Robert Cauley - Chairman and CEO Hunter Haas - Chief Financial Officer.

David Walrod - Jones Trading Christopher Nolan - Ladenburg Thalmann.

Good morning. And welcome to the Fourth Quarter 2017 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, February 9, 2018. Before we begin, the company would like to direct you to their corporate www.orchidislandcapital.com.

Here under the Events & Presentation section of the website you can find the supplemental materials that would be reference during today’s call.

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 the 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 thank you everybody for joining us this morning. I am going to go through the slide deck, I hope everybody had a chance to visit our website, the Events & -- Event section of the website and pull down the slide deck.

As I go through, I am going to be flipping from page to page, I won’t necessarily go in the order that the slides appear in the deck and accordingly I will move slowly so everybody had a chance to catch-up and follow with me. As I have done in the past, I am going to kind of follow the same rough outline.

I will start by giving a brief overview of the highlights of our results for the quarter. I will then move on to a discussion of events that took place in the markets during the quarter, kind of with an eye towards focusing on the events that were most relevant for us.

Then I will transition to a discussion of how we were positioned going into the quarter. What we did during the quarter with respect to the portfolio and how the events that unfolded during the quarter affected us giving our position.

Then I will discuss the results in more detail with respect to the portfolio which again I will focus on what happened and how we were positioned. I will talk briefly about the events that have unfolded since the end of the year, which is you all know are quite substantial. Then I will have a discussion of our dividend.

We did lower the dividend in January, I will kind of give some background information what went into that decision. And then finally, I will talk about our share repurchase program. Yesterday, the Board authorized an increase in that repurchase program and I will give you some details on that.

With that I will turn to slide four, which is the highlight of our results for the quarter. I will give everybody a second to get there.

Bottom -- topline number was earnings per share, we have a net loss of $0.12 per share, as always unrealized and realized gains and losses on all of our holding in our portfolio as well as our hedges are reflected in that number. Those were $0.61 loss.

Focusing on just the kind of our proxy for core earnings, excluding those mark-to-market gains and losses we had earnings of $0.49 per share. Book value was down in the quarter, was move down $0.44 to $8.71. We declare dividends totaling $0.42 per share for the quarter.

Economic return was a negative $0.02, annualized 20 basis -- 20 basis points or 90 basis points on the year. The total return for the year was 2.9%. Now I will go through some of the events that unfolded during the quarter and as I said, I will try to give everybody a moment to keep up with me. The next slide is going to be six, page six.

And what we have here basically what happen on the long end of the curve, the 10-year treasury and 10-year dollar swap, that is the most relevant, put on the curve for mortgage investor generally speaking because it tends to have the greatest influence on mortgage rates and agency mortgages are driven by movements in rates and prepayments, so obviously very relevant point.

As you can see during the quarter there was very little movement on the long end of the curve, either swaps or in just straight treasuries there was a sell-off in September associated with debt actions and data turning around, but basically nothing much happen on the long end of the curve.

However, if you turn to slide seven, same thing we have the treasury curve on the last and the dollar swaps curve on the right. You can see that the curve flatten quite a bit, both curves. This had to do with the markets starting to price in more hikes by the Federal Reserve in 2018 and possibly beyond.

As you recall, the Fed hike twice in 2017 in March and June and then in September now they were going to let their portfolio start to wind down, but more importantly it was a statement of the effect that the Fed was looking at most recent negative inflation data or soft inflation data, I should say, looking beyond that, they were of the opinion that inflation would hit back towards a 2% target and that means events would driving inflation to be soft or transitory.

And as a result, the market started to price in more hikes and of course, the data were strong and most significantly the administration and Congress where we get the tax package done, it’s quite fiscally expansionary 1.5 trillion estimate deficit spending over the course of the next 10 years. So that was what caused the curve to flatten.

Slide eight gives you a pictorial representation of this. As you can see as we ended nearly end of the year, the 5s, 10s curve which has become the markets favorite proxy for the shape of the curve reached the very 50 basis points towards the end of the year had been as high as 253 basis points in November of ‘13 after the taper tantrum.

