Good morning, and welcome to the Second Quarter 2021 Earnings Conference Call for Orchid Island Capital. This call is being recorded today, July 30, 2021.

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

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

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

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

Thank you, operator, and good morning. Welcome to the second quarter earnings call. I hope everybody's had a chance to download the slide deck from our Web site. And as usual, I will proceed through the slide deck. As I go through our remarks before we open up the call for questions. I’ll just lay out the agenda for today's call.

I'll start off with a overview, a brief overview of our financial highlights. And then I will go through a review of the developments in the market for the quarter and more importantly how Orchid reacted or interpreted these developments and the decisions that were made regarding the portfolio and our hedges and leverage ratio.

I'll start off with just giving a brief review of how the company and the portfolio are positioned coming into the quarter. And then also provide some comments on our outlook, see you help in terms of how we see things evolving overtime in the future.

And then I'll return it over to the financial results in bit more detail, as well as the portfolio and our hedges and then finally, just wrap it up with some closing comments and our outlook and then turn the call over to questions. So with that, I will turn to Slide 4, so the results for the second quarter 2021.

Orchid Island had a net loss per share of $0.17. Net earnings per share were $0.24 excluding realized and unrealized gains and losses on our RMBS and derivative instruments, including net interest expense on our interest rate swaps.

We had a loss of $0.41 per share from net realized and unrealized losses on our RMBS and derivative instruments again, including net interest expense on our interest rate swaps. Book value per share was $4.71 as of June 30, 2021 versus $4.94 at March 31, 2021. In Q2 2021, the company declared and subsequently paid $0.195 per share in dividends.

Since its initial public offering, the company has declared $12.11 in dividends per share, including the dividends declared in July of this year, total economic loss of $0.035 per share for the quarter or $0.07.

Turning to slide 5 and 6, we give the results of Orchid versus our peer group, which is defined on the bottom of the page and the note on each page. And you can see our results with a year-to-date and one, two and three, sort of look back as of June 30th, as well as for the calendar years.

This is both on the case of Page 5, using stock price and dividends to compute total rate of return in the case of Page 6, we see book value. I'm going to have a few more comments on these slides at a later point in the call. So for the moment, I'm just going to move on and turn to market developments.

As Orchid entered Q2 and as we positioned the portfolio towards the later stages of Q1, we had shed a lot of our exposure to lower coupons, production coupons in the 30 year space predominantly in our TBA positions we had added to our hedge positions.

And we just started to deploy capital more towards IOs, that allocation has gotten actually inside of 10%. And since that we achieved two and it was 18 and is since actually slightly higher. In that we were positioned quite defensively entering the quarter.

So now I'll just kind of go through the developments placed in the quarter and how we responded and how we view these developments. I think if you see on Slide 8, you see the movements in the treasury curve. Obviously, the blue line there on the left or right represents the market as of -- this is 3/31.

The blue line or the red line is at June 30 and then the green line is at last Friday. So obviously the market has rallied. I think you can break down at the moment in the market into three phases for this year.

The first quarter through early April, the economy was recovering rapidly, stimulus was being administered by the government, we saw growth in any measure of surge and we saw the emergence of meaningful inflation worries. The market sold off and the curve steepened very rapidly. In early April it started to change.

And the events of Q1 led the market to adopt them very, very defensive, extremely defensive short positioning in the rates market. This was evident in the futures of an interest markets and so forth. But also one other development it started to push things it is kind of countered to one’s intuition.

For one the fed was very skeptical in terms of their means of inflation, Chairman Powell stressed over. And relatively, he thought inflation was going to be transitory and he did not think that it would persist. And also, while the economic data was generally very strong, there was one notable exception, which was job growth.

It was definitely lagging expectations. We had a number of non-farm payroll reports that were below expectations. And as we heard Wednesday from the Chairman and it’s something that's very important to them and their outlook in terms of gauging whether or not we make substantial further progress.

And there are few other outside factors that kind of caused us [pain straight], if you will or [Technical Difficulty] as the markets need to rally in the face of ever stronger economic data from these outside factors were simply things like yen denominated investors were able to deploy capital in their treasury market and realized very strong returns and we also heard of insurance companies deploying capital from equities into bonds.

And so all of this kind of led with one might call very counter intuitive development related to market. Then the third phase was really kind of mid June when we had fed FOMC meeting and a few things emerged from that meeting.

One, we saw that there was some disagreement amongst the members of the committee, even though the Chairman was very much in charge. We saw that they had indeed have inflation concerns, they were starting to think that maybe inflation might be a little stronger than they may first expected.

And I guess more meaningfully, we saw in their dots that at least some members of the committee thought that fed would have to hike much sooner than the market had thought previously. So this seems kind of all collapsed together to form what we would call very hawkish meeting.

And then also in around that time, we saw the Delta variant, which we're all very much aware of begin to emerge. And that very much call in the question the growth outlook, not just in the US but on a global basis. And so the market since rallied again and has rallied as we speak today.

So clearly, we’ve gone through quite a shift from where we were in Q1. But in terms of our view at Orchid Island and how we positioned both at the end of Q1 and today, we are still positioned defensively. We're not convinced that inflation is temporary.

We think that that's somewhat of an oversimplification in the sense that while there are clear elements of the price pressures we've seen that are transitory, lumber prices and some of the popular ones, but some of the developments in the inflationary side are clearly not and I don’t think it’s somewhat just an oversimplification to just dismiss it out [Technical Difficulty].

