Robert Cauley - Chairman & CEO Hunter Haas - CFO.

Mickey Schleien - Ladenburg David Walrod - Jones Trading.

Good morning, and welcome to the First Quarter 2017 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, April 28, 2017.

At this time, the Company would like to remind their 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 and the 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. Good morning and welcome to the First Quarter Earnings Call for Orchid Island Capital. With me today is Hunter Hass, our Chief Investment Officer and Chief Financial Officer. Today we will depart from our normal practice and incorporate a slide deck presentation into our call.

Hope you had a chance to download the slide deck from the Investor Relations section of our website. If not, please do so. Now if you can, as we have been provided some help over Allison Table that will facilitate this day's discussion. Before going over the slide, I would like to go over the course of the quarter and their impact on Orchid.

As the year 2017 unfolded, risk markets and particularly the equity markets were bullied by optimism stemming from developments in Washington, generated by the incoming Trump administration.

The President Elect made every effort to let the world and the markets know that the Trump administration is going to be very pro-business and pursue an aggressive legislative agenda that encompassed healthcare reform, tax reform, infrastructure projects and regulatory relief.

As various cabinet nominations were announced, most of which were from the business world and the new President continuously met with leaders of most major industries, the equity in risk markets continue to rally, setting all time new highs in the case of the Dow Industrials and S&P500 in early March.

Optimism was so high that when the Federal Reserve raised the feds fund rate by 25 basis points at their March meeting, the markets reacted calmly.

Various members of the federal open market committee and fed governors have increasingly discussed the reduction of the feds balance sheet as the next phase of the removal of monetary accommodation, in addition to increasing the Fed's fund rate, of course.

Member of the fed have indicated that the reduction in the fed's balance sheet would be accomplished by tapering the reinvestment of the pay downs they received on its MBS holdings and maturities of treasury and agency debt holdings. The market, particularly the MBS market is keenly focused on a timing and extent of a reduction of fed purses.

The prospect of the largest source of demand for agency MBS reducing its purchases has caught agency MBS assets to cheat into comparable duration treasuries.

As for MBS performance, repayment speeds moderated during the quarter with the combination of the typical seasonal slowdown coupled with substantially higher mortgage rates versus levels prior to the election.

Pre-payment fees prepare a peer to have hit a trout in February based on a report released in March before picking up and slightly in March based on the report released on April. Now to the slides. First on Slide 5, we provided a brief overview of our results for the first quarter 2017.

And I would like to remind investors that the information provided on this slide was disclosed on April 12, only to clear at our April dividend as a practice going forward for the first quarter of every month we will continue to provide our preliminary results for the past quarter in addition to the dividend for the current month.

And of course that dividend will be declared in full knowledge of the results of the prior quarter. So first off, we had earnings per share of $0.07 per quarter, this included $0.63 of losses per share from net realized and unrealized gains and losses on NBS and derivative instruments.

Absentee's unrealized and realized gains and losses, we had earnings per share of $0.70 for the quarter. Book value per share was $9.75 at March 31, 2017, a decrease of $0.35 or 3.5% from $10.10 at December 31, 2016.

Dividends of $0.42 were declared for the quarter and some the combination of a $0.35 decline in book value and $0.42 in dividend resulted in economic return of $0.07 for the quarter which is 0.7% unannualized or $2.8 annualized. Now I’ll review the balance of the slide deck.

The slide deck has three basic sections, and I will follow the deck in sequential order. The first section covers developments in the markets during the quarter. Specifically, I will focus on the rates and MBS markets. On Slide 7, we provide a picture of the 10 year treasury and the 10 year swap yield for the quarter.

These are our primary focus for MBS investors. As you can see both cases they were relatively stable for the quarter, in the case of the 10 year treasury ended the quarter 5.7 basis points below the 12/31 level and the 10 year swap rate was 4.74 basis points higher reflecting some slight widening of swap spreads.

There are few notable events that occurred during the quarter as you can see in March, 10 year yields and dollar 10 year swap rates increased.

