Good morning, and welcome to the Second Quarter 2019 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, July 26, 2019.

At this time, the company would like to remind the listeners that statements made during today's conference call relating to matters that are not historical facts are forward-looking statements, subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Listeners are cautioned that such forward-looking statements are based on information currently available on the management's good faith, belief with respect to future events and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in such forward-looking statements.

Important factors that could cause such differences are described in the company's filings with the Securities and Exchange Commission, including the company's most recent annual report on Form 10-K.

The company assumes no obligation to update such forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking statements. Now I would like to turn the conference over to the company's Chairman and Chief Executive Officer, Mr. Robert Cauley. Please go ahead, sir..

One, in late 2018, each of those buckets was approximately $1.75 billion, so we've taken off a lot of our front-end hedges, but also you'll note that the last contract there is December of 2020. We have not yet extended those out. We may -- I think at some point, we anticipate the market may get a little too aggressive in pricing in the Fed.

We're kind of looking for that development in which point we would then try to add some Eurodollars. Our five year note future on the bottom left remains in place, that hasn't changed quite some time. On the right-hand side, there have been some changes. The top of the page, we have our swaption position.

This is another long end hedge where we take a longer tenure of tail as a means of protecting against a surprise move of highering rates. Although frankly, we don't see that as a high probability given developments abroad. Our TBA position is a slight typo there. It clears that we were still short 30-year 3s, it's actually 3.5 as of June.

And then finally, in the swap position, we have a -- really it's barbell position, so we have a combination of just some very old swap positions, very much in the front end of the curve inside a year, when it will put on an extremely attractive level.

And the balance are in the belly of the curve, the 4 and 5 year part of curve, and the reason being there is that we've had such a movement in the belly of the curve, as the market moves the price and Fed eases.

If there's going to be retracement, we expect that that's where the magnitude will be the greatest and so that's why we've put the hedges there. So that's where the lines throughout these hedges lie. Our long-end hedges are the TBAs, the swaption, and of course, the IO securities that I talked about.

So that's kind of what we've done in terms of market developments, what those developments meant for our results and what we have done to change the portfolio. Looking forward, at this point, as I said, I think it's very high likelihood the Fed will ease next month and that will help our funding costs, which has been stubbornly high.

Repo rates have come down over the last month or 2, but there's still, of course, pricing in less than 1 ease. Generally, repo is in the low to mid 2.50s, occasionally in the 2.40s. In this slide here, on Slide 28, all we're trying to show you is, what would happen if the market implied pricing were to be realized.

And as you can see, in the bottom page, you can see an expansion of our NIM. Whether or not this happens, it remains to be seen. We did take some actions in that regard with respect to our ATM program, which we've had in place for a number of years. We did issue some shares in the second quarter.

Typically, we only use the ATM when those shares -- when our share price is above book value. In this case, these shares were issued at a slightly discount. It raised the all-in cost of that capital to a little over 3%.

We didn't do it with a lot of capital, but we think it's justified on the grounds that with the churn in the Fed outlook that the accretion to earnings will justify the slightly increased cost of that capital. And that's as a result, that's the step we took. Otherwise, these slides are basically just for historical reference.

And there's really nothing more to be pleased in those. So with that, operator, I will turn the call over to questions..

[Operator Instructions]. Your first question comes from the line of Gary Rieve [ph]..

You mentioned the ATM program towards the end of your presentation. You guys are kind of nearly at the end of what you're authorized to do there.

Is there any talk or thought on the part of the Board of upping that as you go -- as we go into the easing cycle?.

Yes, I think that's likely. We exhausted the program early in Q3. So we would anticipate, at some point, putting in place a new one and ATM has been an excellent vehicle for us..

Okay. Great. And then in the quarter, I saw a couple of your competitors' quote, sort of, a prototype security.

Any thoughts on that as a source of funding?.

We did look at those. Unfortunately, given our size, the coupons on those, whether it be preferred or convertible debt, they're pretty pricey. I think the bar for those to make a lot of sense is still a little too high. That could change, especially, if we were to have an aggressive easing cycle.

But for now I think we're -- we don't really too excited about the potential returns from those..

Got it. Got it. And you guys are a little bit above book today.

Any thoughts on doing some type of placement potentially?.

You never know. We generally don't like to speak about those things, the dividend policy, capital raising. But as I said, it looks like the outlook is about to change and to the extent that it does. Obviously, it would be -- a steeping of the curve would be an attractive for us -- opportunity for us, and we would probably consider that..