And that being said, the Delta variant does pose a risk to growth. But even as much as it's -- as bad as it's been, we do think that eventually we will see growth recover and start to see the economy kind of resume the growth trend that we were on up until a few weeks ago.

And in fact, you could maybe argue that the Delta variant in a sense could prove inflationary in the sense that as more and more people are reluctant to go back to work or for instance if the federal government were to extend the supplemental unemployment insurance and that was extended and exacerbates the job shortage and wage growth that we've seen.

So that's possible that may have a kind of counterintuitive outcome as well. But generally speaking as the fed eventually does taper their quantitative easing, they will stop pumping reserves into the system. And the sources of downward pressure on rates will start to abate.

And as a result, we remain defensive and we kind of [again] balance of risk skewed towards higher rates. And also it's important to note that we do have an inflation outbreak, especially if it is significant and we’re certainly not calling for that.

And if it does occur as levered bond investors, we know that can have a very meaningful impact on our portfolio and our book value. Whereas the continuation of low rates while it can put important pressure on our earnings maybe generate faster speeds, it does tend to have a devastating impact on book value that a spike higher than rates can generate.

So moving on to the slide deck, Slide 9, I really don't have to say much, the picture tells a thousand words. Obviously, we've been rallying. Slide 10, I do want to make a couple of comments here. And the one notable development we saw this quarter was selected in the green line at the bottom of the page is the curve that is flattened.

Obviously, we've had a bull flatten in second quarter and into the third. And we had, as I said earlier, added to our IO position, so obviously this did not -- it was not a good outcome for them. But that being said, we do view this move in rates as an opportunity to add to those positions at attractive level.

That all being said, we have maintained significant allocations to poles inspection, in particular and as we'll see in a few moments those have behaved extremely well in terms of prepayments, and that's very important for protecting our net interest margin and of course ultimately our dividend. Turning to Slide 11.

Starting with the top left and see the performance of the various TBA coupons this quarter. It's really a mirror image of what we saw in the first. In the first quarter, you saw lower coupon suffer meaningfully [down] in price and the higher coupons were flat to slightly up. This quarter we have slightly pretty much the opposite.

Now that being said, this slide does add at the end of the second quarter since quarter end, our coupons have actually done a little bit better, a big driver of that has been most recent prepayments fees. We have started to see the emergence of some burnouts. But I would say that remains a very much an open question going forward.

With this rallying in rates and compression in primary spreads, secondary spreads, which I'll talk about in a minute, I think it very much remains to be seen just how much burnout we do see in higher coupons. And of course that will affect the performance of both TBA and their rolls as well as specs in those coupons.

As you can see in the bottom left, the rolls in the production coupons remain very, very strong, which is not surprising given the presence of the fed. What is surprising is that roll in particular the three coupon, which as we speak is trading is big a drop as we see in the 2% coupon, and that's very much counterintuitive.

It's clearly being driven by squeezing the front month as the back month rolls, it’s still positive but much lower. And then finally on this page just point out the fact that spec pay ups have recovered. Sometimes this reflects a combination of factors.

For instance, the underlying TBA, the stronger -- or weaker, you may see movement in the payoffs, which kind of capture some of that.

But generally speaking, we have seen recovery in TBA specified full pay ups this quarter and this remains reasonably healthy in the Q2, not necessarily a meaningful strengthening but versus duration expectations but still attractive. Turning to Page 12. This is our proxy for implied vol in the market.

I think there’s one point I want to make here is if you look at this picture, you can see that while vol spiked quite dramatically late in the first quarter and has since come off, it does still remain above the level we saw for the last nine months of 2020.

So vol is still modestly elevated, although, as we know that not maybe not likely to persist absent another shock, because we have generally been in a very low vol environment for a number of years for the most part.

The next slide, I want to talk about a little more depth, because this is really germane to both what happened in this quarter but much more importantly, how we position Orchid’s portfolio and how we see things evolving overtime. I want to really focus on the left hand side here, this is the TBA LIBOR OAS and I want to make a few observations.

You see all these various lines, they correspond to the different coupons, the gray line on the bottom that represents the thin two and a half. And if you look at where that line was back in June of 2020, it was north of 50 LIBOR OAS.

And as you can see, in April and May of this year, it got all the way to negative 20, so obviously that is a very big move. And other proof positive made similar moves and you're not necessarily getting into negative territory.

But clearly a big moment, of course, it's all driven by quantitative easing and the fed by combination with pay downs worth of $100 billion a month in mortgages. So obviously, mortgaged are guiding very tight now they’ve since rebounded, especially when the feds first started to hint that possibly tapering.

And so locally they look more appealing than they did then but I think if you look in a much longer horizon, they are still not quite all that attractive.

And you would assume that once we're completely out of the quantitative easing and rate hikes and so forth that eventually those levels will tend to migrate back towards where they were, and may or may not get all the way back to those levels. But you would assume that they would tend to do so.

And that really drive our thinking with respect to the mortgage market. So I think you can make the following statement. So I think it's very likely, not certain ever, but likely that the following three things will occur. One, I think it’s very unlikely that we will not see few week tapering before the end of the year.

And certainly given what we’ve heard this week end of year at the absolute earliest probably next year, early next year and then also that there will be pro rata.

Mortgage market participants were worried that the fed might start to taper mortgages before treasuries, and it's been pretty clear when Chairman Powell speaking Wednesday that he's not sure that mindset. He thinks their impact on the market is pretty much the same. So I think it's safe to say there will be pro rata.

I think the second point you can make with fairly high degree of confidence is that once it starts, it's likely to be very gradual. They're not going -- they're going to telegraph it before it happens. And when it happens, they're not going to do in such a way that's going to have a violent impact on the market.

So it's probably going to play out over six or 12 months.

And then the third point is that assuming and maybe you can't say this following point with as much conviction, but assuming the fed follow their previous course of action, whereby they first taper QE, then at the -- in there a period of rising rates and then the third leg of that is quantitative tightening where they stop reinvesting the pay downs in their portfolio and remove reserve from the system.

And if that does in fact play out then that means that the fed will be buying mortgages at least in the form of reinvesting pay downs probably in the late 2023 and maybe beyond. So all of that kind of paints a fairly benign picture in terms of the impact of tapering on the mortgage market.

Well, that being said and this is where we go back to the slide on top of the page. We are coming off extremely tight levels.

And while it's true that many sectors of the fixed income markets are equally tight, the fact that you've had so much buying pressure in the market, not just by the fed.don't forget if the fed pumps reserves into the system, the banking system, those funds are invested again.

So we've seen the banks be very large buyers of mortgages for some time now. And is that a phase you're going to take a lot of that pressure, downward pressure off. And I think this decline in sponsorship role, as I said, I think we'll start to see these levels back off.

And as a result, while we don't think this is going to be an extremely violent move, we do in fact think it will play out fairly benignly overtime but it will in fact occur. And so we will position so as to avoid or minimize our exposure to the coupons we think are the most vulnerable, and those would be 30 and 15 year in production coupons.

And so we will continue to stick with our overweight, if you will, the pools of probably higher coupons and inspect form so that we can protect ourselves from prepayments and protect our NIM. So I think that's a very important Slide. Slide 14, the top of the page that shows returns for the quarter from the US Aggregate Bond Index.

And it's the picture that this paints very obvious was very much a risk on quarter, risk taking and is obviously animal spirits are very, very robust.

As you can just look at the returns for the quarter here, the high risk sectors, emerging markets, high yield, the S&P 500 high yield, emerging investment grade, investment grade and so forth, have all done very well.

And the lot more risky risk averse asset classes, treasuries, mortgages and each asset backed, they’re relatively poorly comparison into those sectors. Turning to Slide 15, a couple of important points here. I think I'm going to start on the top right.

And what we see here is the primary, secondary spread and we’ve talked about this at length for some time. Obviously, this kind of represents the difference between rates in the treasury market and rates available for borrowers. And we started at a very high level and we knew that there was a lot of room for that to compress, in fact, it has.

And it has comes down close to 100. It seems to have leveled off some. We also know part of the reason that that couldn't compress quite as rapidly is just simply the fact that originators didn't have the capacity to handle more mortgages. So they had to increase their income.

Well, in fact, they have and now we're in a position where they're very responsive to movement in rates. Also recently, there was a regulatory change, the adverse market fee was removed.

And this basically just represented another fee that was paid on new mortgage originations that was typically passed onto the borrower, so in effect it's kind of just a one time shift down in rates available to borrowers. We refer to this as an elbow shift. But it just means that rates can go lower and in fact they have.

And if you look at the left side of the page and the two lines there, one is the refi index, the red line is the rate, mortgage rates. That has since quarter end, note that this ends at the end of the second quarter, it has moved lower. As you would expect, the refi index has responded, although, not as strongly as you may have expected.

It's still only in the three thousands. It may go higher. But so far we've taken rates back down close to where they at their trough late last year, and then refi index is not back to the peak that we saw at that same time. How that plays out in the balance of the year remains to be seen.

But as it does occur, obviously -- or doesn’t, this will also coincide with what we see in terms of burnout and higher coupons. How much of it we seen. And obviously, that's a big driver of performance of the TBA versus spec pool. So that remains to be seen. And now I would like to speak about financial results in a little more detail on Slide 17.

As always we present a Slide that kind of decomposes our income statement into, I guess our proxy for core earnings, which is simply our net interest expense net of repo and expenses, and in the middle column our realized and unrealized gains and losses.

And as we said at the onset of the call,, we had an $0.17 loss for the quarter, $0.41 loss on our realized and unrealized gains and losses on our MBS assets and derivative assets inclusive of interest rate swap accruals and then $0.24 after that.

And one thing to note, as I mentioned that we were positioned defensively coming in, in the quarter and we remain so. So there wasn't virtually nothing done to the hedge book over the course of the quarter and essentially very little done since. So most of these losses, this $0.41 in losses that you see most are unrealized.

And while that knows exactly what the future holds, it's possible since most of these losses are unrealized to the extent that the market will move in the opposite direction, there is some potential for those losses, unrealized losses to go away. And in reverse that impact that they have on our results and book value.

Again, that's just the potential, not making any predictions. With respect to the right side of the slide, we just show the returns of our allocation of capital between pass throughs and structured securities, modestly negative return in the pass through portfolio this quarter, really just reflects the fact that mortgages lag our hedges.