As we're all aware the Fed did raise rates in middle of March, and as is the case the market -- the Fed is very cognizant of disrupting the market and so to the extent that Fed used, the market is not anticipating a rate hike they can in this case did through their rhetoric and public pronouncements try to talk the market up in anticipation of a Fed hike.

In fact we did get one as we know, and the market saw the price in a more aggressive Fed. Shortly thereafter, the Trump administration’s proposal for Affordable Care Act replacement was not voted on, it more of less failed and the market started to rally at the end of the quarter that continued into April.

It was added by geopolitical events; first the missile strike in Syria secondly the rhetoric between the Trump administration and North Korea and then finally really the economic data for March was almost uniformly week. And as we found out this morning CEP [ph] for the first quarter was sub one percent at 0.7%.

The market really hasn't reacted too strongly for that data, because we've seen now for several years the first quarter can and often is very weak.

But it's not necessarily a good barometer what to expect going forward, of course we don't know that for sure this year but the market seems to be anticipating the fact that this was some of our operation possibly caused by seasonal adjustment issues or the like.

In the rest of the economic data, the underlying data with respect to the consumer in the housing market seems to be quite strong in an event. Slide 8 and 9 just give you a picture of the change in the treasury curve and the swap curve for the year or the quarter, I'm sorry.

As you can see both cases are relatively stable, modest, flattening in the case of the treasury curve, the very front end of the curve moved out kind of pivoted around the five year point of curve so 10 year and beyond.

Rates were down very, so slightly in the case of a swap they are all up beginning somewhat of a flattening most of the movement is on the front end. Again this ends our March 31, which doesn't really pick up.

What happened post the end of the quarter, when the market started to remove pricing for Fed hikes which had kind of occurred in mid-March with a strong language from the Fed. Slide 10, here we’re going to talk a little bit more about the mortgage market.

Want to focus here on 30 year fixed rate coupon, specifically higher coupons which make up the bulk of our holdings.

As you can see relatively stable for the quarter, but it's important to note couple of things; one, say for instance the 10 year treasury which I mentioned finished slightly down in yield both 4’s and 4.5’s which we have pictured here we’re down in price and as you can see 4.5’s were down more in price than 4.

So clearly throughout that quarter coupon underperformed. Also we added five in the quarter, so they also underperformed. And we attribute most of this widely to initial reaction by the market to the rhetoric out of the Fed. As I mentioned, they started to talk about tapering the re-investments.

As for now it looks like that’s probably going to occur late 2017 or early 2018 and we’ll probably be gradual but of course the market will be very keenly focused on any change to that timing or the extent of the tapering. So it will be very much a primary driver of MBS performance for the balance of the year.

Of course to the extent that there is material widening that represents a very fine opportunity. So there's a silver lining for sure there. The next Slide on page 11 we show payups on certain specified pulls, these are important component of our portfolio.

What we try to show you here on Slide 11 and 12 are the payups for what we would call the 2 extremes and the TBA deliverable universe. So 85k which is probably the premiere call protected security, 85k is the lowest loan balance available.

On the second page we show you new, which is kind of basically just buying a brand new mortgage, so the lowest form of payup protection. And we’ve provided 3 plus years of history, here as you got to get a perspective of how things change.

I just want to point out a couple of things, going back to 2013 as part of our IPO what you can see that 85k, 4’s were very very high payup, and you also know that there were no 4.5’s there simply because they weren't being produced. You could buy a lot of 2.5’s at that time, but of course the world changed after the taper tantrum.

Also you can see in 2016 these payups got quite high, nearly as high as they were in 2013. Of course then we have the Trump administration win the surprise election, those values change. But I do want to point out that if you look at the first quarter ’17, they are relatively stable, at least most if not all and that’s certainly not all.

In some cases they were stable in some cases they were not. I mean in the case of 85k, relatively stable is for 4.5, but if you turn to slide 12 you can see in the case of the new that they continue to leak lower and that of course also is reflected in our mark-to-market because we do all the security.

So didn’t lead to second layer of widening if you well. Now I'd like to discuss our results for the quarter in little more detail. So if you would, please turn to slide 14 and we think this is a very important slide. And the reason we provided this slide, the way we have is the following.