Yes. It seems like an opportunity to cash and leverage ahead of a more favorable cycle..

Thank you..

Your next question comes from the line of Christopher Nolan..

Bob, what was the issuance prices for the ATM, please?.

I don't have those in front of me, but our book was 6.82% at the end of the third -- or the first quarter and 6.63%. I want to say, it was somewhere in the high 6.50s on average, but don't quote me on that yet..

Yes, I am getting 6.60% or so..

Yes, so it was slightly below book. As I said, the typical cost of capital in the ATM is about 1.8%. So it added about 1% that quarter, 1.5% to that..

Got you.

Also, I saw that you had an increase in allocation to 30-year 5% coupons, was that the specified pool that you were talking about?.

Yes, very much so. And it's -- in these cases, we're going to buy higher quality call protection because of the prices. And another thing is, we've been looking for some bonds that are little more seasoned so they're off the ramp, so they're much more predictable. We don't have to take that ramp risk, if you will.

And so that's what we added in that bucket there, loan balance and season pools..

Final question. Reading the management commentary in the earnings release, it seems like you guys are very much in the camp that there will be a rate cut.

What happens if there's not a rate cut?.

Well, as we said, and I quote, like I said it was a calculated risk and it was. I think at this point -- well, if there isn't one, obviously, something has to change. The market pricing today is for about 2.5 eases by the end of the year.

It would have to -- it's really a function of -- if the Fed doesn't cut next week, and it not much of that, but what would they say. So in other words, when Chairman Paul has his press conference, what does he say in the statement, how does he respond to questions.

If he could convince the market that we've changed our thinking again, and we don't really care about what's going on in Europe or trade tensions, we're just focused on the domestic economy and the data we've seen in this month, whether it's GDP today or durable goods yesterday, payrolls at the beginning of the month, even the CPI number in the middle of the month, if they change back to that and they say, based on that there's no need to ease, the market has to move.

The five year treasury can't be 50 basis points or 40 basis points inside Fed funds in that case. So you would have a meaningful sell-off in the belly and in probably the long end of the curve. And as I mentioned, while that might not be great for our capital raising, our NIM or anything, ATM and that kind of stuff, that is how we've hedged ourselves.

So our hedge is concentrated in the belly and in the long end of the curve. So that would have to be -- that's certainly a nonzero probability, but that would do I think a lot to undermine the credibility of the Fed. And then I think the subsequent effect of that would be a much higher risk premium being priced into the market.

Because now the market would have to price in the fact that the Fed is somewhat of a random unpredictable animal that can change its thought process on a dot. And they did do that for some extent in the fourth quarter, but that I think was a result of a lot of market pressure.

There's certainly no market pressure for them to do so now, so if they were to do so, I think the risk tenure would be materially higher than it is now, and that would not be a good outcome..

So is it fair to say that you guys are assuming a 50 bp cut in the second half of the year?.

I wouldn't say -- we'll see how it goes. I think 25 is a very high probability. And there's likely to be more beyond that, but it remains to be seen.

The other thing, I think, is while the market pricing is looking out through the balance of this year, even in the 2020, my view is that once we get to second quarter of 2020, I think the market focus is going to shift to the election and the expected outcome. In my mind, the outcome of next year's election is binary.

In other words, the outcomes depending on which party takes the White House are materially different. One being more pro-growth, the other not so pro-growth. And I think the market will start to price that in, as I said mid next year. So I think the Fed's in the driver seat until then, but after that, I think it will change.

So whether we get 1, 2 or 3 remains to be seen. I suspect we'll probably get 2. Because I think the Fed is focused on the fact that inflation is low, global economies are weak, and there's a lot of uncertainty with respect to trade. And it's not for so long now, we've been talking about trade tensions between U.S. and China or U.S. and Mexico and Canada.

And now you have tension between U.S. and Europe or between Japan and Korea. So it's spreading and it's not generally a good thing for the global economy..

[Operator Instructions]. I'm showing no further questions at this time. I would now like to turn the conference back to Robert Cauley..

Thank you, operator, and thank you, everyone. Appreciate you taking the time to listen in today. To the extent other questions come up after the call, please feel free to call us or if you're listening to the replay, our number in the office is 772-231-1400. Thank you for your time. We'll speak to you next quarter. Thank you..

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect..