Orchid Island Capital Inc (ORC) 2020 Q4 法說會逐字稿

Good morning, and welcome to the Fourth Quarter 2020 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, February 26, 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 the 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 had a chance to download our flip book, which we posted on our website last night. And as usual, I'll be going through the full book over the course of the call.

I just want to start off by saying that Orchid had another very strong quarter of continued book value recovery from Q1 and strong earnings. We continue to pay a very attractive dividend that is covered by earnings, which in turn allows our stock to trade at or above book value, which it has for several months now. And again, this, in turn, allows us to opportunistically raise capital by either our ATM or our secondary whenever opportunities in the market present themselves. This, of course, gives us a chance to enhance the earnings power of the company.

With respect to the slide deck, we do maintain the majority of the slides from quarter-to-quarter. Depending on the quarter, some are more relevant than others given that we're kind of late into February. I will be skimming over some -- especially the ones on the market-focused slides. And then also given the significant changes in the market, especially over the last 2 weeks, I will spend some time going over steps that we've taken with the portfolio since year-end.

With that, I'll just go over the slide deck now. As usual, we'll start off by giving you the highlights for the quarter of our results. As I said, we'll go through the market developments relatively quickly, discuss our financial results and then spend the most of the time talking about the portfolio, our hedged positions and changes made to both -- over the course of both the fourth quarter and year-to-date.

With that, on Slide 4, Orchid reported income per share of $0.23. This is net earnings per share of $0.30, excluding realized and unrealized gains and losses on our RMBS assets and derivative instruments, including net interest expense and interest rate swaps. We had a loss of $0.07 per share from these realized and unrealized gains on our RMBS and derivative instruments, including, again, net interest expense on the swaps.

Book value per share was $5.46 at the end of the year, an increase of $0.02 or 0.37% from the ending value at the end of the third quarter of $5.44. In the fourth quarter of 2020, the company declared and subsequently paid $0.195 per share in dividends. And since our initial public offering, the company has declared $11.785 in dividends, including dividends declared in the first 2 months of this year. Total economic return of $0.215 per share or 4% for the quarter, which is 15.8% annualized.

Turning to Slide 5 and 6. This is where we present our results versus our peer group. Our peer group is, of course, listed at the bottom of each page. On the first slide, we show the performance calculated on a total-return basis, using change in the stock price and dividends; and on the second page, using book value. Because we are doing this before all the results are in for the fourth quarter, book value numbers are not available for all of the peer groups, so the second slide is only through the third quarter.

But as you can see, again, Orchid's had very strong performance versus the peer group. As you can -- in each case, we're looking back either 1- through 7-year period and in the actual calendar years. And Orchid continues to generate very attractive returns for our shareholders.

Turning now to the market developments, which again, I'm not going to spend a lot of time on -- given how late we are in the first quarter and what's happened so far. On the left side, you can just see the changes in the treasury curve. The blue line represents the curve at the end of the third quarter; the red line, the end of the year; and the green line's as of last Friday. Even since last Friday, the market has moved quite a bit.

But just to focus on the fourth quarter for a moment, over the course of the quarter, rates didn't be move higher. For instance, the 10-year treasury moved from just below 70 basis points to over 90. And this is very much driven by the recovery with respect to the vaccine, not so much COVID cases because, as we all know, COVID cases in the fourth quarter were starting to rise very dramatically. But we did get the announcement of a vaccine during the quarter, and the market started to price in a modest recovery. Obviously, that's changed in Q1.

But also, it's important to note, with respect to a mortgage investor, that the spread between the primary rates available to borrowers in the implied current coupon on our mortgage, what we call the primary/secondary spread, did continue to contract in Q4. So prepayments were still very, very fast in the quarter and really showed no meaningful sign of slowing on a seasonal basis, which we would typically see.

The second slide just shows the same thing with respect to swap -- the swap curve. And just a brief comment on what we've seen this quarter. Obviously, with the economic data, developments with respect to vaccines and the drop in COVID cases, all of these have improved very dramatically in a very short period of time. And not surprisingly, rates have followed suit, especially in -- again, in the last 2 weeks. And so what we're really seeing is the normalization process of both the economy and the rates market are moving very rapidly.