Basically what you see here is in the case of the third column, the numbers that will appear on our [indiscernible] which we will file in the near future. This is basically the results of the quarter, but what we've tried to do here is to disaggregate basically our results into two general categories.

The call -- mark realized and unrealized losses, this basically just reflects mark-to-market on everything we own. So pass-through’s IOs, inverse IIOs, even though all our futures all of our hedges and these are of course subject to whatever happens in the course of a quarter. So these numbers can be quite volatile up or down.

The next column is basically net income absent in that and it basically shows you the things that tend to be more stable.

So in the case of the realized and unrealized gains and losses, these can and are often quite volatile from quarter to quarter and the net income basically shows you the net interest income from the portfolio less the expenses we incur, and these tend to be more stable.

The reason we do this is the following, we use what’s known as the fair value method of accounting which as I just said means that we take everything into earnings in every given quarter, everything that changes in value and this does and can – can and does introduce an element of volatility to our earnings.

That being said, without question the far right column it is the GAAP results that we reported and those are the most important results. But we're just trying to show you that we do have this component of our income that’s driven by mark to market events which can and are volatile and so in this case we have as you see on the table at the bottom.

GAAP net income of $2.45 million which is about $0.07 per share but the mark to market gains and losses were almost $0.63 a share, excluding those realized and unrealized gains and losses we have earnings of $0.70 for the quarter. Going down, starting with interest income $32 million that is a 29% increase over the fourth quarter of 2016.

It's result of our slightly larger portfolio and as I’ll discuss in a few moments some changes to the composition of the portfolio whereby we raise our weighted average coupon. Interest expense was up 35% to $6.7 million that reflects both the Fed hike in December of course its anticipation of another hike in March.

So why board and funding levels increased. Net interest income as a result is up 27%.

Expenses were relatively flat for the quarter, down 3% in the aggregate and the mark to market gains and losses across all assets and hedges $20.7 million or $0.63 cents per share that's verses losses of $38 million in the fourth quarter when we had the initial reaction to the Trump administration surprise win.

So we will continue to show this slide when it gets helpful to investors to recognize that there are very volatile components to our earnings so we're just trying to disaggregate them to make it easier for you to see that but we also recognize with the far right hand column is our GAAP results and those are of course the most paramount.

Turning now to Slide 15, we’ve presented this slide in our press release every quarter this is basically a roll forward of the portfolio as it tells you what happened over the course of the quarter. I want to point out a few things first in the column labeled pass-throughs.

You can see under securities purchased and securities sold that we did some meaningful reposition of the portfolio also in an effort to get the high average -- coupon higher, the age of the portfolio down and we also were able to do this with a lower average purchase price across the portfolio and Hunter and I will discuss that a little more detail in a few moments.

Also I want to point out the premium loss due to pay downs which is our proxy for premium amortization was $4.65 million that's down materially from $6.87 million in Q4.

With respect to interest only securities, we added approximately $43.5 million most of these IOs are off of jumbo collateral in other words very negatively convex collateral which has a lot of extension potential and operate scenario and that's exactly why we add it to protect against the more meaningful selloff.

With respect to the inverse IOs, you see that we have sales of a little over 38 million. This is a story that started in the fall of 2016, when perhaps as I mentioned earlier it gotten very very high.

We have taken steps to sell some of that collateral the street where it was structured into an inverse IO which we took back then with the meaningful selloff as a result of the Trump administration surprise win these bonds extended quite a bit and they have a lot of exposure to the very fun end of the curve and we look to reduce that exposure over the course of the first quarter of this year.

Now turning to Slide 16, not a lot to say here other than I want to point out the fact as you see our allocation of capital is closer now to 50:50, it was 54.2% pass-throughs at the end of year now it’s 52.4% and just as a reminder comparison at the end of the first quarter of ‘16 it was 59:41.

So basically reflects a change in allocation to reflect the fact that the structured portfolio is generating a little more return and as I mentioned, we wanted to add the IO positions to increase our protection against up rate scenarios. Page 17 shows returns by sector.