We did have a positive mark-to-market on the pass throughs but we do reflect premium amortization in our mark-to-market, so it did decrease it. And then of course with the bull flatter in the rates market had an adverse effect on IO positions, and we generate a return of negative 15%.

But we, as we said, we still have the same view of market going forward and view that it’s just creating better entry points for those assets. Turning now to Slide 18. This kind of captures the economics of the portfolio net of our hedges in pictures. I’ll point out the green line -- I’ll just identify what we have.

The blue line is the average yield on our assets. The red line is our funding costs, our economic funding costs, which means it’s incorporating our hedges. We don't use a hedge accounting, per se. We do reflected in these numbers. And then the net of the two is the green line.

And there's some obvious conclusions we can draw from this one, this green lines, as you can see, it's been quite stable. And that kind of translates into what you see in the dividend. But also the blue line, while it has been declining rather sharply, it also is starting to stabilize.

And then finally, the red line I think given where we said market wise and the outlook of the fed, especially the leadership of the fed, I think it's reasonable to expect that our funding costs will remain low, probably certainly through the end of this year and then quite possibly through the balance -- and most of the balance of next year.

So the sum of all these things makes us you know optimistically constructive on the dividend, this appears to imply that we should be able to maintain this level at least the next six to 12 months, maybe beyond. Slide 19, this shows the same thing slightly differently.

This is an earnings per share where we disaggregate the mark-to-market gains and losses from our proxy for core in those lines, exactly the same as what you see from our peers. And then finally, Slide 20 in terms of the results.

And as I said earlier, I wanted to defer the discussion of our results versus our peers and the reasons I wanted to kind of go through this in person. And what you see in this chart, those two graphs two graphs, we show this in our presentation before.

The top one just shows you our annual dividend yield in the the top half of the page using the book value at the beginning of the period as the denominator and the bottom we just use the beginning stock price. And in both cases, the blue line represents Orchid’s yield and the bottom is the peer group.

And I apologize in the bottom of the page, we don't define the peer group. But if you go back to Page 5 and 6, it's the same that’s exactly in peer group. So that's what we're comparing.

And I think what you want to distinguish to see is that Orchid is clearly paid a higher dividend versus the peer group, basically all the way back to 2014 and that's reflective of the strategy.

And we tend to have a high dividend yield, we tend to have a higher leverage ratio and we tend to put a lot of emphasis on higher yielding assets, which in many cases are spec pools, high quality spec pools. And as a result, we can generate with those yield well speeds and high income.

So as you might expect, there is a very high yielding portfolio and it's reflected in these charts.

And that being said, just in case of everything in the financial markets when you have slightly higher risk portfolio, you're going to tend to have higher volatility as well and that's reflected, for instance, in the first quarter of this year, the fourth quarter of 2016.

So we have had episodes where our book value volatility, our performance has lagged out of our peers and as reflected in those results back on Page 5 and 6. Now that being said, we did just have such a quarter in the first quarter. Frankly, we don't have those episodes too often.

They tend to occur not even within a quarter, often within a matter of weeks. But otherwise the entire yield of the portfolio tends to make up for and often in most cases lead out performance versus the peers. And as a result, that's why we continue to pursue this strategy.

So while the result as of Q1 or Q2 aren't as good as they were prior to that quarter, again, I think it just reflects the proximity of Q1. And I think know have borrowing another shock to the market in the near-term or the higher yield of the portfolio will close that gap and ultimately and hopefully lead to outperformance, not underperformance.

So that's that for that. Moving on to Slide 21. We've talked in the past about the reposition of the portfolio here into the numbers. On the left-hand side, you can see that the allocation of the structured portfolio. At the end of the first quarter, it was 9.5%. It's now 18% -- is at the end of Q2, in fact, even higher now, as we speak.

And then again, on the right side, we just show you the actual numbers that we invested in the various sub-portfolios and then the details of the changes in those in terms of asset purchases, sales and so forth.

And now with that, I'm going to move on and talk a little bit about the characteristics of the fourth quarter as we sit here today on Slide 23. As usual, we go through the composition of the assets and the hedges on bottom of the page, the structured assets are in the middle.

Weighted average coupon has actually not changed very much in the pass through portfolio, although, it’s 2.97. It's 2.95 the end of the first quarter. So it didn't change much with crisis slightly higher just because of the rally. But I will make a few observations, some small, some large. First with the small.

As you can see the lower duration assets 20 year and 15 year assets, they essentially are unchanged from last quarter. The changes just reflect runoff. And in some of the highest coupons 4.5, again, pretty much unchanged and are 30 year 3.5s. Since quarter end, we have made a change to that bucket.

But the more notable developments that are really meaningful are in our exposure to the 2.5% and the 3% coupon. One, we reduced our exposure to 2.5 coupon from 1 point -- north of 1.1 billion to under 700 million and we've also increased our exposure to the 30 year 3s, that was about 1.85 billion, now it's 2.725.

So that growth there reflects two things. One, allocation out of the lower coupon, as I just mentioned, but also, we were able to grow the portfolio through our ATM, as were many of our peers this quarter. And most of that growth is reflected in that coupon.

One other point I'll make with respect to the pass throughs, our exposure to the 30 year 4 coupon is reduced by about 140 million, and that really was the case where we sold pools of restructuring assets, so that’s an idle. So that was actually part of the allocation of capital from pass throughs.

And of course in the middle page, you see our positions in structure IOs, that reflects traits such as the one I just described but also just the acquisition of new IOs. With respect to the hedges, notable change. If you look at our TBA shorts, it was 400 million at the end of this quarter. That number was 1.3 billion at the end of the first.

So we took off TBA hedges and they added our shorts in five year treasuries and 10 year ultras. Otherwise, pretty much everything's the same. Since quarter end, we have done some trades.

We sold or we bought a new two and a half with the intention of selling some of our existing assets that are just ramping up the curve and prepay in [past], but the net effect on that on our allocation with that coupon will not change.

But we have added, again, we’ve kind of been growing and kind of investing with somewhat of a like, trying to pick up points, trying to maximize our entry points. So we have added to the 3% exposure. And again, some IOs we've added. And one other thing is that we did sell some 3.5 and put back in IOs some of kind of trade I mentioned.

With respect to the hedges, there have been no changes. Slides 24, as you can see our allocation with very high quality specs has come down, but the specs generally has not -- we just try to change the mix.

And these are obviously very important for us because we don't use the TBA dollar roll market, so we have to generate our income through our pass through pools and that's really critical that we maintain our speeds, of realized speeds as low as possible.

And then if you turn to Slide 25 and you'll see on this slide and the next one, we've been successful. What we show here on Slide 25, four graphs or charts. The first top left is June and May and April, and then quarter-by-quarter going back several quarters. And I want to point out that our greatest exposure in 30 year space is the 3% coupon.

And if you look in both June and May, and April, you can see our performance versus the cohort has been very good. Our pass through portfolio prepaid at 10.9 CPR in the third quarter, obviously, very good result. It was 9.9 in the first quarter when rates were much higher. So the strategy is working in that environment.

So it's critical to our ability to generate income and pay the dividend. On the next page is just same kind of story in different pictures. I will pause, this does end at the end of the second quarter. Obviously, since then, the orange or yellow, whatever you call that line, which represents a 10 year yield has declined back into the 120s.

But importantly, the green line, which is our prepayment speed, which again we depict in this picture is basically just defined -- and doing the following mathematical calculation is to divide the total dollar amount of prepays by the principle balance of mortgages. And so it's kind of normalized for size.

And as you can see it’s been in the range, we continue to be in the range we entered this quarter and it's even below where we were back in '19. So seven with rates touching all-time lows in 2020 and rallying back towards those levels this year, prepayments have been well maintained. Moving on to Slide 27, which show our leverage ratio.

As you can see, it's down, reflects combination of two things. One, more allocations to IOs but then also somewhat defensive posturing. And as we have average now for those kind of taking our time somewhat deploying it, so that we can make sure that we can pick what we view are often entry points.

And so it's probably -- somewhat lagging is it may migrate up slightly from there, but it's not going back to the mid to high nine range that we saw in prior years. Slide 28 just shows our hedge positions. As I said very low, essentially nothing has changed with respect to those since quarter end.

And with that, that concludes my long winded prepared remarks. And we can open up the call to questions operator..

[Operator Instructions]. Your first question comes from Jason Stewart from JonesTrading..

Bob, thanks as always for the commentary and perspective. So I appreciate that. So I love the increase in the IO exposure.

Maybe you could talk a little bit about what the levered ROE looks like in terms of the IO strategy versus just the core [agency] strategy?.

Well, the IOs, which we done [Indiscernible] chiming here too. First of all, a lot of the IOs that we've added are defensive in nature. So there's currently -- the collateralize by assets is in the money of prepaying fast. So those tend to be some negative yielding assets.

The idea of being that in the backup in rates, those cash flows will extend in those will become positive yielding assets. With respect to the pass-through portfolio, I would say, they're comparable. As I went -- slide it was that the NIM is very comparable to where it's been.

And so the combination of the two site compression and the overall ROE available but very much predicated on how rates in the market evolve overtime. If we were to stay here, we probably stay near those levels as you would expect. And then with upside in the event of a rate back up. And then I will open that up to Hunter if he want to say anything..

Just with respect to the IOs specifically, I think we've been targeting really two types of asset classes. One is call projected securities with good underlying pool convexity. We have been sort of mostly focused in the 3, 3.5, the occasional 4%, primarily backed by loan balance collateral, some of which is paying a little bit faster.

But where we're putting those on, those faster speeds and faster speed expectations are built, already built in. And our effective yields or option adjusted yields on those types of assets are generally kind of in the 2.5% to 3.5% model projected range.

The front carry might be a little bit lower than that just because there is some burnout that's being baked into the model. So anytime you have a yield over cash flow or lifetime of cash flows or the remaining life of the bonds cash flows to the extent that speeds are going to slow down in the later years, it tends to be kind of back loaded.

But I think that the ROE is based on where we are putting on, we’re repo-ing some of these, anywhere about 50 to 65 basis points sort of area.

And so if we said, just as kind of a generic target, we were able to achieve a 3% yield on these IOs and 55 basis points, we're getting into that sort of low double digits return on our capital after taking effect of the haircuts, which are a little bit higher, say predominantly, I think the majority of our portfolio is on it with 20% haircut.

So you're looking at maybe a maximum 5% leverage and maybe 2.5% NIM above funding there. But I think more importantly, the benefit for us is that we're able to decrease our reliance on rate hedges and that's particularly important.

Bob spent a fair amount of time talking about how we always need to guard against a staff hiring rates, because that could be very devastating to us.

But one of the things that we're also focused on is the fact that if we get something crazy and unexpected that causes us to rally and for rates to stay low that IOs tend to, or mortgage rates in general tend to sort of bottom out into a widening event. So it’s very simple mechanics.

It's to the extent that mortgages widen then that means that the rates to borrowers are not going down as quickly as, say, the risk free rates, or treasuries, or swaps, or whatever.

And so while we may experience some short term pain owning IOs and a basis widening move, ultimately, the cash flow streams are better, because fewer borrowers are able to refinance or at least they're not refinancing at the same sort of clip that we would have modeled into a lower rate environment.

So that's -- the removal of those costly rate hedges and the ability to preserve a cash flow stream into a rally is something that we really like here..

And so maybe, Bob or Hunter, how do we put, what you just said, with the disclosure, that plus 54 leads to $45 million loss to book value? Because it seems like that there might be some discrepancy between a perfectly parallel shift and some sort of elbow or steepening in the curve..

Yes, that leads for a long time and we've been empirically trading much, much shorter than those rate stocks would imply. And so we like to look at those and certainly pay attention to them. But really last couple of years, we have been empirically much more flat than those rate shocks would imply..

And I would say that the, just going back to the dollar amount of the losses, you had a very modest positive number on pass throughs, but then you have recapture, premiumization in that market. We also had a very big negative number on the IO book. So the portfolio was net negative.

And then the biggest position in the hedge book that was a swap and also our swaptions, and we had a very meaningful erosion in those over the course of the quarter. And so the bulk of the loss was in the hedge book. But unfortunately that was not offset by gains in the pass through/IO book in fact, a loss. So it exacerbated it.

So again, it was all -- if you had to summarize in one phrase, it was just meaningful underperformance of mortgages versus their hedges and that's it. I mean we got it both ways. The assets were down in price, as I said, mainly because of the IOs, but obviously, the hedges rallying across the curve.

But our exposure -- we don't have as much exposure to long end of the curve but belly of the curve, we have plenty and it was still there..

It just seems to me like that number, maybe overstating the projected net loss. But hopefully that that -- and then maybe the most important question [Indiscernible] my peers keep going. When we talk about levered ROEs with high single digit, low double digit kind of range versus 17% payout on book value.

What's the reason for keeping the dividend at that level versus just changing it to a level that's consistent with levered ROEs?.

Well, I mean, I will say between the dividend at $0.065, it's certainly not because we earn $0.065 every quarter or every month, and we do have episodes where we earn above and below that.

And what we're trying to do when we set the dividend is try to pick kind of the center of mass, if you will, of where we think we're going to earn going over longer periods of time. And there are episodes where you're above the line and there are periods where you're below the line.

But unless we feel that that's a permanent shift then we're not typically going to change the dividend. Then given our outlook and what I said earlier about how we view the IO positions, we expect that we'll be at that number on average going forward.

If something were to change, we were to -- meaningful deterioration in the economy or the outlook and it look like we’re going to stay in this low rate environment then obviously the allocation to IOs would probably not be warranted. The composition of the hedge book would not be warranted and the allocation to pass throughs will go back up.

So there would be second transition in that direction. But if you go back to where we were in '19 and '20 and then when we entered even in early the first quarter when we had a very high allocation to pass throughs, over the last year and half when we knew were generally very attractive ROEs is that period.

It’s just when you go through these periods of transition like we did in the first quarter and even this quarter, sometimes you get these outcomes. But we don't think that's going to change the long term outlook.

And so -- and like I said, borrowing change in such outlook, we will continue down this path even if it means we're slightly under earnings for a few months..

Your next question comes from [Tim Delisle] from [Indiscernible] [Seven Canyons]..

I echo his sentiment. You guys did great call. You gave a lot of information on where you are and where the market is and [Indiscernible] quarter for that.

Can you refresh me when you came into this quarter [Indiscernible] our book value?.

Into the second quarter, it was 494..

Well, the end of the second quarter….

471..

Do we have an update as to where you are, where you expect to do right about now from maybe [Multiple Speakers]….

We were up slightly from that number..

And you were [Technical Difficulty]….

[Tim], you’re breaking up a little up….

Have you updated your -- your release of about a week ago or so shaped you to have been very active going into quarter end with your ATM, as well as into this new quarter.

Is it still active or will it be as soon as this call is done?.

Yes, we’re probably likely to do so..

And how much accretively, how much of the book value maintenance so far this quarter in a quarter where [effectively] it looks like rates have moved [Technical Difficulty] long direction? How much of the [Technical Difficulty] this quarter so far can be laid at the feet of the accretive offerings you've been able to make so far this quarter?.

In Q3?.

Yes..

I would have -- well, we're only up slightly [Multiple Speakers]. We had -- our equity issuance this quarter is modest. So I don't think it would -- I don't have that number I apologize.

But I do not think it's significant just because we haven’t issued them, it’s just now we did -- some of the sales that occurred at the end of the second quarter settled in the first. So they're not reflected on the June 30 balance sheet. But the share issuance in this quarter obviously is much, much less than Q2.

And by the way, equity issuance through the ATM in Q2, I wouldn't say was so much backloaded. We announced a new ATM on June 22nd but we have sold quite a few shares under the previous program in Q2 up to that date.