And based on comments from the Fed chair this week, it seems that the Fed chair is comfortable with these moves. They view them as the market reassessing the economy and pricing and recovery, which is something they very much like to see in addition to raising inflation expectations. Although, yesterday was a little bit different. Yesterday, we saw the front end of the curve move. And I think it remains to be seen, the level of comfort the Fed has with that. But that's probably more in a conversation for the first quarter earnings call than today.

The subsequent slide just show the change in the 10-year rate over both the quarter and for swaps, I mean, going back 2 years. As you can see, the change in the fourth quarter was very modest. We ended the quarter just over 90, but we were over 150 yesterday. So obviously, the market has continued to sell off and price in a recovery in a very dramatic fashion.

Slide 10, I think, is very telling. What we show on the bottom of this slide, this green line is the slope of the 5s/30s, curve. I mean this is basically a proxy for the slope of the curve. And as you can see, going back to 2013, we entered into a very long flattening period, which has changed dramatically over the last couple of years and especially 2020 and early 2021. Interestingly, yesterday, this actually reversed and has continued to reverse slightly today. So this 5s/30s spread actually got north of the level here of 155 and actually got into the 160s but has since come back about 15 basis points or so just in the last not even 2 days.

Another telling slide is Slide 11, just to go over to show you how much things have changed in this quarter. As you can see, in the fourth quarter, mortgage prices were fairly stable. Higher coupon mortgages did well as the market really anticipated potential burnout in the case of the higher coupons. We've seen some of that to date, maybe not as much as the market expected. And of course, lower coupons were supported by Fed purchases, which continue -- or are ongoing.

Just to give you some points of reference, if you can see on the top left, we show TBA prices over the course of the fourth quarter. If you look at the bottom line, that's the price of a Fannie 2. And as you can see at the end of the year, it was pushing up against $104. Yesterday, those bonds traded below par. So obviously, a very significant move. The red line are Fannie 2.5. They were a mid-$105 price. Yesterday, they were at a $102 handle. And ironically, the top line, Fannie 4s, which were a high $106 price at the end of the year, actually have traded up in price since year-end. Again, reflecting the desire for higher-coupon securities.

With respect to the roll market, the story really hasn't changed. The levels have changed somewhat. Higher coupons tend to trade with flat or negative drops, and the lower coupons have attractive drops, although that has been changing slightly lately.

On the right side of the page, we see spec prices. Obviously, they've been very, very strong. We'll have more to say about that a little later. It remains to be seen where these levels are given the moves in the last 2 weeks. Next week, we have the auction cycles, and we should be able to get a good picture on where things are. The last week, especially the last 2 days, we've had very limited color with respect to spec pricing. And I think just given the magnitude of the markets move in such a short period of time, there just hasn't been enough trading to flesh that out.

The next slide is implied vol, which is obviously very important for mortgage investors. As you can see, last year, in March, we had a huge spike, and then it was very, very subdued through the balance of the year. Yesterday, we were in the mid- to high 80s. So we've spiked again, not quite as dramatically as last March but, again, a very big move in a short period of time.

These next few slides, I can go over fairly quickly. One thing that's interesting to note here on Page 13 is LIBOR OASs for TBAs. As you can see, they had tightened somewhat in the fourth quarter, and that continued to be the case early in the first quarter of 2021. So even though mortgages cheapened quite a bit in the last few days. Keep in mind that this is after tightening to multiyear tights earlier in the quarter. So they were really just coming from a very tight level and so were really just getting back to what you might call fair values. So this is nothing like, say, for instance, the taper transom -- tantrum, where mortgages got exceptionally cheap. We're really just getting back into more fair-based ranges, I would say -- price range.

Slide 14. This is, again, kind of more last year's news. As you can see in the fourth quarter, risk assets had an extremely strong quarter. Of course, we all know that stock markets continue to make new highs or we're doing so. And that reflects -- was reflected in the bottom side, which you see the year-to-date returns. And again, risky assets, whether it's high yield or emerging market high yield or the S&P, were very strong. And lower-risk assets after having a very strong first quarter, has actually kind of trailed, not surprisingly.

Slide 15, I think this is very relevant for us in today's discussion. On the top left-hand side, you see the red line there, which is the mortgage rate available to borrowers and the level of the refi index. And as you can see, the level of rates to borrowers continued to drop all year. It got down as low as 2.80% and, depending on your source, could even have been below that and, in many cases, were. The refi index was very high, around 4,000. And it actually got as high as 4,500 earlier this year, never quite as high as we've seen in the past but still a very strong, steady level of refinancing. We all, of course, know how strong the housing market is.

Over the course of just the last few weeks, though, this red line sort of reversed course and is probably over 3% today. Last week -- or this week, actually, the refi index dropped a little over 10%. It's below 4,000. And I would assume if these rates hold, that will continue to drop.

One important note, one of the large production coupons is the 2.5% 30-year mortgage. And we are kind of just past the point where they went no longer 50 basis points in the money, depending of course on the gross WAC. But so now that coupon is probably not so refinanceable. And that's a meaningful development for the coupon stack.

On the right-hand side, you see the primary/secondary spread. As you can see, by year-end, it was around 150. That continued to compress into the first quarter depending on the items you look at to calculate that. We use the Freddie Mac survey rate versus the implied yield on our current coupon mortgage. That got much closer to 1% earlier this quarter and now has started to move up with rates pretty much basis point for basis point.

Bottom side. So it's just the refinanceability of the mortgage universe. Obviously, that could continue to change, especially given that we've had a lot of 1.5%, 2% and 2.5% mortgages originated in 2020 and early '21. So 10-year rates moved meaningfully above 150. A lot of that portion of the mortgage universe will no longer be refinanceable.

Now with respect to our financial results on Slide 17. The left-hand side, we just basically decompose the numbers which we talked about at the top of the slide deck, where we break out our earnings asset, mark-to-market gains and losses. And this just provides the detail.

On the right-hand side, we show the returns by sector in terms of how we allocate capital. And given what happened in the first -- or the fourth quarter, mortgages in spite of the rates moving slightly higher continue to tighten throughout the quarter. And the pass-through portfolio did quite well given how high speeds were and the compression of the primary/secondary spread. Interest-only securities actually had a negative return for the quarter. That is not the case in the first quarter. This year, as you would expect, those numbers have reversed, and IOs are doing quite well.

Just a few more historical slides before we get into the meat of the presentation. On Slide 18, we do show our dividend history and this NIM as we reported, just kind of focusing on the last 4 quarters. As you can see, the blue line there at the top of the page just represents the yield on our average assets, and of course, it's been declining. The red line is our funding cost, which has also been declining. And net of that is the green line which shows that our NIM has actually expanded modestly over this fourth quarter period and seems to have dropped.

If you look at the dividend, you'll see it more or less mirrors that. The dividend got as low as $0.55 briefly earlier in 2020 and has since recovered. Remains to be seen what we'll see for the balance of 2021. But to the extent you have rates remaining higher and curve steeper, as long as funding stays low, which I would think is reasonable after the balance of the year, it should be a very attractive earnings environment for agency rates for the balance of 2021.

Slide 19 is just our earnings per share.

20 just shows you the allocation of capital. I will just mention briefly on the left-hand side, as you can see, the allocation of pass-throughs has been very high and trending higher for several years now. We're just starting to reverse that ever so slightly add some more IO exposure. And that, I think, just reflects the changing nature of the investment environment we're in.

With respect to the right side, you can see that the portfolio grew somewhat. As I mentioned, we've been able to opportunistically add capital either through the ATM in the case of the fourth quarter or through a secondary earlier this quarter, and the company continues to grow slightly.

And now really just turning to the -- what we've done in the portfolio. First of all, with respect to the fourth quarter, as I mentioned, we had 2 primary developments that drove decision-making. On the one hand, you had rates moving slightly higher. You could see, with the introduction of a vaccine, that was likely to continue. But you also saw a compression of the primary/secondary spread, which was keeping refinancing activity quite high.

And what we did, if you look on Slide 22, I mean, the portfolio looks so much like -- different than what we saw at the end of the third quarter. And basically, what we were doing is we're going down in coupon -- out of higher-coupon, very high-quality specs into lower-coupon, lower-quality specs. Basically, the reason being that over the course of the quarter -- really into the first quarter of this year, what we saw is that the pay-up premiums for all specs were raising -- rising rapidly, but also, the highest quality were very, very high. And given that rates were backing up and there's a lot of duration in those premiums, we were trying to reduce the portfolio's exposure to those. But we're also able to do so by going into lower coupons to keep prepayment levels very, very low. And we spoke at the top of the call about our -- the earnings power of the portfolio, and it's been very strong for quite some time now, and we were able to keep it so by doing these trades.

So we were kind of reducing our exposure to very high pay-up premium TBA spec pools. We also added some TBA dollar rolls to capture some income that way. And then we also started to change our hedges. Like, we added some shorts -- TBA shorts in a 3% coupon. So that was -- those did very well for us in the quarter.

I'll come back to what we did in the first quarter in a moment. In the meantime, I just want to talk -- move through the balance of the slides.

Slide 23 shows you this one slide that was very topical last year. It shows our allocation in the case of the red line, the very high-quality specs. And as you can see, it started to come down over the course of the year and has continued to do so into 2021 as we do what I just mentioned with respect to the change in coupons. But also with the increase in rates, we would also expect that the refi index would start to come off.

That being said, on Slide 24, as you can see, these are our prepays over the bounds -- or over the fourth quarter and the last 4 quarters versus the cohorts. And since the portfolio has had a focus more on high-quality specs versus TBAs, security selection was obviously very important and critical for us to maintain the earnings part of the portfolio. And we're very happy to say that we've done so quite well over the course of the year. And that's allowed us to continue to earn a dividend, a very attractive dividend.

So you can see here the prepays for each of the months in the fourth quarter were well below cohort speeds and, looking on the bottom right, you can see, have been so for some time. But that -- the way that we achieve that now is just changing.

Slide 25 just shows you the level of 10-year versus our prepays. This little green line that we show in the chart, this is basically a very simple calculation. We just divide the dollar amount of prepays by the unpaid principal balance of the portfolio. And as you can see, over the course of 2020, when we had rates at the lowest levels ever, we were able to keep our refis quite low through our security selection. In fact, it was even lower than the '19 -- late 2019.

The leverage ratio for the quarter was relatively flat around -- in the high 8s.

And then finally, with respect to our hedges, we continue to add to hedges over the course of the fourth quarter and into the first quarter, less so with respect to swaps, more with -- [essentially, this] would have a higher option component. So you see on the top right-hand side of the page, you see the payer spreads, which we've added. And we continue to focus our hedging strategies in that area. And then also, we did -- and I'll get to this in a moment. We did make some changes to the swap book. The balance of the hedging, other than the small positions in Eurodollars and 5-year futures, is in TBAs.

So now I'd like to spend a few moments to talk about this quarter given the move in rates. I'm sure that's very topical in everyone's mind given the magnitude of the move. So obviously, a lot has changed, especially in the last 2 weeks.

So what we've done with respect to the asset side of the portfolio is basically shed all of our very low-coupon securities. We no longer have any 30-year exposure to any coupon less than 2.5%. We've changed the maturity profile. We've reduced our exposure to 30 years by about $250 million, increased our exposure to 20 years by $300 million and 15 years by $250 million. We no longer have any TBA longs. In fact, we've increased the shorts. Now our shorts in 3% coupon are over $500 million, and we've actually added some shorts in 30-year 2.5s.

Over the course of the month, the leverage ratio was down slightly to about 8.5%. We view this as kind of a transitory step just to kind of wait out the correction in the rates market. And actually as a consequence of the TBA shorts, which we've added, inclusive of those, our economic leverage ratio is down to 6.6%.

Although, I have to point out that the bulk of the TBA shorts are in the 3% coupon, and the drop there is actually negative. So there's -- the cost of shorting those is actually the opposite. It's actually a mild positive. There is, of course, a cost on the shorts of 2.5% coupon. But given the fact that while that might be an increased cost and a drag on the portfolio, with speeds slowing and probably expected to slow them further, I think the net of those 2 will be negligible.

And then finally, we have done some trading with respect to adding to the IO book. We sold some of our fixed rate CMOs that were front sequentials and were able to add -- take back an inverse IO off of that. It's a very short cash flow, so we think we have minimal exposure to Fed hiking. But we get to retain the most attractive component of that security, which is the IO component, which we probably expected to do quite well as rates move higher.

With respect to hedges, we've also made some changes. Our swaps, we did 2 things with the swap book. We restruck those. Now we have a weighted average strike of 0.53% versus 1.14%, and we extended the maturities of -- from 4 on average to 5. We also mentioned we have a lot of exposure to option-based instruments, and we've restruck those to higher strikes so that they offer us better protection in the event of rates continuing to increase and less downside exposure if we rallied back.

And then finally, we've added a few other trades, which I won't spend too much time detail-wise, but these are what we call conditional flattener trades. These are trades that are kind of more forward-looking in anticipation of a normalization of the rates market and, eventually, the market pricing in Fed hikes. This is a trade that will protect the portfolio from a meaningful flattening of the curve and which, of course, would put downward pressure on our NIM and upward pressure on our funding costs.

So we put those trades on at attractive levels. And of course, we monitor all of our hedges just to make sure that they're struck or the levels that we have them on -- or at most effective levels to protect the portfolio.

So basically, well, that's about it. I've kind of gone through everything with respect to the portfolio, both in 2014 -- or '20 quarter 4 and also quarter to date.

And I think with that, operator, we can open up the call to questions.

(Operator Instructions) Our first question comes from Jason Stewart with Jones Trading.

Thank you for the update for the 1Q activity. I was wondering -- it sounds all great in terms of the way that rates have -- had been incredibly volatile and sort of are settling out here. Can you put a pin in it and sort of estimate what book value per share is after doing all that?

It's quite challenging. We're certainly going to be down slightly. I would say yesterday accounted for at least half of the move quarter to date. The problem is, I mean, we have a rough estimation, but what we don't have a lot of exposure to spec pay-up levels. There was very little activity yesterday and the day before and nothing that you can really benchmark off of. For instance, we saw some [50 WALA do] a 5 -- 4.5 trade in very seasoned, higher coupons. Next week, we will probably see all the origination list. We'll get some levels on specs. And we've also seen some recovery today in the market. Very choppy, as I said, for the last 2 weeks and meaningfully so yesterday. I would guess that all of the move in our book value quarter to date, over half of it occurred yesterday. So definitely going to be down a few percent, but I would be hesitant to put too fine a pencil to that level and also probably going to be changing in a few days anyway.

Right. And the quarter is not over. Correct. When we think about the IO positions, how big -- it's been trending down for quite some time for good reason. But how big do you think it could be? And do you really think it's a true hedge against basis widening? Maybe put some thoughts around that. That would be helpful.

Yes, the basis aspect of it is a little bit challenging because mortgage derivatives tend to widen with just regular pass-throughs or TBAs or what have you. I think what we find, though, is just as it relates to the refinanceability of the underlying instrument, that does present an opportunity. When you have a large widening and, say, like TBAs and you have primary rates increase, there will ultimately be a kind of a dollar-to-dollar, if you will, impact in the derivatives because they are so sensitive to prepayments. So -- but on a mark-to-market basis, as you're going through a period of widening basis, they will definitely experience the same sort of problems and on a levered fashion that mortgages will, but the fundamentals are vastly improved when something like that happens.

My answer to the question in terms of how much more would we add, I think it's very opportunity dependent. Bob alluded to the fact that we added an inverse IO off of a front sequential that we've been holding in the portfolio for a couple of years. That collateral was off of New York 4s and have been behaving rather well. We felt like the floater market would have [caught enough wind] with this sell-off and then the demand ticking up for those that we could sell one with a really low cap and maintain a short cash flow and that really dovetail well with our kind of our macro view that we will see a bear steepener. And the long end to get quite volatile, but we believe that the Fed is going to remain anchored at or of near 0 for the next couple of years. And so if that plays out, while that cash flow does have exposure to higher rates on the front end, we like that trade. It's something that we -- I think we would do more of if we found the right opportunity.

Really, basis hedge, just to chime in a bit. I mean, the basis blows on -- I think it's really important to understand that at the end of 2020 and into the early parts of the first quarter, mortgage was getting really, really tight. TBA OASs, depending on your model, most people use benchmark off of yield book, minus 20, minus 25, very, very tight levels. And so while we've come off a lot, you're coming off of very tight levels. So mortgages are not at multiyear cheaps by any stretch of the imagination. They're fairer -- or more fair, whatever proper grammar is.

At end of the day, if you're trying to hedge that basis, rates are not going to be 100% effective. The only thing you can really do is short TBAs or maybe put options on TBAs. I mean that's -- and when you're a REIT, you have limited ability to do that. I mean you can't hedge 100% of your mortgage exposure, or you kind of have no reason to be in the business, at least for any length of time. So you're going to be net long, and benefit when it tightens, and you suffer a little when they widen.

Our next question comes from Mikhail Bergermann (sic) [Mikhail Goberman] with JMP Securities.

I definitely appreciate the comments on book value and portfolio positioning in the first quarter as well. Just a question on how you guys are thinking about leverage going forward. Obviously, going to -- it looks like it's going to be a pretty volatile, wild year in mortgages and rates. And also, how are you guys sort of thinking about the dividend going forward?

Sure. Well, I guess the way I presented it to the Board and the way I really deeply believe is that we were at very low levels of rates, at all-time lows, and we started to sell off. And as we got north of 1% and approached 120, the mortgage market target to get skittish. And my view was that 125 or 130 was that point where the 2.5% coupon was no longer refinanceable, and mortgage investors were going to really become concerned with extension of the mortgage universe.

But I also thought, if we went, for instance, from 125 to 150 on 10, that, that would be a very painful episode for mortgages. But once you got above that level or meaningfully above that level, I don't really think you can go much higher in rates. For instance, rates across the pond, either pond, are still relatively low compared to ours. And so there's that kind of [our] -- there's also the potential impact on the equity markets and financial conditions and the likelihood that the Fed wouldn't tolerate that and would step in and maybe extend the [land] with their purchases, that kind of thing. So I really thought there was at least a soft cap on rates.

And so if we could get to that level, north of 150, where refinancing activity was meaningfully subdued but the Fed hadn't hiked, you had a very attractive investment opportunity and so we kind of got there much quicker than we thought. But now that we're here, if we stay here, it's not that bad of a place to be. Yes, mortgages are wider. We gave up a little bit of book to get here, but the earnings outlook are very, very attractive.

And so maybe we stay volatile like this for the balance of the year, in which case, we'll just have to face that and deal with it. But if rates stabilize in a higher range, call it, 140 to 160, whatever it happens to be, it's really not a bad place to be. And I don't think that puts downward pressure on the dividend. Yes, granted, we've had to change the hedges somewhat. We even took the leverage down a little bit, but we view that as temporary because we're just trying to protect ourselves through this move. But unless we stay in an extremely volatile market for the balance of the year, I would expect we'd be able to remove those. And so that gets us back to an environment where it's -- again, it's -- the curve is steeper, funding is still cheap, prepays are lower.

The big challenge of 2020 was avoiding excessively high refinancing activities. So everything we talked about in every earnings calls of all the steps we're taking to keep refinancing down, and we show you all these slides in the earnings call deck about how our portfolio prepaid versus the cohorts and so forth. But now that's less of a concern. We have a steeper curve and slower speeds. So I don't see anything negative.

(Operator Instructions) Our next question comes from Christopher Nolan with Ladenburg Thalmann.

Any idea in terms of where prepays stand year-to-date?

Yes, we had 2 very good months. We'll get another one next week, but we did -- if we can get you those numbers. But they were in our most recent press release in February. When we put out our February dividend, we had the January prepays, which were...

I'm on the -- prepays released in January were 16.7% for the pass-throughs and 44% for the structured. Combined total is -- [by December], was 20%.

I think we have those in Q4. They were...

That was Q4, yes.

Yes. I -- Chris, I don't have it in front of me, but our February press release had the January level. And February, which was released -- was not released yet, I expect to be in line. So it's been a good -- it's lower than Q4.

Great. And then, I guess, how much of your capital are you allocating to IOs?

Well, it's -- now it's probably just about marginally over 10%. It had gotten well under 10% with this inverse we took back. And like as Hunter said, that may be an attractive asset for us to pursue or other IOs. I mean it's -- we typically looked at IOs as much as hedges versus income. And so we wanted IOs that had a lot of extension potential, in other words, something that was paying fast now but, in the event of a sell-off, would extend and slow down. And so there are plenty of those available before, terrible carry instruments, and they've done well quarter-to-date, very much so. We'll look maybe to opportunistically add those. I think the allocation to pass-throughs well north of 90 is probably no longer warranted. But as Hunter said, it's really opportunity-driven. When the opportunities present themselves, we'll take a step.

Really, what's been driving, I will say this, is that I kind of mentioned part of the reason that we got away from high-coupon, high pay-up premiums in Q4, and this continued into Q1, is the demand -- basically, it's from The Street. A lot of these CMO desks pay up for this collateral because they can carve it up and create par-ish price bonds with banks. The bank demand in the mortgage space has been very, very strong, Q4 and Q1. Deposits is very high, and loan growth has been modest. So they've been big buyers of mortgages, and they tend to buy around par.

So The Street can buy attractive collateral that looks great on an OAS model and create a par-ish price, stripped-down bond. And then whatever is left gets set off to the rest of us. But it makes it very challenging to compete against that when you're participating in these origination cycles -- or auctions because they're a very aggressive bid, and that's really what drove us away from those securities. And that's -- in our minds, it's like this is a chance to sell these pay-ups at very high levels. Rates are going higher. And these pay-ups are going to be imperiled if rates shoot higher in a short period of time, which is, in fact, what happened. All of a sudden, low-loan balance Fannie 3 or 3.5 is going to -- that pay-up premium's going to drop. So we were selling those and adding lower-quality specs in lower coupons, and we realized very low speeds off of those.

So that CMO bid, we'll see if it stays there now that we've moved higher in rates, but that was a big driver of spec levels up until the most recent few weeks.

And then 2 more questions, and I appreciate the detail, Bob. In your comments, you indicated that you're shedding the lower-coupon positions, particularly for those with really long terms, 30 years and so forth. What are you focusing more on now? If you can just -- because I missed that.

So went down in maturity, 20 years and 15 years. And we actually just -- we didn't actually sell 2.5%, but we did add 2.5% TBA shorts. We view that as kind of a temporary trade just to kind of get us through this turbulent period. But the 2.5s, we'll probably continue to own those going forward. We may not have those shorts in place. But otherwise, it's just been shorter maturity mortgages.

And we may add some higher coupons and probably going to start seeing more of them produced, probably going to start seeing some 3s get produced in the next few months. So we'll revisit those...

Final question...

(inaudible) levels, too. What the levels are drive our decision-making a lot.

Final question. In terms of -- as you're going forward -- I mean the environment has changed a lot. And from my position, it looks like it's pressuring book value, but your earnings outlook looks good. Where is the balance for you in terms of sacrificing book values to protect earnings and so forth or vice versa?

Well, it's -- fortunately, when you get a move like this that's so sudden, you can get very cautious and add to your hedges, which are going to put downward pressure on earnings to protect book. And if this episode's over quickly, then it's a minimal impact on earnings. I mean our thought process is we're willing to sacrifice a little bit of earnings in the short run to protect book. If it's a long, long grind higher in rates, then we have to fine-tune our analysis to find appropriate balance.

This played out quite quickly. And we expected this to play out over the first 2 or 3 quarters, and in fact, it played out in 3 weeks. So that, like I said earlier on the last call, if we get to a level of rates, especially if it's north of 150 and appear to be [standing] into a range, then we can get -- take off some of the hedges and not irresponsibly so but be able to track generally pretty nice returns in that environment.

But like I said, I think there's a soft cap on it. I don't see the 10 year blowing through 2% anytime soon. I don't think the Fed is going to be going to -- I don't know if the equity market is going to tolerate that, in which case, it's forcing the Fed's hand.

Chris, just to follow-up on the speed question. The current mix of the portfolio, the 1-month speed as of the most recent [tranche], which was earlier this month, was 13.7% and 3-month speed at 11.2% for the specified pools, which are, of course, the most sensitive.

So one other point to add there is there's a correlation between the drop down, lowering coupon from the end of the year into the new year here because the premiums on those assets are substantially lower. So we have, again, sort of 2 factors going on: One is speeds are a little bit slower. But two is the negative impact of those speeds is a little bit smaller as well because the premium of the assets isn't quite as high.

(Operator Instructions) And there are no callers.

Thank you. At this time, I'll turn the call back over for closing comments.

Thank you, operator, and thank you, everyone. As always, if you have additional questions, please feel free to call us. The number in the office is (772) 231-1400. If we're not in the office, which is often the case these days, we can be reached by cell, but I will leave that to our office manager to [handle out].

And otherwise, we look forward to speaking with you next quarter, and thank you for your time today.

This concludes today's conference call. You may now disconnect.