Like to point out one simple fact, as you can see there are realized and unrealized losses across all asset classes in the case of the IOs and inverse IOs it just reflects the fact there was a slight rally in the market, but in the case of pass-through’s it was widening. But in spite of that we had positive returns on all sectors for the quarter.

So we're very pleased with that it does reflect the earnings power in this case cannot wait in a very volatile quarter. Turing to Slide 19, this is the composition of our portfolio.

I do want to make another comment with respect to leverage, our leverage was up slightly from 8.4% to it’s going to be to 9.2 of course those numbers do not reflect the TBA shorts that we have in place which in our minds reduce our economic leverage by several hundred million.

The reason we feel comfortable with the leverage slightly high is one we've made some changes to the TBA shorts they have longer duration so that we get a great protection.

As I mentioned we added the IOs back by jumbo collaterals which also give us up rate protection and we’ve made some changes to our euro-dollars swap position which I'll get to in a moment. I do want to point out those, we met we did a lot for training for the quarter, the weighted average purchase price of the portfolio dropped from 108.64 to 108.26.

Current price of this quarter versus the last quarter was relatively stable, but we did raise the weighted average coupons from 4.19 to 4.31. So the training was done such that we can lower our average purchase price. And the increased our average grew point which is very positive for us going forward.

Slide 20, just lists our various repo counterparties there is not much to say about it, it’s self-evident. Page 21, lists our hedge positions. We show our euro-dollars. We took these positions outdoor in the first quarter. We now are basically at a 1 billion across all contracts with the exception of the first and last.

We do list in the far right column, our open equity.

So for instance the 1.36 million shown there in the bottom right, if the world never change from 3:31 that would be taken into taxable income interest expense rather -- over these contract periods and then the treasury future short that’s 3.1 million and again if the world never change that would be taken into account for interest expense basically over the next 10 years.

Finally on Slide 22, we show you our TBA short positions. We went from basically 100 million of 3’s and 100 million of 4’s at the end of the year to 150 million of 3’s to 197 in 4.5’s, since then we have moved the TBA shorts into all 3’s 250 million there.

With respect to our swaps, we did increase our swap position slightly from 700 million to 800 and also you can see on the second last call in the market value.

These are in the money as we speak, so to speak they order swap for $600 million or shorter swaps are quite in the money and the newer swaps with the pay fix rate of 2.14 slightly out of the money. We’ll take a second and discuss some trading activity Hunter. By the way this is the last slide, this shows your hedge position laid out over the curve..

The primary theme in the first quarter and really even extending into April has been to continue to shorten the duration of the portfolio, we've done so as Bob just mentioned adding hedge positions, adding to the swap position, adding longer TBA shorts, vis-à-vis the Fannie 3 shorts that we have in place and continuing and up in coupon shift out of lower coupon, 15 years, 20 years and even 30 year 4%, 4.5%s which were the really the performance of the 4.5%s was a primary culprit of our unrealized and realized mark-to-market losses in the period.

Coupon widened considerably versus treasuries using Wall Street hedge ratios on 10-year. We spotted that the coupon under performed by roughly 0.5 point maybe a little bit more than that depending on whose hedge ratios you use. So, we've continued to sort of leg in as that coupon has gotten cheaper.

As Bob mentioned, the first quarter was big for reducing our exposure to inverse IOs. We had a unique opportunity similar really to what we saw in the third and fourth quarter of 2016 when pay ups were very high in the early part of the first quarter, we saw at least on a spread basis very tight levels for certain call protected inverse IOs.

I think there was some concern that we've gone too far and might rally back a little bit in the wake of the Trump Euphoria that we saw in the fourth quarter.

Whatever the reasons was, we were able to at least on a spread basis sell those inverse IOs at what have basically been year-to-date types for loan balance and other call protected types of inverse IO securities off of the coupons we like, which is primarily 4% and 4.5%s.

As Bob alluded to, throughout the period, we shifted that capital allocation into fixed IOs which are have a large negative duration. Again we're bolstering our position for continued – continuing to be prepared for a rate increase.

So, as we legged into those positions through the quarter, we continue to rally and have actually rallied a little bit in the second, beginning of the second quarter here through April. So, that was a way to our results as we were sort of legging into negative direction positions as the market rallied.

So, it worked against us a little bit in the period, but we'd like what the portfolio is now is significantly shorter if we do get a pop up in rates or an inflation scare of some sort or just realization of any of the things on the Trump agenda that are important ions. I think we can see higher rates starting to see inflation pick up.

All the economist, Bob and I follow are sort of uniformly in the cast that we are going to see higher inflation this year. And I think that it will pay to be prepared to for if and when that happens.

You want to add anything to that Bob?.

No, I would say, the portfolio has been for quite some time now kind of biased to an uprate scenario. We continued on a lot of securities that have risk, their exposure to prepays, whether it's hard coupon premiums or the IOs and inverse IOs.

We have periods like we did, mid to late 2016, probably the election, you have a big rally that amortization puts downward pressure on our earnings. But we do view the underlying economy is quite strong and the market very much is focused on trump and his ability to execute on his legislative agenda right now.

It looks like it's maybe a struggle and of course the first quarter data was, we can sell, the market just kind of sees that as reinforcing this kind of negative bias.

But I think if you look at the underlying economy, it's still quite strong whether it's the housing market in the case of say for instance home price appreciation running in the mid-single digits, very strongly, new home sales, existing home sales are still increasing. The labor market is still strong.

The Fed has mentioned in many cases that they view say 50,000 to 100,000 is the number of jobs that need to be added and recorded absorb new entrants to the workforce. We've been running above that for some time.

Various measures of unemployment continue to either be flat a low level or trend down and the consumer spending as a result is – there is some volatility, certainly what we saw today when it was only up 0.3 for the quarter, but it's been running in the high 2%s, low 3% for a number of quarter.

So, all the underpinnings of the economy appear to be strong. I suspect there is some issues with the GDP there that tends to have some seasonal adjustment factors wherever the case maybe. It doesn't seem to be consistent with the rest of the data. So, we are positioned for up rates and we see the economy being supportive of that position.

As Hunter mentioned, inflation is – the price component today was 2.3%. We think it will continue to trend above the Fed too and through the Fed 2% target. I think the Fed will continue to raise rates, probably more aggressively in the Fed that the market is pricing. So that's kind of it. Operator, I think we're ready to take some questions.

[Operator Instructions] Our first question is from the Mickey Schleien of Ladenburg.

Good morning Bob and Hunter. First off….

Good morning..

Your prepared remarks were very good and I appreciate you taking the time to explain the backdrop for you investment thesis. Just wanted to ask you about the balance of the year, there is certainly lot of uncertainty about how and when the fed will start shrinking its balance sheet and the potential impact on spreads.

So, I'm curious to understand how that uncertainty is affecting the cadence of your capital deployment?.

Thank you. Good question. As I said, I think the key is the market has formed an expectation of how they think this will play out. And that is that it will start probably late this year early next and it will be a wind down on the reinvestment at a gradual pace.

What critical I think is, whether or not they stick to that, to the extent they accelerate that or they change that, then I think you'll see more widening. For now, it's been modest. We did see some widening. We may see some more, but it's not been shocking, it's nothing like the taper tantrum in 2013 and I think that's probably key.

The fed is very cognizant of what happened then and they want – it appears they want to avoid having that happen again. Ben Bernanke wrote [indiscernible] and he talked about the need for a gradual pace and I think that made sense. I think the various state governors that have spoken and Board members have echoed that.

So, really, we do anticipate there may be some slight widening over the balance of the year into next. But as long as the rhetoric stays consistent, I think it will be very easy to live with for lack of a better word and also represent some slightly improved investment opportunities..

So, Bob, given what you just said, it doesn't sound like you're going to take a wait and see attitude and you know retain dry powder. You're – it sounds more like a steady as she goes investment pace unless you see something to change your fundamental view.

Is that – would you agree with that?.

Yeah, I would. That's a fair assumption..

Okay. That's it from me. I appreciate your time this morning. Thanks..

Thanks Mickey..

[Operator Instructions] Our next question is from the line of David Walrod of Jones Trading. Your line is open..

Good morning guys..

Good morning Dave..

Hey David..

Just a little more on the Fed.

Can you kind of walk us through your outlook for the pace of rate increases and how you position the portfolio?.

Well, it's – the position of the portfolio as I said is very much biased towards you know stable to higher rates. I think the Fed is going to go in June. The current Fed funds futures is pricing 70% depending on the second you happen to look at the screen. And I think you'll probably get at least one more hike after that.

Everything in the economy seems to be sounded strong and inflation appears to be increasing, so I think they are going to continue to go through the process of normalization. I think the market's a little overly focused on what Trump's able to achieve, the timing of the year doesn't help.

You know first quarter this year was weak and has been for several years. We'll see what happens going forward, but the fundamentals in our minds tell us that this first quarter is not going to be repeated. This is not indicative of what the underlying strength of the economy is.

So, I think you continue this see if the fed goes in June and what's more that's three hikes this year and you'll probably get more next year. I think what will determine what happens in 2018 is going to be the extent to which inflation gets above 2% if it does in a meaningful way then you will definitely probably see three hikes in 2018..

Hey David, this is Hunter. If you happen to have the slide deck in front of you and can go to Page 23. You can see that with respect to how we're prepared for coming Fed hikes.

We have a very large hedge position skewed towards the first three or four years of given for the next three or four years and the vast majority of that is comprised of or I guess about over two-thirds of that is comprised of short euro-dollar positions and pay fix swaps.

So, to the extent that the Fed goes more than anticipated or even just follows really the path of forward rates as you can see on – there is a dotted line that shows what tariff structure looks like at the moment. Those hedges will continue to go in the money and help offset our interest expenses in coming quarter.

We do have a little more of a skew towards the long-end of the curve than we have traditionally in the hedge book. This is accomplished through shorting TY no futures and also being short at the moment some longer duration mortgage PBAs.

So, we – those two positions in conjunction with our skew back towards being more along IO than inverse IO in our structure book, definitely puts us in a position where, if there is a surprise to the upside and inflation, we're prepared for it.

But, for the next one, two, three four years, we do have considerable amount of protection on the front end of the curve as well..

Great that's very helpful.

Then my other question is, just in regard to pre pays, can you give us your thought on how they are going to trend in the coming quarter?.

That's always a tough one because we feel fairly comfortable with our view on the Fed, the long end can be driven by a number of other factors. I suspect it's going to be much more tamed than last year.

You know we have the French election coming up and that seems to be the last hurdle for the ECB to get over in terms of the risk to the economy and the markets in Europe. Yesterday, Draghi was fairly bearish and the underlying data in Europe continues to be fairly sounder evidence of recovery.

And that's been, it's with the extent that Europe continues to recover and we start looking towards a tapering of ECB purchases. I think that important, because what drove rates in the long-end down in the U.S. for a long-time was relative yield difference between European sovereigns and treasuries.

And so, between the Fed buying treasuries and investors buying them because they were such a high yield relative to what was available in Europe.

They really were suppressed and couldn't really respond in a meaningful way the economic data to the extent that source of demand is removed both in the case of the fed and investors overseas, because the yield gap between European and U.S. spreads are lower.

That would imply that the long rates could go higher and of course to the extent they do, that's going to keep fees lower. So, we view those development would be positive obviously. You know even risk, geopolitical risk and escalation of what's going on with respect to North Korea would cause a flight to quality and lower rates.

Let's hope we don't see that for a number of reasons, but you know the backdrop I think is favorable for rates to stay here, creep higher..

I would just add that just more locally I guess our earnings were really impacted by the speeds we saw in the fourth quarter and we are going to witness a – and have a market – mortgage market that has considerably slower speeds than what we saw.

Those even creep early in the January, so absent that negative influence and sort of fully being into the plus 2% 10-year treasury to even 2.30%, 2.40% as we've witnessed over the course of this year so far. That's a dramatically different rate environment and then dramatically different speeds environment.

And I think you can see that starting to show up in our numbers like our premium lost due to amortization, which is sort of an important theme I guess with respect to the earnings power of our portfolio, because it didn't look all that great in the fourth quarter when we were seeing a lot of pressure on our amortization, our income via amortization and that headwind is really come off pretty strongly in the first few months of the year, and in particular in February and March.

And so, we may see a slight uptick as rates bounce around or as we go into the sort of the seasonally high turn portion of the year which is summer time when people move, but we think that our earnings power is much more in line with our given in pay rates now than it was at the end of the fourth quarter..

Okay great. Thanks a lot guys..

Thanks Dave..

Thank you. Our next question is from the line of Andre [indiscernible] or State Capital. Your line is open..

Hi guys. Quick question, just going back to some boring accounting and then mark-to-market share value thing, I guess the other way that sort of flows through is through the balance sheet and that seems like it's picked up leverage quite a bit where we're close to 9 times now..

Right..

What leverage are you comfortable taking on to maintain the dividend?.

Thanks for your questions and thanks for asking the question. We're definitely at the higher end of the range in the low 9s, our leverage is probably ranged from the mid to low 6s at the extreme low and so this new low to mid 9s. As I mentioned, the reason we do feel little comfortable is we made a few changes to the composition of a portfolio.

One, as Hunter mentioned, we've changed the composition of our TBA shorts from you know a mix of low and high coupons to exclusively lower coupon. So, in this case it's fairly 3s, long duration hedge. We've also added to our euro dollar and swap hedges.

And then we've also added these IOs that we talked about which have what we call extension potential in other words. These are IOs backed by collateral that is typically paid very, very fast. It's jumbo collateral.

So, when these borrower are in the money, they tend to prepay very, very fast and when they're out of the money they prepay very slow very binary if you will. And so, with the backup or any backup in rates, those prepayment speeds can drop precipitously and those IOs perform extremely well.

So, we basically enhanced if you will the hedges to allow us to get more comfortable with that leverage level to the extent that we do get for instance a meaningful sell-off and those hedges work.

At some point we say, look, we view going forward, maybe the balance is more, risk is lilted more balanced and we all need as much of rate protection which case we could take some of that off. But we definitely, we're cognizant of the point you just raised and we did take these steps in advance of allowing the leverage to creep higher..

Just some ballpark numbers, the way we think about is, Bob, I think mentioned earlier in the call that we were short roughly 250 million Fannie 3s and TBA form. We still like this takes off a little bit more than one turn of leverage without adding a lot of risk.

So, the trades that we're putting on that go against these shorts and there is a little bit of curve exposure in that we're buying some higher coupon stuff and we are shorting the Fannie 3s. But we're buying very low pay up bonds that we expect to carry well for a few months versus those trades.

So, it's really just a little bit of earnings boost that we put on in this trade and to the extent that we get a sell-off, it helps us with our hedges and it also helps with current carry.

But – I think we put in our last dividend press release what we called our effective leverage ratio, where we sort of backed out the effect of TBA shorts from the balance of the portfolio or the balance of our liabilities I should say. And, so that's just something to be cognizant of.

It's not – I'm not saying that it's not added risk, but it's a much different form of risk..

Got it.

So the headline number is a little bit higher than you'd like, but there are some things in there that you think count against leverage, but don't flow through the financials?.

Yes..

Yes..

TBA shorts don't reduce the liability balance..

Right..

Right. Great, thank you..

Thank you..

Thank you. And that concludes our Q&A session for today. I'd like to turn the call back over to Robert Cauley for any further remarks..

Thank you, operator. To the extent anybody comes up with a question after the call, they didn't think of now, please give us a call to the extent you capture the call on a recorded version versus live. Feel free to call us. Our number here at the office is 772-231-1400. We will be available and very willing to take any and all questions.

Other than that, we look forward to talking to you next quarter. Thank you..

Ladies and gentlemen, thank you for participating in today's conference call. This does conclude today's program and you may all disconnect. Everyone have a great day..