposition of our earnings per share between realized and unrealized gains and basically everything else, which is the net interest income of the portfolio less our expenses. As you can see, absent the gains and losses of negative $0.72, we earned $0.41.

On the right-hand side, we show the decomposition of our returns, by the 2 sub-portfolios that we run. The pass-through portfolio, as you can see, had a negative return of 720 basis points. Realized and unrealized gains and losses were negative $87.5 million. Our derivative gains of almost $42 million were not enough to offset those, and we suffered a negative 720 basis point loss.

The structured securities, which are our hedge instruments among -- in addition to our rates hedges, generated a positive return of 640, even though that number is relatively close to 720 because the capital allocation was skewed towards pass-throughs, the resulting return was negative 3% for the quarter. As I said, that generally reflects the bias towards pass-throughs.

Turning now to Slide 13, we look at our spreads. Interest rates on our portfolio -- the yield on our portfolio versus our hedged funding costs. If you look at this chart on the far right-hand side, you can see that as of the third quarter of -- the first quarter of 2018, the yield on the portfolio was 427 basis points. That's the highest yield our portfolio has ever had throughout our history. Unfortunately, our funding cost is 203. That's also the highest we've experienced in the life of the portfolio.

So our net interest spread is 224 basis points. If you look to the left, specifically September of 2014, you can see that the spread was 329 basis points. That's the highest we've ever experienced. It's since come down to 224. Looking at the bottom of the page, you see our dividend. Not surprisingly at the time that our net interest spread was the highest, our dividend was a lot higher than it is today. The fact that the dividend has come down merely reflects the decline in the net interest spread in the portfolio.

Turning to Page 14, we'll look at these numbers in terms of earnings per share. The top line, the red line is just the earnings per share, absent gains and losses. And as you can see, it's been declining as the curve has been flattening. Once again, if you go back to September of '14, you see that we earned $0.66 in that quarter. We're now at $0.41. That decline is consistent in relative terms with what's happened to the dividend.

So what have we done to position and to adjust the portfolio to reflect what's going on in the market? On Slide 15, we show you the capital allocation. We'll get into this in greater detail in a few moments, but just to point out some highlights, we've increased the allocation to the structured portfolio, which is the more defensive portfolio from 26.5% to 35.4% and reduced the pass-through portfolio accordingly. The capital deployed in the pass-through portfolio has gone from 30 -- $336.6 million to just under $271 million, and the structured portfolio has gone from $121 million to $148 million.

On the right-hand side, we provide a roll forward. And you can see the beginning and ending values of the portfolio and the components of the changes to each.

Now we'll talk a little more detail about the portfolio both where it is today or as it was at the end of the quarter and where we see it going forward.

On Slide 17, we show you the composition of the assets of the portfolio. Obviously, if you look at the IO component, it's higher. With respect to the fixed-rate portfolio, it really hasn't -- hadn't changed much as of this point in time. The weighted average coupon, which is in the second to the last column the right, was 427 basis points, that's down slightly.

The far right column shows our prepayment speeds. We realized on the pass-through portfolio approximately 7.5% CPR, that's in April for speeds pertaining to March. As you would expect, with rates much higher, speeds are very subdued and our prepayment speeds have remained in the upper single digits for some time now.

Slide 18 just gives you some long-term perspective on our capital allocation. Top left just shows structured versus pass-through and each subsequent slide just breaks that down a little more granularly. That's just some perspective.

On Slide 19, we -- couple of things here, our repo balance. As you can see, we have a number of counterparties; they're diversified. Our funding is very diversified, and also the institutions. We have a lot of domestic institutions, European institutions and Asian institutions. On the right-hand side, we show you the trend in our leverage. As you can see, at the end of the third -- the first quarter was 8.5. Today, that number is about 7.8. So it has started -- this downward trend has continued.

Slide 20 goes through our hedge positions. And with this flat curve, it requires a different type of positioning. And the one primary difference versus maybe where we were in the past is that our hedge coverage ratio, in other words, the notional amount of our hedges versus our funding, is at approximately 100%. So we've been taking steps to increase our coverage. This is just the fact, the fact that rates are higher. And our funding costs have continued to rise and may continue to rise. So our liabilities are essentially covered 100% as of the end of the first quarter.

Turning to Slide 22. As I said, I wanted to give a brief history of our company, not that it's -- I'd like to give a history lesson, but I think it's relevant to gain a perspective of how we see ourselves today given these developments in the market and what they mean going forward. When we did the IPO for Orchid 5 years ago, we were faced at the time in the -- more or less the aftermath of a financial crisis, which had a profound impact on the market. Interest rates were at lifetime lows, had been for some years. The mortgage finance industry had been meaningfully impaired by the crisis. And this meant that the refinance function, if you will, in the mortgage universe was very muted. In other words, borrowers' response to refi incentive was much lower than it had been historically.

And this drove how we positioned our portfolio. By that, I mean, we positioned our portfolio to take maximum exposure to prepayment risk. So we owned a lot of high coupon fixed-rate mortgages, we owned a lot of IOs. Given the fact that the refinancing incentive was so muted, we had very high realized yields with this portfolio. This was particularly the case in the first quarter of 2014 when we did our first secondary offerings. This was at the end of the taper tantrum and rates had risen substantially. So this is when it all started. This is how we positioned the portfolio. And this allowed us to pay a very high dividend relative to our peers. This high dividend stream, which we've had up until very recently, allowed the stock to trade for long periods of time at a premium to book.

Now when you start out as a very small REIT, in our case, less than $50 million market cap, the early phase of growth is the most challenging. Typically, REITs go through this growth phase through very, very expensive secondary offerings, very dilutive offerings. Because of the positioning of the portfolio, that we had a -- and we had a high dividend stream, the stock often traded above book value. This allowed us to utilize our at-the-market program so that we could not only issue stock at a very low cost relative to a secondary, it also allowed us to do so accretive to book for most of that period.

As a result, we were able to grow from a $50 million market cap company to nearly 40 -- $400 million. If you look on Slide 23, you see that the stock, relative to the red bars which represent our book value, traded above book for most of our history. This allowed us, as I said, to take advantage of the ATM. In contrast, if you look at Slide 24, the blue line here is Orchid stock as a percentage of book value, the red line is that of our peers. The peer group is listed on the bottom of the page, it's AGNC, Anworth, Armour, CMO, Cypress, Dynex, MTGE, Annaly and WMC for the most part, traded below book.

As a result, when you look at Slide 25, we were able to raise capital throughout this period -- for most of this period. Other than a short period in 2017, most of our peers were unable to do so. So this allowed Orchid to grow at a time when, by and large, the market was closed to other agency REITs. It allowed us to reach a certain level of critical mass and in a very efficient way, a very low-cost capital. And it allows us to be much better positioned going forward than we probably would have been otherwise had -- we had had the same capital raising experience that our peers had had.

But now let's look and see what the world looks like today. If you turn to the next slide, a couple of things just to summarize what's happened. As we mentioned in the first quarter, the top left, we show volatility spiked. So we had spreads on mortgages widened. Funding costs have risen dramatically. Volatility was at its all-time lows and was -- that was reversed. The term premium in the market is at a multiyear low, near a 10-year low. And we may face the prospect of a continuing flattening of the curve.

So what does this mean? Well, it means that we have to take a look, different look at how we position the portfolio. As I mentioned, our hedge coverage is at 100%. The opportunities in the market are no longer at the long end of the curve. They're more in the belly of the curve or even the 3- to 5-year period, if you will. And so while we hadn't done much of that on the asset side as of quarter end, since then we have 100%. In a moment, I'll give you some of the details of that, in terms of exactly what happened, but the -- suffice it to say that we are repositioning the portfolio to position for this curve environment, which we suspect could be this way for quite a while.

We have very little term premium. Funding costs are probably likely to rise. The curve is flat. Returns are not all that great. We positioned the portfolio accordingly. It has had a negative impact on our earnings, but we're hopeful that we're able to maintain this stream. What are the risks to that? Well, going forward, the curve could continue to flatten. Some of the developments of late that have probably influenced that; growth moderated in the first quarter, not just in the U.S. but in Europe, the spread between 10-year treasuries and 10-year bonds has been -- has gotten quite wide and prospects for growth, at least for now, are somewhat less than they were not so long ago.

If that were to change and growth starts to reaccelerate and that spread in the long end of the curve between domestic and foreign yields start to compress, we could see a move higher in longer-term rates. That might -- would bring with it a rise in volatility, which would be beneficial from our perspective as an investor because mortgages might cheapen up some. That would be a positive development.

On the other hand, if we have a continuation of a flattening trend, it will continue to be a challenging investment environment. So in short, going forward, the shape of the curve will be critical. Mortgage spreads and volatility will be key in determining how attractive our reinvestment opportunities are. In the interim, we have positioned ourselves to do as best as we can in this environment, and we just kind of wait to see how it plays out.

And Hunter, if you want you can give a brief overview of what we've done at the portfolio in a little more detail, and then we'll open up the call for questions.

Sure. So just -- I think we went over some of the details in -- as far as the portfolio change in the first quarter. And I would just highlight that a lot of the focus there was adding negative duration, both in the hedges trying to improve the convexity profile of the portfolio into a rising rate environment. And the substantial increase in our swaption positions were long -- some shorter expiry 1-year and in with tails on the long end of the curve, namely the 9- and 10-year part of the curve. We added a fair amount of IO in the first quarter and into the second quarter. So those are largely -- I think, they are all actually IOs off of 4% coupon MBS. Some of them are jumbo mortgages, some are just -- we bought an excess servicing deal that came out as well.

The focus there as we think while IOs are certainly on the tight end of the spectrum, we feel like the speeds that they've been -- the speeds in the first few months of this year don't reflect what we feel like the speeds will be in the current rate environment. So they're still paying double digits and are now out of the money versus where the borrowers can finance their homes now. So they're not -- no longer refinanceable or at least not refinanceable to a point where it would make economic sense to do so unless you're taking cash out or moving or something to that effect.

So with respect to the rest of the portfolio, the pass-through portion of the portfolio, we've been focused on selling longer duration. Again, bonds that are going to perform poorly into the next 50-year basis -- 50 or 100 basis point increase in rates. As we've sold approximately $565 million worth of securities that we modeled would be decreased by about 5% and up 100 rate shock. And we've replaced those with IOs and short pass-throughs and structured securities to the tune of well, roughly the same amount, $555 million that we purchased versus $565 million that we've sold. The duration on those are much lower. The yield is marginally lower. But the risk-adjusted return, we feel like, is much better. So that's going to be a continue -- where we're going to continue to focus to the extent that we continue to shift the portfolio, it will be in similar types of assets.

The up a 100 shock when I looked at on what we've added versus what we've sold is what we've added, we expect it would be down 1.75% in an up a 100 shock versus what we've sold. As I mentioned, it would be like -- more like down 5%. So that is going to be the focus going forward. I don't want to get into too much detail into what exactly we're buying because we probably want to continue to buy a little bit more of it, but I'll leave it with that and turn it back to Bob.

Thanks, Hunter. Operator, I think at this point, we've concluded our remarks and we can open the call up to questions.

(Operator Instructions) Our first question or comment comes from the line of David Walrod from JonesTrading.

Your leverage, you mentioned that it, I mean, picked up a little bit in the first quarter. And you said it's now more like 7.8. In your written commentary, you mentioned that leverage will continue to come down. Where are you targeting leverage going forward?

We don't have a specific number in mind, but I would say, the high 6s is probably a stretch, probably 7 would be -- that -- we don't really look at it like with a number in mind, it's more with the composition of the portfolio, what's the model sensitivity of the portfolio and then to the extent it has to be tweaked to get it to a number we're more comfortable with, we adjust it. And that involves allocations between pass-throughs and IOs, so to the extent, we added more towards IOs since they're not levered, it will come down. It usually falls out of the allocation decision whereas it's not a specific target where we sit down and say, we're going to get to this number. But I think 7 is probably a reasonable range, plus or minus.

David, you might note that in the presentation, the leverage at quarter end was 8.5. We had, I think, net like $130 million of securities that had not settled, but had already been sold. So the risk, if you will, at quarter end was lower than what's represented here. If we had to adjust that number, it'd be somewhere like 8.1, 8.2.

Okay. Can you give us some thoughts about where book value is today relative to the end of the quarter?

We don't have a specific number, but the positioning that we've taken has shown up in the results. We mark our portfolio on a daily basis, but we're using a pricing service. So those marks are not the same as we might do for quarter end. But so far, I would -- ballparking it $0.05 to $0.10 down.

Okay. And then, I guess, my final question would be your thoughts on the share buyback that you referenced in the -- in your written commentary?

Yes. We would -- we want to use that. It's an efficient use of capital to the extent we're able to buy shares back at a meaningful discount. I don't know where the stock will close today, but in the last month or 2, the stock was trading north of -- comfortably north of 90% of trailing book. And we didn't really view that as all that attractive. We actually expected after the last dividend cut that the stock would trade at a more substantial discount, but it hasn't. So it's on the table. We have an allocation for up to 10% of our outstanding shares. And as the stock trades, I think someone mentioned on our last call, when we first introduced it, they said, what's your threshold, and we were saying something around 90% or high-80s percent. That's probably still the case. The stock as of yesterday was not trading there. It was several percentage points above there. So I guess, the answer is the same. Going forward, we will use it, but we prefer to maximize the benefit of the program by doing it at a more substantial discount to book.

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

As a follow-up to Dave's question, on the buybacks, would you consider doing a tender?

We have not had any discussions in that regard. I think the stock is liquid enough that we can do so with just a typical share buyback program. And I think if it was at a bigger discount, if we were, say, consistently trading at 80% of book and we could do a large slug of stock in one fell swoop, we probably would give that serious thought, but I think the way we're positioned now with the stock trading in the low 90% range of book, I don't know that, that would be worth our while at the moment.

Okay. And then can you give us some idea of what the duration of the portfolio is currently?

Hunter, I think -- as he mentioned, we've done -- since quarter end, we've taken some steps in that regard. I don't know if he has the exact number.

I do. Just one moment. Bear with me, sorry. Looks like -- I'll just speak to the way we have this modeled. So just -- the duration of the portfolio itself is about 355. But when we look at the shocks and -- and again, that's just the mortgage assets. When we look at the shocks, which is what we prefer to do, we modeled that we would be, with hedges, roughly flat in a down-50 and off about $0.20 in an up-50 scenario. So you can get some sense of where not only the duration is, but what the convexity of the portfolio looks like, which is what we're trying to improve into that up-50, up-100 scenario.

Got you. And then given that your 100% hedged on your liabilities, what's your assumption in terms of further rate hikes? Or is it more just thinking about where LIBOR goes?

Well, I'll -- well, 2 points to that question. First of all, LIBOR -- our funding does not track LIBOR that closely. It may have in the past. Certainly, in the first quarter, it did not. LIBOR had its own little -- life of its own. Repo funding today is still in the mid-190s. Is that for 1 month?

Yes.

And 1-month LIBOR is about 190. 191 today, actually. As far as rate hikes, I mean, it looks to us like it's probably going to be at least, 2, probably 3, I think, in the meeting next week, even though they probably won't take any -- there won't be a press conference, they won't hike rates, but I wouldn't be surprised if the wording of the statement tried to prep the market for how they view the rest of the year. Certainly, we'd expect them to hike in June. The key will be, is there anything in that language that leads you to believe it's 3 more hikes versus 2. We're probably leaning towards 3.

A little more uncertainty with respect to next year. There may be some cracks in the wall a little bit. Some of the data in Europe has been -- actually, a lot of the data in Europe has been consistently weak. A little bit of stress in the corporate bond market and so forth. Are these the kind of things that are going to cause the Fed to slow down? But certainly, for the balance of the year, 2 to 3 hikes, I think, is a very high probability.

Great. Final question, given that you're migrating more and more towards the IOs, I presume that you're just assuming that we're going to see a flat, continued flattish but rising yield curve, slowing prepay speeds. I mean, anything else here?

No. I mean, the one caveat, and what we saw is -- actually, starting mid-last week when the steepener took place, does that reflect fundamentals or does that reflect the fact that the market has flattened so much so quickly? I think it was more the latter. What could cause things to -- cause the curve to resteepen? You'd certainly have to see the data strengthen appreciably. I think you'd start to see inflation data, mid-2% go well beyond that. That might cause a volatility to spike up a little higher, which is good for reinvesting. But absent those things, I think you just kind of grind this way. I don't know that the curve necessarily inverts this year, but it's -- could continue to flatten and move higher.

Don't forget, I mean, we just talked about fed hikes, 2 to 3 hikes. I mean, the 2-year has been on a very steady increase for quite some time now. It's perhaps 250, probably on its way to 3. The 7-year is not far from 3% itself. So what does that mean for the 10-year? Everybody's hyper-focused on the fact that it broke through 3. And some people think this represented a double top, and we're going to rally from here. Well, if you're going to rally meaningfully from there, it's not going to be far before you see initially 7s, 10s then 5s, 10s invert. Because that -- the Fed looks awfully hell-bent on raising this year, and that's going to drive the front-end of the belly of the curve, higher still. They're not that far from 3% as we sit here today.

So is the 10-year going to meaningfully rally? I think it's just going up because it's being driven higher by shorter tenders, frankly. So I would not be surprised if it did hit 325. But that still could be a relatively flat curve. And who knows, we may finish this year with 2 years, 10 years and 30 years, all with a 3-handle. But -- so it's not going to be a great investment environment, it never is. We field calls from investors and people -- what happened to the dividend? You say, well, REITs are a countercyclical stock. They tend to do well when the economy is not doing well and vice versa. Well, the economy is doing very, very well, and the Fed's aggressively raising rates, so it's going to compress our earnings potential. We position as absolutely best we can for that, otherwise, you wait it out and wait for the next cycle, down cycle and then the Fed eases and the curve steepens, and it's a phenomenal investment opportunity.

I would just -- specific to the IOs, I would just add that, when we reach the point where we feel like the value has been fully extracted out of those positions, we won't hesitate to sell them and reduce our exposure to that sector. Right now, we feel like there is fair value in them because speeds are continuing to decline. But as we sit today, 90% of the mortgage market is not refinanceable. So we think throughout the summer and into next fall, we'll see a continuing decline in speeds that should be supportive of that position. But once they have no upside left in them, we'll focus our upward rate hedges on a different type of product, and we can use interest rate derivatives or some other form of protection.

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Thanks, operator. Everybody, thank you for your time. To the extent you have a question that comes up later, or you didn't have a chance to listen to the call live and you want to ask a question, please feel free to call us. The number here in the office is (772) 231-1400. Otherwise, we look forward to speaking with you next quarter. Thank you.

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