I will say something about this a little more as it pertains to our positioning, but for now I just want to point this out that this was kind of most meaningful development in the fourth quarter was the almost daily drop in the slope of the curve into early ‘18.

Now turning to slide nine, we have several things in pictures on this page, I want to talk about. Top left shows you the performance of Fannie 30-year fixed rate, Fannie 4s and Fannie 4.5, these are the TBAs.

If you are familiar with us and our positioning for the last several years actually these tend to be our core holdings and as you can see pricings of Fannie 4s were down 29 ticks and I am sorry, 20 ticks and Fannie 4.5 were down 29 ticks. In comparison Fannie 3s were down 6.5, Fannie 3.5s were only down 10.

This was a result of the flattening of the curve. These coupons duration wise the 4s and 4.5s are more in the belly of the curve and that’s where we have the greatest sell-off a long end of the curve as we discussed previously really didn’t move so much. So our positioning were heavy concentration of 30-year 4 and 4.5s was not idea for this quarter.

We have been positioned defensibly especially since the fourth quarter of 2016 and even beyond that did well on a relative basis then that threw a lot of 2017 was not as ideal position especially in this quarter with the big flattening. Bottom left just shows you the performance of the rolls of those mortgage coupons.

You can see that the 4.5 roll spiked in early December. We actually took advantage of that and put on some long Fannie 4.5 TBAs. We did so by delivering some pulls into that and that was a means by which we could shed some effects of paying pulls and take advantage of the pop in the roll.

On the right hand side we show the payouts for few representative securities. On the top is the 85,00 KMAX. These are kind of the highest payup premium pulls. Below that is just new production which would be the lowest of those. So we kind of showing you the bookends and this really goes back all the way to out inception in early 2013.

Just focusing on events for 2017 and in particular the fourth quarter, you can see that these payups were very stable and also -- if not slightly higher. Keep in mind, I mentioned, the fact that those two coupons had a really rough quarter underperformed. So net-net in total dollar price, these were still somewhat down.

But they did show very significant resiliency during that period and even into January of this year when they still remain strong. The February cycle was a bit challenging, because that’s when the turmoil in the market has started last Friday really started to kick in.

With that, now I am going to kind of move on and talk about how we were positioned in greater detail and then we will get back to how the inter-wind of our positioning and developments in the markets effecting our results. So I am going to turn to slide 16, get everybody a second to get there.

This is kind of the most the big picture view of how we are allocated. Starting with the top left, you see the allocation between -- of our capital between pass-throughs and structured, and this is running in a fairly steady range for some time.

It’s started to change in the second late in 2017 when we started to add -- appear to add more pass-throughs versus structured securities. But really I will just explain in a moment that’s somewhat misleading. We did reduce the positions in the structured portfolio. We sold two inverse IOs.

Those were in response basically developments with respect to Fed expectations. That has since changed. I will get into that in a few moment in terms of the first quarter of ‘18.

Top right you just going to see the size of the overall portfolio and as you know we have been growing the company for some time since inception especially starting in early 2014. And the allocation to fixed rate is, as you can see has resulted in a pretty sizable portfolio.

One final note on the bottom right hand as I said, we did lower our inverse IO holdings during the quarter and I will get into that in a little greater detail in a moment. Slide 15 is just something you are familiar with. This is basically our portfolio and I have a lot to say here.

Other than as you can see on the topline adjustable rate securities arms and even 15-year we have been reducing those holdings and continue to do so, the portfolio is again predominantly 20-year fixed-rate mortgages and 30-year 4s and 4.5s and as you look to the right you can see that the average coupon on the 30-year fixed rate is 4.29, it just reflects a slight skew towards 4.5 versus 4, but that has been coming down.

It used to be more greater skew if you will. Slide 19, I will give you a second to get there, this is where we have kind of talk about our hedge positions. We have made changes to those, which I will get into in a moment, but I am just kind of go through where we were at the end of the year.

On the top left you see our Eurodollar positions going back to our inception when we were very small company.

Eurodollars were only -- the real -- only the -- only hedge instrument available to us in a core part of our hedge strategy, since then we have gotten away from that somewhat but as you can see we still have substantial Eurodollar shorts in place through the end of 2020 hence the weighted entry rate which is listed in middle of table, as you can see in particular for the next two years is either in or close to in the money.

That’s -- was not been the case historically as the forward curve has never been really realized for some time.

With respect to our TY hedges, we did make some changes to that, actually in August, so that was late third quarter, when the curve was flattening -- before it started flattening and when the 10-year was on the verge of going to 2% we moved our hedges more towards the belly and reduced our TY short.

Top right, we talk about out -- we show our TBA positions. We have traditionally started 3% or 4% coupon TBAs. I mentioned earlier when the 4.5 were popped we added a long position there and delivered pools. Note also that net-net we are still short TBAs.

And then finally our swap positions, we have little over $1 billion in swap in place at the end of the year and those are now in the money, weighted average rate of 1.43%, that is finally in the money. It’s been a long time coming. With that, I am going to move on to slide 13A/B, give you a second as always to get there.

This kind of shows you in detail what we did in the portfolio and I am going to start on the left hand side of the page. And as you can see, the allocation to pass-throughs went from 63.7% to 73.5%.

And as I said that’s somewhat misleading and the reason that it went up so much -- in fact if you look on the right hand side you can see that the market value of our pass-throughs is actually down on the quarter, even though the capital allocation is much higher.

And the reason is that while the capital allocation to pass-throughs went up $80 million, most of that is because our cash balance went up by $65 million. So the way we do this capital allocation calculation as we include cash in the pass-through strategy. It’s predominantly there available to support margin cost on the portfolio.

We typically don’t apply much leverage to the structured securities and so we included there and we are raising capital during the quarter and we basically allow that cash to accumulate as a results our leverage ratio which I believe is on slide 18 dropped pretty precipitously.

And so even though we had a long and the TBA 4.5 I mentioned, I also mentioned, that we are net-net short TBAs and so unlike say, some of our peers who use a lot of dollar rolls, their economic leverage is often higher than their GAAP leverage ratio. In our case that’s not the case. Our economic leverage ratio is actually lower.

So we did appear to increase the allocation in the pass-throughs, but that’s really misleading it. It was just a cash allocation predominantly and as I mentioned, we have leverage ratio that drift down.

Now, I will go to slide 11 and we will talk about how this impacted us in terms of results, we have talked about what happened in the market, how we were positioned and what we did with respect to the portfolio during the quarter. On the right hand side, you see our returns by sector. The pass-throughs had a negative return.

That basically was driven by the fact that we were positioned in higher coupons and the curve flattened and they underperformed.

As you see the realized and unrealized losses were over $43 million, almost 9 million of that is what we call premium loss into pay down under our accounting methodology we do not explicitly amortize the premium on our fixed-rate pass-throughs.

It’s captured in the mark-to-market, so $9 million of that $43 million is just premium loss due to pay down, but there were still obviously a sizable move in the portfolio. The hedges were unable to offset that.

With respect to the structured securities, as you would expect, IOs did fairly well with stable long-term rates, but inverse IOs did poorly as a result of the movement on the front-end of the curve and an increase in Fed expectations, and as I mentioned, we sold two of those positions, which also helped cause the -- our allocation to shift to the extent that it did.

So that’s basically our results, now I would like to talk about what’s happened since the end of year and what that is -- we have done as a result. As far as 2018 goes, it’s really a tale of two periods.

Up until last Friday when the pay roll number was released and average hourly earnings had spiked much more than the market expected and caused quite a bit of turmoil as we all know. But up until that point it really just been a long end sell-off.

The yield on the 10-year moved from the low mid 240s which is where it ended 2016 and moved into the 280s. So that was kind of meaningful sell-off and steepening of the curve.

But then as I mentioned last Friday things started to change dramatically, volatility has spiked, obviously, as mortgage investors volatility increases our negative for mortgages. There is evidence that we may have some inflation, obviously, the equity market has been extremely volatile. The curve 2s,10s has steepened.

Although, the 5s,10s has remained more or less, it’s kind of up only slightly from where it end of the year, but that mostly that is because it flattened end of the year and then steepened in the last week. So it appears to be almost down for the year but that’s doesn’t reflect what’s happen since last Friday.