So we’ve assumed there are programs of a certain size it ended and we started new one on June 22nd but at that point, we had already so far from share. So we were selling shares accretively to book throughout most of Q2 and much lesser amount early in Q3.

And we would assume after this call, depending on market conditions and price -- performance of the stock that we may so in the future. But I wouldn't say that was so back loaded..

I would attribute that most of the gains this quarter in the portfolio is being from, specifically, the Fannie 3 specified pools perhaps, so those have really done very well, especially into the end of -- the first three weeks of July, they really ratcheted it tighter versus where they were at the end of June and has outperformed -- and general mortgages have outperformed over the last week or two.

So we’ve seen a lot of tightening in the last week or so, even in the TBA markets. But specified pools for the first few weeks of the quarter did quite well..

Just regarding the earlier ATM, and will your Q have, will the Q be able to give a little bit better run down as to the characteristics of the slide relative to IO and the inverse IO positions? [Multiple Speakers].

It's not in the Q and so we can do it now, but it's not in the Q..

Just what the general lack in and what kind of seasonings characteristics [Technical Difficulty] and I'm sure you would grant me that IO spend to be a little bit leveraged selection of security selection and general pass-throughs?.

So there's really sort of a barbell approach. And so we have some higher coupon predominantly, predominantly fours with gross racks and say in 430 to 450 range. There's a handful of 4.5s in there that are really more generic in nature. These are pools that have very, very large negative durations and very high positive convexity.

And then the other side of that barbell is really this collateral types that we've been adding over the last -- really starting in the second quarter and then it continued through the third, which are loan balance, predominantly loan balance, higher loan balance, say 150, 175 pay [max] 3s, 350 to 375 gross WACs off of -- that are paying a little bit on the pass through side.

The price then that continue to pay on the pass through side, and then some really pristine collateral that use IOs were ones that we made off of specs that we used to own. So 85K Max 4s, New York -- slow pay, New York 3.5s that does really on kind of the 20s, while good gross WACs.

So less than 40 -- less than probably 50 basis points of spread above the coupon. So for the 3.5s, call in the 390s and for the 4s and the 445 sort of area. And so the idea is pairing possibly convex fast paying IOs with slower paying IOs that have a much flatter S curve that also have good convexity characteristics in the underlying pools.

I don't have the combined gross WAC. I think that will actually be in -- I do have it, I’d take that back -- 441 for the kind of [Multiple Speakers]….

IOs are 419 versus 440, but they’re much smaller...

The inverse IOs book is relatively small, it's a little bit of a carry play We've added some kind of higher risk structures there with that. I think there is only like $5 million worth on the books. But they're like low strike inverse IOs off of custody collaterals. So it was sort of the same concept.

They have very high sensitivity to interest rates and are going to do well. Most of the -- this was put on one trade, and it was basically sort of fading the fed in the short term. So by a relatively short cash flow that was very dependent upon money market rates staying low or LIBOR is staying low.

And so that cash flow is working it’s way up pretty quickly and going our way so far. So it's been on the books for a while though..

Your next question comes from Christopher Nolan from Ladenburg Thalmann..

[Technical Difficulty] raise in the ATM in the quarter?.

Which quarter?.

Second quarter..

I want to say 125 million at a average price of 540 in the second -- but it's almost 125 [Technical Difficulty] versus 540..

So is that net or gross?.

Net..

And follow-up on the previous question in terms of -- using the ATM going forward. Bob, given your comments in terms of your keeping the leverage ratio, it seem to be not that much changed. But given the outlook, it sounds like it's somewhat an attractive environment for you.

Is the capital plan to continue to grow equity aggressively through the ATM?.

Well, it positions [Technical Difficulty], so to speak. The price of the stock versus book value and the investment opportunities are there, we will because obviously it’s accretive to book value in doing so. And then hopefully it's maintaining earnings. If it's hurting earnings then it's kind of a short-term gain long-term loss.

So we don't want to do that. And as I said, the leverage ratio may be down, it probably will go back up slightly. There's somewhat of a lag as you raise capital and deploy the proceeds and you don't earn the income on the assets right away.

So that and just towards IO allocation, which is part of the reason why the leverage ratio is lower, we're not at but nearing kind of the target range for that. So at some point that will level off. And then I think from there, it really is just a question of how the market looks at the time and where we want to deploy the capital.

Right now, it's 3% coupon and to a lesser extent, 2.5 and 3.5, mostly coupons are the vast majority of the portfolio and then IOs is those 100 related to the IO strategies kind of on the barbell in terms of different strategies, simplifying that that's kind of where it is.

And then the other thing that might affect net income and earnings would be substituting IOs in for rate hedges, because those IOs have the potential to be obviously yield versus paying something. And the far outlook on rates materializes overtime and we're pretty confident that it will, but it's been a rough year-to-date.

But if it does that will bode well for us book value and earnings and that would be in fact again happens then that would be very attractive time to be raising capital. Because we would be raising capital into a raising the current environment given our portfolio, which would be higher coupon and IOs.

So if we see whatever drives it and if we see rates moving up over the balance of the year and the next year, that's good for us in terms of our positioning and also good for our earnings outlook. So yes, we would love to be able to raise capital into that scenario..

And on top of IOs, I mean, given your comments where you expect that at least for the next 12 months or so, short term rates to remain somewhat low and the yield curve to steepen.

Given that, are you trying to keep your IO allocation -- capital allocation at current level?.

Yes, that's the idea, right? We didn't see that steepening occurring, which would be good for those positions. You never know how it's going to play out. I mean we saw in the first quarter, it didn’t play out very quickly and very moderately. And so we don't know that.

We kind of never knew what we think we're going to hit but we don't know necessarily how that plays out. If at some point we thought we were kind of seeing the full extent of the sell off, and yes, you want to start getting rid of some of those, because you would have been monetizing those gains and maybe going into pass throughs.

But yes, I mean, that's -- I mean, you never say never. And I heard Board this morning thinking that the fed should start raising rates early next year. But I also heard Powell on Wednesday and I don't see them raising rates anytime soon. So as a result that means the curve, which we think are on the front end has to steepen.

So you never know but I think that's the way it's going to play out. I think it's going to take a while before they start raising rates..

Your next question comes from Mikhail Goberman from JMP Securities..

[Technical Difficulty] your prepared margins that you've seen some element of prepayment burnout so far in the third quarter. I was wondering if you could briefly just sort of expound on that a little bit.

And also on the question of prepaying, how do you think they will respond to the removal of this adverse market [refi charge]?.

I'll say a few words and then I'll turn over to Hunter. Well, just in the space that we reported, most of the -- what we’ve seen is an acceleration in speed and the lower coupons, production coupons, like 2.5s. And the reaction to the movements in rates has been much more muted in higher coupons.

You have to factor in some other factors and if they count things like that, which vary from month-to-month, but not so much the last report but the one before that you did see slowing in higher coupons and somewhat of a continuation of that this month.

And so like I mentioned on the call, you seen some very good performance of higher coupons late June and into July. Whether that sustained or not remains to be seen.

But it seems if the focus from now of the originators is back to the production coupons it is obviously there, but much easier refi to actually to right, I mean it’s fresh, it’s the lowest hanging fruit. So that's where you're seeing those as they ramp up.

Don’t forget in 2020 when primary secondary spreads were high and sales were high, a lot of the 1.5s, 2s and 2.5s that were originated had very high gross net WAC spreads, and typically hundred. So all the 2s were 3% coupons to the borrower, all the 2.5s were 3.5% coupons to the borrower, and now available rates are in the high 2s.

So those people are the target. When we saw the first quarter and rates spiked higher than those borrowers were in the money, so the originators turned their focus to more seasoned higher coupon bonds or high SATO bonds. And we saw those speeds accelerate, but now it's kind of -- that’s reversed. And so that's what we're seeing.

If we stay here at this level of rates for a long period of time, eventually they'll refi all the 2s and 2.5s and then they'll turn their attention to the higher coupon borrowers again. And I'll turn it over to Hunter to add his thoughts..

Yes, I think that we've been investing with a little bit of a base line philosophy that rates aren’t going to get materially below, call it, 280s to the borrower.

And so one of the trades we've been putting on and I've done so in quite large size are elbow shift strategies with low gross WAC, so call it collateral from -- where the property is in the State of New York that are say 330, 340, gross WAC where elbow shift is taking the real some incentive to refi away from those borrowers at 275, 285, call it, refi opportunities.

And also, we've gone fairly deep into agency or investor pools. There was some release earlier in the year that agencies were going to strictly limit the number of investor pools that could come through -- content through in agency form.

We've seen a dramatic drop off in terms of production that production has really shifted over to more private label side of things.

And so, so far it’s been a strategy that has also sits with us over the elbow shift strategy where those are typically the ones that we added and I think were 330 to 350 gross WAC, but the GSCs really don't want to be focusing on those at the moment. And so it's proven to be a good strategy for us, and we'll continue look at other things.

We had a little bit of a disappointment, and our loan balance collateral, I think that was about, in July, that was I think a byproduct of the refi now initiative, which is looking to refinance low income borrowers.

Obviously, that's one of the risks you take when you invest in low loan balance collateral is that tends to be some low income borrowers in those pools as well.

I think that's going to maybe have a month or two's worth of negative impact, and then all of the borrowers that really qualify for that, for that new program or that are at least receptive to refinancing as a result of it. And it kind of work its way through the system pretty quickly I think and through our pools pretty quickly.

So we continue to be pretty bearish and hence the allocation to that I think similarly, I guess 2, 3 -- 3% buckets, so we've been very, very picky about the gross WACs in the pools that we've acquired in the 3% bucket and we’ll continue to do so, try to keep it somewhat under 3.5%, which really in conjunction with whatever specified characteristic we're layering on to that collateral, makes it at least at this point not really worthwhile to go through the trouble as [Technical Difficulty] some loan..

And Mikhail, you mentioned the adverse market, that is pure cut to the rate to the borrower assuming they’re passed on to [borrowers] vast majority cases, that reduction or elimination of that fee is off savings to borrowers and just lower available rate available to borrowers [Technical Difficulty]..

[Operator Instructions] There are no further questions at this time. Presenters, please continue..

Thank you operator and thank you everybody. We again appreciate you taking the time to listening on our call. To the extent that any other questions come up after the call or you listen to the replay and you want to call, as always we're available at the office to take those calls. The number is 772-231-1400.

Otherwise, look forward to speaking to you at the end of the current quarter. Thank you..

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