Orchid Island Capital Inc (ORC) 2021 Q3 法說會逐字稿

Good morning, and welcome to the Third Quarter 2021 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, October 29, 2021.

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. I hope everybody's had a chance to download the slide deck that we put up on our website last night because I will be, as usual, following the slide deck as I go through the process of the call. And then, at the end of the call, of course, we will open up the call for questions.

First of all, just to kind of give you an outline of how we'll proceed, it's very much the same as it's been in the past. We'll start off with the financial highlights, go through the market developments to give you some background, help you understand our performance and positioning, then go through our results in more detail. Finally, we'll go through the portfolio hedges and assets, and I'll give you [the great] understanding of our positioning.

With respect to our financial highlights, Orchid Island generated net income per share of $0.20. This was net income of $0.22, excluding realized and unrealized gains and losses on our RMBS assets and derivative instruments, including net interest expense on our interest rate swaps. The loss of $0.02 per share from net realized and unrealized losses in RMBS and derivative instruments, it does include interest rate swaps [interest], as I mentioned.

Book value per share increased $0.06 from $4.71 to $4.77, and the company declared and subsequently paid $0.195 a share in dividends. Since its public offering, initial public offering notice, the company has declared $12.31 in dividends per share, including the one declared in October of this year. Total economic gain of $0.255 per share, or 5.41% for the quarter, that is not annualized.

Moving on to Slide 3 and 4, this is, as always, we present our performance versus our peers. On the first slide, we show our results using the stock price of Orchid Island and our peers through September 30, and we're calculating total return using stock price and dividends paid. The bottom of the page, we show our peer groups and AFG somewhat over time as different entrants are coming on into our space.

The second page just shows you the same numbers only using full value for purposes of calculating total return, so it's the change in book value plus dividends paid. Again, it's shown with a 1 quarter lag simply because we don't have all of the results of our peers for the third quarter, although I will add that, based on the early results that we have, it looks like Orchid has had a very solid quarter. Again, these numbers are presented both on a look-back as of the end of the second quarter, and then for each of the various calendar periods.

Moving on to the market developments. I just want to pause and just, again, reiterate why we do this as opposed to just going through our results and giving a description of our positioning. The purpose of going through these market developments the way we do is we want to give you a deeper understanding of why we had the results that we had, or why we're positioned the way we are and how we see things, going forward. So that's why we spend time on the market developments, because we think it just gives you a deeper understanding about how Orchid's doing.

So moving on again to Slide 8. This slide is the same slide we use every quarter. It just shows you a snapshot of the various curves of both the nominal, or the cash curve on the left and the swap curve on the right, and then, of course, for Q1 as well.

And as you can see on the left-hand side, or the right; rates, at least based on this snapshot, do not appear to move at all. The only movement at all really in this quarter was a flattening of the curve. So if you look, for instance, at the 5-year point of the curve, you can see that rates increased in the long end, flat and went down. So we had a meaningful flattener here, and we'll talk about this a little bit more in detail.

But I want to just say something about this. Well, even though, on a snapshot basis, it looks like nothing really happened, if you look on the next slide, [typical] top left, you can see that rates actually for most of the quarter, were lower. So even though we ended the quarter with the rates unchanged, most treasury benchmarks hit their low yield for the year during this quarter. And the reason is, is that we have the emergence of the Delta wave the pandemic, and (inaudible), of course, was very severe. And when it first emerged, nobody really knew just how severe it would be, and the market reacted, as you would expect, in uncertainty with respect to the impact on earnings.

And I want to draw a contrast between Q3 and Q4, and I think it's a very important one. When the Delta wave emerged, as I said, obviously, it's a very bad development, and it caused a lot of uncertainty. But I would think it's safe to say there was a very strong consensus in the market that, once the Delta wave was behind us, and once the various forms of supplemental unemployment insurance and so forth were behind us in September, but the market and the economy was really poised for strong growth. I think there was very strong belief in that. And it was just a matter of time before, once this Delta wave moved past us, that we would resume very strong growth, and particularly wage growth. And the Fed had talked about the transitory nature of inflation, and they thought that, once the pandemic got behind us and we had the labor shortage go away, that inflation will go away, as well.

Well, that was Q3. So now, let's fast-forward to where we are today. And as you can see, rates were moving up at the end of the third quarter. And the reason is, is that because people started to realize that maybe this wasn't going to be the case as we initially thought. For one, the Delta wave isn't gone, but it's certainly in retreat. And all of the various supplemental unemployment insurance measures are gone. The foreclosure moratorium is over, but we really haven't seen jobs really increase. Now, we may see more next week, but so far, they really haven't come back as quick as we thought.

And also, just growth in this quarter has steadily, in terms of expectations, declined. At the beginning of the quarter, expectations were that the third quarter would have fairly strong growth. Yesterday morning, we found out it was only 2%. And while there might be some rebound into the fourth quarter, I think there's a lot more uncertainty with respect to 2022. So that is a very meaningful change, I think, in the longer-term outlook or medium-term outlook, if you will, that's taken place over the course of the quarter.

And the other thing I'd mentioned is inflation. The inflation that we're seeing now, including the data that was released this morning, is certainly challenging the transitory nature of inflation. It's starting to look like it's going to -- if it is transitory, it's going to be transitory for longer. So it definitely looks like it's going to expand well into Q4 and probably into next year. And if you listen to earnings calls, not by mortgage REITS but by the other companies in, for instance, the S&P 500, they all tend to echo the same theme, that they expect inflation to be with us for quite a while.

Now in the U.S., the U.S. is maybe not exactly the same as the rest of the world. For instance, our energy intensity, which is a measure of how much energy prices impact our economy, has moved down over the decades. Back in the '70s when the price of oil went up and had a very devastating impact on our economy to cause inflation to go higher, but now cars are more efficient. We're much more energy inefficient (sic) [efficient } as a country. And therefore, the impact of higher energy costs on inflation in the U.S. are not as severe as they were. That may not be quite the case around the world, certainly what we've seen from Australia this week, Canada, England, the U.K. Central banks in particular there are responding quite strongly to very high levels of inflation.

So inflation has definitely become the preeminent story, and these supply shortages of goods and labor are also persisting much longer than we expected. And so starting to really factor into the growth outlook, not just for Q4 but into 2022. So that's important, not just for our immediate results, but it does matter for us in terms of positioning, because we view this uncertainty as a reason to continue to position the way we are defensively in nature and basically waiting for the resolution of some of this uncertainty before we, for instance, maybe raise the risk profile of the portfolio. So we'll talk a little bit more about that and (inaudible). So anyway, that was what we wanted to draw from that.

Slide 10, if you just look at this slide, it really just captures the slope of the curve. And really, what you're seeing is a convergence between the yield on the 5-year treasury and the 30. The 5-year treasury is historically the most sensitive to changes in the direction of rates. So in this case, the market is expecting short-term rates to go higher and sooner. And so you see the 5-year react. Typically, the long end of the curve is most sensitive to inflation, and we certainly see that. Why it's moving the way it is, that's a bit of a quandary. There's 2 rationales that I've seen floated, one by an economist that we follow at Cornerstone Macro. And the view expressed there was that, if the Fed is going to tighten more and sooner, then maybe the terminal funds rate will end up being lower, and that explains why longer-term rates have come down.

And the other one, it may just simply be the massive international global capital flows that we see, especially in the rates market, sometimes can cause movements in the long end of the curve. It don't really jive with what's going on with the domestic economy, but these can, in fact, and do often drive rates. And so we've seen, especially this week, meaningful moves day-in and day-out on the long end of the curve. It don't necessarily appear to be being driven solely by domestic events. In any event, whatever reason, we are seeing a flattening of the curve. And again, for levered bond investors such as ourselves, that gives us some cause. We need to pause; that is, we need to see how this ultimately shakes out.

Moving on Slide 11 in respect to the mortgage market. As I mentioned, just want to remind you that we were defensively positioned coming into this quarter, defensively positioned at the end of the quarter, and will be for now. If you look at the performance of the mortgage market on the top left, we basically just show you the performance of the various 30-year coupons. What we do here is we normalize their prices as of June 30, marked each at 100 and just show you the change in their prices over the course of the quarter. And as you can see, mortgages did well towards the end of the quarter. Rates started to move higher, and it became clear that the Fed was about to taper their asset purchases, specifically in the 22nd of September Open Market Committee meeting when the Chairman made it quite clear that a taper into their asset purchases was on the near-term horizon. And you can see Fannie 2s and 2.5s fell off in price, and that probably reflects a combination of those 2 factors.

With respect to rolls, the top 2 lines, the red and the blue line, just show you the strength of the roll of those 2 coupons. The Fed is still very much involved, and those rolls are quite strong. In contrast, higher coupons are soft. The Fannie 4 roll has been negative. The Fannie 3 rollout's had a few spikes. It's generally been negative. The key change there is that green line, which is Fannie 3s. The perception now is that, as rates backed up, that perhaps a 3% coupon will enter the production window and, therefore, enter the Fed purchase calendar.

And so, as a result, you've seen a move-up in that roll. And that has, in turn, affected the spec market on the top right. I apologize. This chart's kind of cramped. It shows you 5 years of data. But as you can see on the right-hand side, pay-ups got quite high through the course of 2020 and then collapsed during the first quarter, and then we [recovered] during the third quarter when rates were lower, and then finally have fallen off at the end. And that reflects both rates being higher and, again, roll, especially in some of the higher coupons, in particular 3s being a little stronger. And as a result, we did see some softness in those pay-ups toward the end of the last quarter.

Moving on, Slide 12, just a snapshot of vol, looks relatively benign here in the course of the third quarter. But over the course of the fourth quarter, it has definitely picked up with a lot more uncertainty in the market, and especially with respect to central banks, timing of rate hikes and so forth. So we've seen vol pick up.

Finally, on Slide 13, these are just OAS levels. If you noticed on the left, you can see the production coupons, 2s and 2.5s are still quite rich. And for us, that just means that it's not the right time for us to start to meaningfully increase our allocations there, especially with the prospects of not only just tapering, but potentially the pace of tapering could change to the extent the Fed had to alter their plans with respect to rate hikes. So the combination of those 2 are causing us to kind of stay away for now.

I'll just make one comment. If you look at some of these lines here, you can see there's a sharp drop all of a sudden. That's just because the model that we use, which is Yield Book, updated their model, and it caused a lot of these OAS levels to drop. And that's it for that slide.

Just some more bigger-picture comments on the markets as a whole on Slide 14. Just want to draw a few conclusions from this. The top chart just shows you the quarterly returns. On the left-hand side you see most of the fixed income markets, mortgages, treasuries and so forth. And you can see the returns for the quarter were very, very modest, basically 0, very much unchanged.

If you look at the right-hand side, riskier assets did better. But the one that really stands out is the TIPS market. And you can see the TIPS market had a very strong quarter. And basically, what this reflects is people demanding more protection for inflation. So they're buying TIPS. They're building up their prices. Yields on nominal treasuries only increased modestly. So as a result, real yields declined quite a bit in the breakeven, the difference between the 2 increases. So a very strong quarter.

With respect to the year, if you look at the bottom, you can see most of these sectors of the fixed income markets are slightly negative. It's clearly the riskier assets that have done well. And I guess the takeaway from that is, at least for the first 10 months of the year, risk has done much better than haven assets, or low-risk assets.

Moving on to the refinancing activity, which, of course, is very important for us, the top left, we show the refi index versus the average mortgage rate. And what you've seen here, and what you're seeing in Q4 so far, is the conversions of those 2 lines. The refi index has remained subdued, and mortgage rates are creeping higher. The bottom chart just shows you the percentage of the universe that's in the money versus the aggregate refi index, and these both are trending down. Finally, I'd just say the primary secondary spread seems to have kind of reached a floor. I don't know that there's much room for that to improve. I think that originators have basically extracted all the efficiency they can [out of] the process, and those spreads seems stable.

Now going to our financial results. Just to go through those in a little more detail on Slide 17, as we always do, we show our results decompose between just the returns to the portfolio less our expenses. And in the middle column, we show our realized and unrealized gains.

A couple comments. You can see that we had some unrealized losses of a little over $11 million on the mortgage portfolio. That really just reflects a very modest movement in rates coupled with some softness in spec pay-ups. We still do, as we have since the first quarter, have a large allocation to spec pulls and no real exposure to TBA rolls. So as pay-ups were soft at the end of the quarter, that's reflected there. The hedges just reflect a modest increase in rates. So the net-net of that is a slight decrease. That's the $0.02 that we mentioned earlier.

And then, as far as returns for the quarter, as you can see, the pass-through portfolio had a very not-strong quarter. NIM did very, very well, reflecting a combination of an [upping coupon bias] and very low realized speeds. And I would also note that, and we'll say a little bit more about this in a minute, but our allocation to structured assets, and particularly IOs, did very well this quarter. We are using those for a number of reasons, but one of the benefits, obviously, is that they generate positive returns, positive carry. So it's nice able to get positive carry out of our hedges.

Finally, couple of more slides here before we get into the real nuts and bolts of the portfolio. Our NIM is reflected on Page 18. I just want to point out, it's remained stable. The yield on our assets have declined ever since really the onset of the pandemic, finally seemed to stabilize and bounce a little bit this quarter. Our funding cost, which reflects the effect of our hedges' continues to inch down. The net effect is that we've got a very stable NIM, and we have a slight uptick for the quarter. The near-term, I think it looks well for the balance of the year. I'll say why in a moment here.

Just moving forward, Slide 19, really don't need to say anything about this. This is just historical information, and frankly, is Slide 20, as well, just shows you kind of basically, [in picture], how we run the portfolio versus our peers.

Now let's get into a little more of the details of the portfolio. If you look on Slide 21, this is our capital allocation. What I want to point out is, obviously, we had a fair amount of capital raising this quarter as a result using our ATM. And as a result, the portfolio increased by approximately 22%. While that did increase, we also increased our allocation to IOs. It increased by approximately 3% in percentage terms, but in dollar terms, it increased by almost 50%, 48% or so. So we've continued to add IOs as a hedge instrument. As we mentioned, we see the Fed tapering on the horizon, so (inaudible) 0 probability that it could be a little faster than maybe the market expects. As a result, you would expect mortgages to be a little soft. And we think IOs 1 are a good hedge for [up-rates], but also maybe a little less sensitive to mortgage basis widening, and that's why we've increased that allocation. The right-hand side just shows you the roll-forward of the various sub-portfolios.

Now turning more to the portfolio, Slide 23. You can see that, while we don't have last quarter's slide deck, I will point out that as we've grown the portfolio, increase the size, it's generally stayed the same in terms of this layout in terms of coupons and allocations. The 3% coupon remains our largest concentration. For instance, the weighted average coupon on our 30-year portfolio is 2.96. It was 2.97 at the end of the second quarter, so essentially unchanged. The [wall] of the portfolio is actually lower than it was at the end of the second quarter. So even though we've had the passage of 3 months' time, the portfolio is actually [lower overall], and that just reflects the fact that we've added a [little wall] assets to the portfolio, and we have slightly upticked the allocation to specs.

One thing I do want to point out is, if you look at that 30-year line, we have nearly $4 billion in market value exposure, and those assets prepaid for the quarter at 7.6% CPR. That's lower than turnover. Very, very good outcome. The yield being derived from that type of asset with that type of dollar price is somewhere in neighborhood of 2%, and funding costs, even hedge funding costs at around 50 basis points. That's very nice NIM. I did mention that we increased the allocation to IOs. We have more line items here, and I'll talk about our hedges in a moment. And then after the call (inaudible), I can give you some more detail on how we've selected the various IOs we have.

Slide 24 just shows you the slight uptick in the allocation of the specs. We historically have owned specs in lieu of TBAs, and the higher-quality assets we've added, generally [New York storage] or lower loan balance, did uptick slightly this quarter.

And then, finally, on Slide 25, this is really critical for us. This shows you in particular this 3% cohort. If you looked at each month presented here, September, August and July, or the quarters looking back, you can see that our allocation to that sector has done very, very well relative to the cohort as a whole. And that's a combination of those low realized speeds and the higher coupons on the asset are what generate the net interest margin that we are able to do, and that really is what drives our economic performance and dividend.

Slide 26, again, it's just more historical information. It just shows you that speeds, which are the green line, have remained very subdued. They're much lower than they were even in 2019. So even though we've been in a predominantly much lower rate environment, speed has been well. Maintain in the near-term, our outlook is favorable, with rates slightly higher. And the seasonal, I would expect speeds to, if anything, be slightly lower for the next few months.

The next slide just gives you our leverage. It does look like our leverage dropped. That's somewhat misleading. Technically, as of 9/30, our leverage ratio was 7.2. But as I mentioned, we've been raising capital through the ATM. It was somewhat backloaded in September. We took in a few big chunks of cash towards the end of the quarter and deploy those in the monthly auction cycles in very early October. So we added another turn of leverage since then. And really, since regs settle for 30-year mortgages in October, our leverage ratio has been around 8.2%. So it is still flat. That being said, as I mentioned, we are generally defensively positioned. And given the uncertainties surrounding outlook, we anticipate continuing to do so. So that leverage ratio will probably stay somewhere in the low to maybe mid-8s.

And then finally, our last slide is on the hedges. We have had some changes since quarter-end. This table depicts simply the look-back between June 30 and 9/30. But since the quarter-end, we have added some TBA shorts. We've added some long and shorts in the future space in the 10-year ultras. And then, with respect to our swaptions, we did basically restructure some of those, increase them in size, raised the strikes on those, and the maturity dates were extended. We did a lot of that just by taking some profits and building those positions.

So the hedge book continues to grow as the portfolio does, as well. Just one general note, though. I would say that we are relying much more on IOs and swaptions and, to a lesser extent, futures to hedge versus swaps. Swaps obviously will have a direct impact on our funding cost in terms of paying fixed (inaudible) until the Fed starts to [hype]. So the hedge allocation's been mostly in swaptions and IOs and, to a lesser extent, futures versus swaps.

And that's about it. With that, I will open up the call to questions. Operator, we can take any questions you might have.

(Operator Instructions) Your first question is from Jason Stewart from JonesTrading.

I wanted to start with the funding cost and your outlook for the fourth quarter. There's a couple of markers on the horizon, and we typically see a little bit of pressure going into year-end. What's your expectation for just overnight repo, not considering swaps, but have we seen the bottom here? Do you expect any pressure? Or do you see this pretty smooth sailing through the end of the year?

I'll just say a brief word, then I'll turn it over to Hunter. As we always, when we approach quarter and year-end, always anticipate that pressure, so we always tend to try to start layering in some fundings over quarter-end. So that's no different than this quarter. And I'll give it to Hunter to talk about levels.

Yes, we continue to see a high amount of demand for collateral. So we get tapped on the shoulder every few days or so with counterparties looking for more assets from us that they can put on our repo books.

I haven't seen a lot of pressure. I'd say that, just anecdotally, when you're 2 or 3 months from the turn, counterparties tend to try to bake in a little bit of that uncertainty. It's no more than 1 basis point or 2 right now. So if we're rolling something at 12 basis points for 1 month, we could probably do it over year-end for 13 or 14. So not seeing a lot of pressure, and still seeing a lot of demand for assets to [rethink].

And then, in terms of operating leverage, I know that there's a calculation for the management fee. But what's your expectation as you continue to grow the equity base in the portfolio for the rest of the operating line items? I mean, should investors expect to see operating leverage? Or are you expanding the platform at all? How should we think about that, going forward?

I would say that with respect to the platform, I can't really say that we have any plans for that. Otherwise, I mean, we should continue to benefit from scale. I mean, we only have 2 variable costs. The biggest one by far is the management fee. And the second one is just our repo funding cost, which is much, much smaller. But we continue to benefit from it as we grow, and we're at a point now where the management fee is at 1% fixed basically from now on. So every dollar of capital we raise, our weighted average management fee should come down, and most of the rest of the cost structure is fixed, so it gets diluted. So we should continue to see a dilution of the cost structure as we grow.

Almost all the capital we raised in this period was done at that lowest marginal management fee rate, and we don't really anticipate our fixed costs increasing materially. So those 2 things will contribute to operating leverage, going forward.

I didn't hear a book value update. I heard the update on the hedges, and it looks like, based on my math, you're closing on some nice profits. Do you have a book value update for us quarter-to-date in 4Q?

We don't have a hard number, but I would say it's down somewhat. That would reflect the increase in rates and spec softness.

Yes. The softness that Bob referred to on the Slide 11 on specified pools resulting in his comments, he was discussing the 3 specifically, which we have a lot of exposure to. We continue to see weakness in specified pool pay-ups for the first few weeks of the new quarter, so a little bit of a giveback there attributable to this crazy roll market with Fannie 3s.

So it's tough to comment on book value this early in the new quarter because things can change so quickly, but we're down very marginally.

Yes, it will be very important to see how we do next week. As we get into November, we have the auction cycles. And we really haven't seen as much trading activity in the second half of October we've had for the last really year. We've gotten into a cycle where you have a typical auction cycle at the beginning of the month, then you get a mid-cycle list; and occasionally, you can get some Fannie cash window list in the last week of the year, or month, rather. We did not get that. So there is some uncertainty on the level of pay-up, so the market will be very keenly dialed into next -- I think the cash window is going to be Tuesday next week. So we'll see where those levels are, and that will give us an update.

I would say, based on what we've seen to date, though, book is down. I don't have an exact number, but I'm guessing it would be probably 1% or 2%, but I can't give you anything more specific than that.

Your next question is from Christopher Nolan from Ladenburg Thalmann.

Bob, on your comments in terms of the overall yield curve environment, is it fair to say that your expectations are for a flatter yield curve?

Yes, that definitely looks like it's going to continue to be the case. It's easy to explain what's going on in the front end of the curve. The longer end of the curve is much more of a challenge, but try to give my best guess of what's going on over (inaudible) my comments.

This week in particular, every day it's just [seen intraday]. We get big moves. When you walk in and New York hasn't opened yet, and London hours, the market's flatter and then it turns around and goes the other way, and then Europe closes as we go back the other way. Very challenging week. But going forward, I think that inflation, assuming it's going to continue to persist, stretch the bounds of transitionary, if you will, that's going to keep the front end of the curve soft. What goes on in the long end is -- who knows, but it's hard to imagine the curve not (inaudible), but staying pretty flat.

By the way, I didn't mention it in my prepared remarks, but the spread between 5 and 30s at one point was north of 150 basis points. It's less than 75 as we speak. So it's dropped by half in a very short period of time, so it's likely to continue to do that. And there seems to be some [contagion] between what's going on amongst other central banks and what's going on with the Fed. It's great that we have our meeting next week so we can get some clarity in that regard.

But you know this week that the Central Bank of Canada stopped QE, and they're going to raise rates. Australia was amazing. They have yield curve control there, and they just stopped participating. Apparently, they're ending that program. They've done nothing to stop the run-up in yield. I was just checking yesterday. The yield on the Australia 2-year, which was slightly negative in mid-September, is approaching 50 and moved meaningfully again today, I understand. And then, the same thing in the U.K. It's moving rapidly, and it seems to be influencing market expectations here, which, again, all these forces are just going to drive the curve flatter.

And then, should we expect to increase capital allocation for IOs in the fourth quarter?

We had soft targeted 25. I think we're at 21 and change. I would say we're probably going to continue to move in that direction.

And then, I guess, on Page 23, you have in the portfolio characteristics your asset sensitivity. Are you planning to position this a little bit more where you have a little bit neutral sensitivity towards a 50 bp rise in rates?

Yes. The short answer to that is yes. And I would say that one of the things is we've been raising capital. It's been coming in quickly particularly this last quarter. So sometimes we add assets and we try to do so uniformly, but get a little ahead or behind in 1 or the other. So we will continue to add IOs, as I mentioned. Since quarter-end, we have increased the hedges. I mentioned we added to our treasury shorts ultras. We added TBA shorts. We added some IOs, and we repositioned some of our swaptions. So the profile would look differently today than it did at quarter-end, but yes, the short answer to your question is yes.

(Operator Instructions) Your next question is from Mikhail Goberman from JMP Securities.

A few of my questions already been answered, but just wanted to get your thoughts on what you're seeing for agency MBS spread widening or tightening, going forward, and how you're thinking about positioning the portfolio; A, assuming ceteris paribus, we kind of putter along the way we are now, although obviously seems to be quite a lot of volatility last week, as you mentioned, but assuming you expect a flatter yield curve, going forward, and also in maybe a more volatile scenario where you have a massive -- not massive, but heightened, perhaps, spread widening?

I'll take that. I'll turn it over to Hunter in a second. One thing just to keep in mind is that we certainly see the good days and bad days for mortgages, and we pretty much have a pretty good feel for that. So that will tell you kind of what we expect. But the thing you have to keep in mind is that everything else is very rich also. And to the extent there are many, many multi-sector asset managers out there, which there are, they are relative value traders. So mortgages, by nature, can never typically get too rich or too cheap for long. So that's just kind of an overriding principle.

So yes, mortgages are rich. So is everything else. Tapering is on the horizon. The market knows that. But we also have bank demand, which tends to represent an additional floor, if you will, in addition to the Fed, simply because as the Fed pumps reserves into the system, they find their way to banks and banks have to invest these reserves, just kind of the opposite of where we were in '19 when they were depleting reserves, and we couldn't get repo because the banks were all up against their liquidity ratios and so forth. Now it's the exact opposite. They have too much cash, so they're buyers.

So yes, I mean, I would say tapering is key next week. If they give us something different than what the market expects, you're going to see a knee-jerk widening, but then what happens? It just represents a buy opportunity. So that's kind of the way I look at it. Hunter?

No, I totally agree with that. I think that every buying opportunity has been well-received over the last year or so, I guess. Obviously, we're sort of in a state of free-fall right after the pandemic outbreak. But [Fed] stepped in, shored up the market. And since then, any marginal widening has been [met with buy].

And on, I think, the yield front as well, we definitely see yield-based buyers step in every time rates increase marginally. And those are typically sort of unlevered money stepping in, and then levered money stepping in when things widen out on a spread basis.

As to your question, I think if we continue to sort of gyrate around in this range, I don't think things will change meaningfully. I think we'll continue to see slow emergence of burnout in the portfolio. And then I think, if we do have some sort of an inflation scare or something, for us, I think that's what we are most concerned about, is a breakout to higher rates caused by something like inflation. That seems to be sort of on the back burner right now, or less of a concern for the market. But it's something that we always have to keep our eye on.

The nature of the way we're positioned in premium MBS specified pools, in that type of situation, I think the portfolio does relatively well for the next 25 or 30 basis points. We could see spreads tighten on our assets just due to the fact that our refi incentive is disappearing. We increased that exposure through the use of IOs as well, and we've been really focused on positioning [any] cuspy mortgage assets that are going to really have a dramatically reduced incentive to refi in the next 20, call it, 25 to 50 basis points.

So that's why, a lot of times, you'll see our profile skewed a little bit. We're at (inaudible) negative to the up 50. I think that's because, empirically, we've observed -- I mean those assets, the types of assets that we typically hold do well in that scenario. That's also why we've tried to not play chicken with the Fed being in production coupon TBAs, a little bit unique in that regard. We have been trying to resist the allure of the drop market in Fannie 2s and 2.5 just on a relative value basis of horribly negative OESs. And our concern is that those are going to be the first assets to widen into a taper. That's my thoughts.

Just one other thought I might add is that, in terms of (inaudible) evolve and something that the market doesn't see coming, if you look at the market pricing and compare that to what Powell said at the September Fed meeting, when he basically implied that tapering will be done mid-summer; and if you look at the euro-dollar market, the Fed funds futures contracts, you see the initial tightening right after that. Obviously, that's very much in contrast to the last cycle when there was a long pause for when QE ended to the first [height]. So the market is very much at odds with a repeat of what happened the last time, and who knows how it plays out.

But let's say, for instance, that inflation continues to get worse, whatever, and the Fed concludes that they have to bring forward their tightening. We would presume that they don't want to be tightening, raising the Fed funds rate at the same time they're buying assets. So they would then accelerate the tapering. In that event, that's not what the market is currently expecting in spite of the fact what the Fed funds market's telling you. And I think in that event, you would see the production coupons soften quickly. And for investors, they might just say, okay, we're going to just sell these lower coupons, they may leave the space or they go up in coupon. And that's kind of how we're positioned for that to happen.

So I don't think there's a chance that they're going to not taper or extend the taper unless the economy -- for something that is not currently visible. So I think the risk is that they're forced to accelerate the tapering, in which case, you would see the production coupons probably soften up, and that would benefit us.

In that type of environment, we are in a fairly enviable position to the extent that our leverage ratio is lower than it typically is, not as low as some out there that are waiting for this sort of buying opportunity moment, but we definitely have another turn or so of leverage that we could quickly add in a buying opportunity type of moment. But perhaps more importantly, we have been pretty successful lately in raising capital, and would definitely use that lever, so to speak, as a way to add cheaper assets in the event we saw that type of scenario play out.

Your next question is from Kevin Jones, Investor.

Yes. I didn't have a question. I just called in to listen.

No. Well, glad, thank you for doing that.

I'm at a loss for words.

Well, thanks for the call, and have a great weekend.

(Operator Instructions) We do have a follow-up question from Christopher Nolan from Ladenburg Thalmann.

What's the management perspective on doing additional equity raises?

Well, the ATM is something we want to continue to use. We've done secondaries. Probably obviously, as you know, we don't do a lot of those. We have done them. There are benefits to the ATM. The cost of capital is cheaper. You get the money in kind of slowly over time, so it makes it easy to invest. You don't have to do it all at once. And our basic mantra is, when the stock is trading above book, we consider raising capital. When it's trading below, we consider buying it back. And then, we always factor in market investment opportunities at the time in both cases.

So today, the investment opportunities are okay. They're not spectacular. And the stock had been trading at a premium to book, so it was accretive. So in that instance, if that were to continue, we would probably be still inclined to continue to use the program.

(Operator Instructions) There are no [audio] questions at this time. I will turn the call back to Mr. Cauley.

Thank you, operator. Thank you, everybody. Appreciate you taking the time to join us. And we certainly enjoyed all your questions. To the extent you all have additional questions that weren't answered and you have to listen to the replay and want to call, please feel free to do. The office number is (772) 231-1400. We'll always be glad to take your questions. Otherwise, we look forward to talking to you next time. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.