What is notable though is that starting last Friday with the large equity move and what we have seen over the course of the week. As of yesterday’s close we are at a point now where the equity market has sold off approximately 10%, but rates of that where they were after all the earnings numbers, so the 10-year as well in the 280s.

And I think what that means is from the perspective of the bond market that’s significant, because it means that rates where they were week ago, even though there has been a 10% correction in the equity market and a big uptick evolve.

So I think that one thing that may pretend is that the rates market believes that this turmoil in the equity market is temporary, the economic fundamentals are extremely sounds, fiscal policy has become very, very stimulative, as you all know.

President Trump signed a bill that was handed out overnight and that’s going to increase spending almost $300 billion over the next two years coupled with the tax cut. So we have got very, very stimulative fiscal policy in the U.S. The economy was very strong coming into this and of course, globally everything is strong as well.

So, I think, unless the equity market really rules over the bond market seems to be of the mind that, this correction is not a material lasting effect in, it’s seems like it’s going to continue to sell-off and in fact have so far today.

So what does that mean for us? What have we done? Up until last Friday volatility was fairly well and we took advantage of that. We put in place a couple of swaptions along the long end of the curve or I should say one large position. So we were able to put it out in a very attractive price.

We put in place a receiver in the belly in case we were wrong to kind of offset that, but only partially. The volatility reduced by the equity markets and the resulting rally earlier in the week when rates rallied two-year rally below 2%. We took advantage of that by adding to our yield on our positions.

We moved those shorts up fairly substantially and we repositioned our TY hedges little more balanced between the belly in the long end of the curve. We have also added that to our IO position. I talked about how that it come down somewhat in the fourth quarter.

We move that much closer to being in balance taking advantage some attractive IOs that were available at the time. So that’s kind of what we have done post year end. Now I would like to talk about dividend and I am going to start with slide eight.

As you recall, I mentioned the fact that the curve has been steepening -- has been flattening rather for some time, really kind of reached the peak after the taper tantrum, but it’s trended down ever since and that accelerated late last year. If you look at slide 12, I will give you a second to get there. You can see two lines here.

On the one hand you have the blue line which is our reported earnings per share by quarter. As you can see for the fourth quarter we were down $0.12.

Then you see a red line which is simply taking the earnings per share as reported and removing the unrecognized and recognize gains and losses, that’s our proxy for core earnings, although it’s -- I use that with a small P.

It’s really not a pure example of what our core earnings are but it does get the point across as you can see at the end of the March quarter we were at $0.72 and it is drifted down substantially and that is reflective of what we have realized in the portfolio.

Finally, let’s go to slide 17, this is a little more accurate picture and we have several lines here on the top.

The blue line represents the yield on our assets and as you can see for instance going back to March of ‘13 was around 2.5%, that was before the taper tantrum, that’s when we were in extremely low rate environment and really seem like we would potentially be there forever. Then we did have taper tantrum.

And as you can see that trend -- that line is continue to trend up and as of the end of 2017 it was over 400 basis points, so substantial move.

However, if you look at the red line, which is our economic cost of funds, you can see that line was extremely well for a long period of time approximately 35 basis points, hence since moved up to almost 200, so a very substantial move.

The green line is the net of the two, as you can see, early in our life, that number moved materially higher and eventually got to be north of 300 basis points. And if you look at the bottom side of the page, you can see we had a substantial dividend increase from $13.5 to $18.

However, that green line in the pulse taper tantrum world started to slowly come down as our combination of things depending on the time and the year, but substantially come off that peak, and first, resulted in a dividend cut in the middle of 2015 and now as we ended 2017 that number was all the way down to barely over 200 basis points and the dividend was unsustainable at that level and we were required to reduce it from $14 to $11.

Going forward, obviously, as you can see the shape of the curve matters, up until a few weeks ago when the curve was on -- seem like a never ending flattening trend and there were many pundits out there thinking that it would eventually get inverted that scenario is not good for a NIM type business model such as ourselves.

However, since then the market seems to have turned around at least for now and as we steepening that is a more favorable environment.

As for the balance of this year and Orchid Island Capital’s dividend, it’s really too hard to say at this point, because we don’t know, we don’t have a crystal ball, we don’t know where the markets are going to go with any high degree of confidence simply because it’s the volatility here is still very much at play and as I mentioned earlier the equity markets were to rollover and really cause problems to the financial system then the Fed may in fact pause and that could kind of change everybody’s outlook on rates going forward.

Absent that we would probably continue to sell-off, the Fed will continue to hike rates and the curve may not flatten as much as it appeared that it was going to a few weeks ago, time will tell. And then finally, I would like to talk about our share repurchase program, that’s on slide 22. This basically shows several things.

The red bars are our book value per share over time and the blue line just reflects the price of the stock. Now in this case we started at the end of 2013. 2013 was the year of the taper tantrum but it was also our first year of operations and we did basically no capital raising of any kind nor did we do any share repurchases.

But as you can see as we entered 2014, rates were a lot higher. We did a couple of secondary offerings. We were able to grow the company substantially, get to a point where we actually eligible and it’s through an ATM program, which is what we did in the middle of 2014.

As you can see that the blue line was pretty much constantly above the book value, there is a few moments where it’s not, that’s simply on our X dates and we were able to start to raise capital through our ATM program and it was very, very an attractive way to raise capital because the cost is so low.

As I mentioned earlier, we had reduced our dividend end of 2015. At that moment our stock traded materially below our book value and we put in place a share repurchase program, which we -- 2 million share program. We used about 60% of that. Mid ‘16, things started to recover.

Even though the stock wasn’t completely above book value on a consistent basis, investment opportunities were attracted and we started to use the ATM on a limited basis. In the latter half of that year, environment was extremely attractive.

We raise a lot of capital and had a very nice premium to book and that continued throughout ‘17, where we were trading above, plus we were able to utilize our ATM program. But now look 2018 and we are trading substantially below book value. As a result, yesterday afternoon the Board voted to increase the size of our share repurchase program.

It is now up to 10% of our outstanding shares and we hope to put this in place as soon as we exit our lock up period very near future. To the extent the stock continues to trade at the material discount to book. It will probably be the case that our best use of our capital is to repurchases our shares at that discount.

If at some point that’s not the case and the discount goes away or substantially reduce, then we may back off from the program.

But one thing I do want to demonstrate when walking you through this slide in such detail is to show you that our -- one of our primary goals in running the company is to take advantage of these opportunities when they present themselves, so when the share prices above book value we can sell shares accretively, we do so and when the share price is substantially below book value we can buy them back accretively we will do so.

So the idea is to try to take advantage of these opportunities when they present themselves. And that concludes my prepared remarks. Operator, we can open up the call to questions..

Thank you. [Operator Instructions] And our first question comes from the line of David Walrod from Jones Trading. Your line is now open..

Hey. Good morning, guys..

Hi, Dave..

Good morning, David..

I guess, a couple questions around one theme, you raised a lot of capital in the fourth quarter, you mentioned that the capital allocation to the pass-throughs was skewed due to the cash and also that your leverage was down at quarter end.

Can we expect you to, I guess, number one, bring the leverage back up closer to the high 8s, low 9s, and two, then that capital allocation to be more where it has been historically?.

Well, we -- as I mentioned, we have already taken a step to do that so far this quarter.

The leverage ratio is not quite up to that level, we are watching that closely, because with the sell-off and the -- there is two things that mortgagers don’t like, one, is an increase in volatility which we have had and obviously increase in rates which where the negative convexity of the mortgages can kick in and the extension of mortgages, as a result, we are mindful of what’s developing in the market and whether or not we should be increasing the leverage.

As of now that decision has not been made. There was a slight uptick but not to that range.

You want to say something, Hunter?.

No. I -- David, in the fourth quarter we sold a rather large proportion of our inverse IO portfolio. So it was one trade consisting of a few securities that really threw that number off, so it was, I think, I believe it was so what $15 million and we ended the year with $121 million portfolio. So it’s a relatively large percentage.

Since year end we have kicked up the portfolio both because the IOs are appreciating in value and because we are explicitly adding them. So we are getting back to a more normal, I think, we went from the derivative portfolio being $121 million to just under $140 million now.

So that’s the combination of an increase in the market value of some of the negative duration bonds into the sell-off and some adds that we’ve done. So it’s trending back towards a more normal level..

Okay.

And also with the capital raise, can you talk about any drag on your effective earnings as you guys raise capital and then deployed it?.

It was particularly late in the year and that’s really when we had to lower the dividend, the curve was flattening. It was just too much.

I mean, we were selling shares early in the year, even really into the very earliest fourth quarter was some of that attractive opportunity then it just really kind of went away from us and that’s why we had to basically collect dry powder wait for a better entry point, which present itself as I mentioned in the early 2018 when that money was put to work.

But it was bit of a drag, presumably now that drag has been removed, assuming the curve doesn’t continue to flatten and so that’s basically that..

Okay.

And then my last question is, you can just speak to, when you think -- when your portfolio -- when your capital is fully deployed, the earnings power of the portfolio, do you think it’s in line with your revised dividend or just what are your expectations there?.

It is as of January and February, but as I mentioned, it really is TBD, because we don’t really know how things are going to unfold.

With this steepening, that’s a very strong positive for us and to the extent that even with the Fed hiking, if the long and continues to move and we can maintain our NIM and we have also don’t forget concurrent with that steepening is probably a slowdown in speeds and we still have a high coupon concentrations, so that’s obviously a very big positive for us.

Also as Hunter mentioned, the IOs that we have added are very much benefiting from that move, so to the extent that trend continues then that dividend seems or appear to be very sustainable.

To the extent that things go the other way, say, for instance if the equity market really rolls over and the Fed has to pause and the curve resumes its flattening trend then that would be a negative.

That would be a negative for several reason, one, because our NIM would be compressed, simply because of the gap between funding and yields on our assets, but it would also probably cause refinancing activity to pick back up and it would also be a negative for the IOs that we have added.

So it’s we really have to just be careful to watch our events unfold over the balance of the year to determine what we do going forward..

Yeah. David just wanted to add a couple of points there. We are really sort of a pivot moment here, where we are going to see what the earnings power of the portfolio looks like in a market where mortgage rates to borrowers is in 450, I don’t know, call it a range of 440 to 465 over the course of the last several weeks.

So as you know, our theme has been to maintain a relatively short duration asset mix through by high premium mortgage-backed securities.

So the one thing that pinched us in the fourth quarter was that we saw the rate movement in the belly of the curve, which lines up with the durations of those bonds work against ourselves 4s and 4.5s is there kind of in the three-year to five-year duration type bucket, that’s where the curve moved the most.

So we saw the negative price action associated with that rate move, while at the same time, we didn’t get the benefit of mortgage rates to the borrowers underlying those bonds moving to a point, our mortgage rates more broadly moving to a point where those borrowers did not have an economic incentive to refinance any longer.

That has since changed in the first quarter. So a large portion of our portfolio is now out of the money so to speak. So those borrowers do not have an economic incentive to refinance, that’s especially true for our derivative portfolio, including our IOs.

So we are going to see over the next couple of months how much the yield on that -- on the asset side of the portfolio has extended, thus far we are really only seeing the negative impact of the increase yields on the funding side of things. So it will be an interesting couple of months.

I mean, we have an idea obviously of what we think that’s going to settle in. That’s generally consistent with the distribution rate that we are making.

But I think the earnings as it relates to your question, the earnings power of the portfolio is in the state of change and a lot of that state change will ultimately depend upon where mortgage rates to borrowers settle in here..

Okay. That’s it for me. Thanks guys..

Thanks, Dave..

Thank you. [Operator Instructions] And we have a question from the line of Christopher Nolan from Ladenburg Thalmann. Your line is now open..

Hey, guys..

Hey, Chris..

What was the weighted average price of shares that were issued in the fourth quarter, please?.

I don’t have that in front of me, I want to say it was in the high 9s, but I don’t have that in front of me, I can get you that information..

Okay.

But it looks like it was accretive to book value?.

Oh! Yes..

Great..

Yes..

All right. And then, if I am reading this right, Bob, if the longer duration on the portfolio, that’s actually working to your advantage as the curve steepens, because I thought it would be the opposite.

I’m just -- I was little confused by your comments to David a minute ago?.

No. Well, what we were talking about and especially the Hunter was stressing was the borrowers rates, so we will be backing up of rates is good from the perspective of prepayments, it’s good from the perspective of the performance of our IO securities.

But as two mortgage durations extend, that’s a negative for the pass-throughs all else equal because they are going to extend be down in price and pay out premium did extend on specified pools will be hurt. So that can be a negative. There is the convexity component of our pass-through portfolio. And so we have adjusted our hedges accordingly.

We’ve increased the percentage of the liabilities stock that is hedged in response to that. So we are trying to mitigate the effect of that.

So it really depends on what perspective, if you’re talking about book value that increase in rates is a negative or potentially a negative, if you are talking about earnings it can be a positive, because it’s going to mean slower speeds and the gap between your asset yields and your funding cost is maintained.

So it’s really depends on your perspective. If you are talking about earnings, it’s a positive. If you are talking about book value, it is probably going to be a negative, especially because we don’t have -- we typically don’t hedge 100%.

We are something less than 100% and mortgage cash flows are -- you hedge them with IOs and you can use different types of instruments, but it’s -- they are a challenged to hedge perfectly in any environment..

Great. Thank you for the clarification.

Final question is, I know you’re just talking about the spreads between 10 years and 30 years, but is -- should we really be looking as to where the one-year to three-year or five-year, where the curve is going from one-year to three-year to five-year or so, because that’s sort of the belly of the curve, that really sort of matches where your duration is at the moment.

I mean, is that the area of the curve that’s really going to affect your earnings power in terms of spreads?.

Well, yes and no, as we have mentioned the duration of our assets is in the belly and we fund obviously on the front-end. However, prepayment speeds are driven by kind of the 10-year area, right.

And so if the 10-year is moving down, the prepayment speeds are staying higher increases -- increasing and we own a lot of high coupon mortgages duration in the belly of the curve, but the prepayment on those is sensitive to the long rate.

That’s what we are seeing in the fourth quarter, where those assets as the belly of the curve sold-off, because of that’s where they laid on the duration spectrum their prices were hurt. But because the long end wasn’t moving prepayment speeds aren’t slowing.

So here is an asset that’s going down in price, let say, high coupon mortgage going down in price and prepayment activity is staying the same. So that’s kind of a double negative.

On the other hand, when you have a steeping of the curve, that means prepayment activity on that instrument is slowing, if the five-year is continuing to sell-off, it’s duration is going to cause us to go down in price, so book value negative, earnings positive, because speeds are slowing.

So, I mean, yeah, that part of the curve, that’s really not relevant for us even though on a duration basis it appears that’s where those assets shares. The earnings perspective is 10s and 2s or 10s funds..

That 10s move the duration of our portfolio is going to get -- of our pass-through portfolio is going to get longer as well. So it will be a transitioning target.

So, yes, that might be -- going back to the fourth quarter when mortgage rates were relatively low because the 10-year was stubbornly low as well, our assets were lining up on the belly of the curve as we transition into higher yield environment on the longer end of the curve are mortgages we would expect to extent some.

And in fact we have seen that happen. The flipside of that the IOs have negative durations and lineup very much on the long end of the curve. So they have a lot of room to expand both in terms of income generating potential, as well as book value increase..

I just want to summarize, if you are talking about earning, it’s that 2s, 10s, funds 10s it really matter, because that movement on the 10-year effect prepayments and movement on the front-end effects our funding cost.

If you are just talking about book value and the movement, the price of our assets, for it’s -- we are -- our assets are predominantly in the belly of the curve, so that that really matters in terms of price movement to book value.

Of course, what Hunter just said is as rates go higher and higher they extend, so they maybe move from a four-year to six-year or potentially big enough sell-off even longer.

So in terms of movement on the curve it really depends on whether you are talking about earnings or book value, because the relevant part of the curve is different for earnings and book value..

Understood.

And just by the long end of the curve movements, which is pretty modest, I would say, since the fourth quarter, it’s -- I mean from -- on a 10-year to 30-year basis, it would seem that your CPRs are likely to go down in the first quarter just the way things are heading?.

Yes. And then also there is a seasonal slowdown. This is typically when prepayment activity is muted and turnover is muted, so if you look at any prepayment model that’s out there, they are going to tend to show all those equal, prepayment activity is going to trough in the first quarter and we have seen that this year.

So it’s been a double win if you will. We have had rate sell-off now in the long end and it’s the seasonal part of the year where speeds are the slowest. So our portfolio the last two months, we mentioned this on the call yet, but our pass-through portfolio over the last two months are been in the mid-single digits..

How many Fed hikes are you assuming for 2018 and I’ll end it with that?.

Sure. I would assume three, maybe four, a lot of it has to do with whether not the equity markets change that. But based on fundamentals alone and assuming the equity market hangs in there, I would say, three or four, in fact, I would say, based on the fact, they pass that bill this morning, probably four..

Yeah..

We have position so that, just as added color we have position so that if we get more than three this year but maybe more broadly, if we get more than three or four over the next couple of years, the curve gets really flat really quick and so we have struck a lot of new funding hedges out in the area of say late 2019 through late 2020..

‘18..

I am sorry, late 2018 through late 2020. So to the extent that have one or two or three more hikes over that period of time then what’s currently baked into the market in particular swaps and Eurodollar hedges will benefit from that pretty greatly..

Got you.

But if the forward end of the curve remains pretty flat, it could be a negative earnings issue?.

Yeah. We -- definitely we go against as if we get only say three, but we feel like there is an asymmetry to that risk profile in that. We just -- unless we just don’t get any that -- that’s really the downside to us.

But if we get one or two or three over the course of the next few years that’s -- has a very minimal negative impact to us at this point the way the markets pricing in future Fed hikes..

And again, Chris, I want to stress this. Three hikes, four hikes, who knows and obviously our funding costs goes higher, but our dividend is a function of the NIM, right. And so if we get four hikes in the 10-year stays here and goes lower, that’s going to be a big negative for our earnings.

If we get four hikes but the 10-year ends the year at 320 we may not be at all, because we will be able to maintain that NIM..

Yeah..

So….

Prepayments speed..

Yeah. Yeah. We are going into, this was a very perplexing thing, I would say, I will spend a moment talk about this and not a lot of people in our space understood this is -- was the incredible outperformance of the long end of the curve, the third year, the third year treasury had an remarkable run until very, very recently.

Why was it? Well, there is several theories put forward.

One was, because equities have such a phenomenal run that anybody that runs a balanced portfolio between equities and bonds was simply just reallocating to rebalance equities that had a big run they have become a proportionally higher part of the portfolio, sell some equities and buy some bonds and bring it back into the target allocation.

The other and predominantly in the case of asset liability managers and pension funds, so there was this -- someone was a bigger buyer of the third year and that’s why the 5s 30s curves just kept flattening and flattening, that seems to have finally reversed.

But and then also we have to consider what’s going on abroad, what’s going on with ECB and their asset purchases, because our longer rates have been very attractive to long rates there. To the extent the market starts to think they are going to taper their asset purchases and maybe reverse them then yields on the long end in Europe would move higher.

That relative attractiveness would go away. That could cause the long end to sell-off. So that’s really what matters from an earnings perspective. It’s not just how many hikes. It’s just how many hikes in relation to what moves -- what happens on the long end of the curve..

Understood. Yeah. Okay. Thank you very much for taking the time and answering my questions. .

You’re quite welcome..

Thank you. And I am showing no further questions over the phone lines at this time. I would like to turn the call back over to Robert Cauley for closing remark..

Thank you, Glenda. Everybody I thank you for your time. Appreciate the chance to get on the phone and talk about what we have been doing and field your calls. To extent somebody has a call that -- question that didn’t come up during the call or comes up afterwards, listen to the replay, feel free to call our office, our phone number 772-231-1400.

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Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program and you may now disconnect. Everyone have a great day..