Good morning and welcome to the fourth quarter 2019 earnings conference call for Orchid Island Capital. This call is being recorded today, February 21, 2020. 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 Limitation 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 good morning everyone. Thank you for joining us today. I hope everybody has had a chance to print a copy of our slide deck. That will be the focus of discussion today. Assuming everybody is ready, I will be starting on slide three, as we give you all the rundown of the agenda. First, we will have a brief highlight of our financial results for the quarter. Then we will spend a few minutes talking about market developments that affected the portfolio and guided our decision making. And then we will turn to our financial results. And finally, we will discuss portfolio characteristics, credit et cetera, hedges and changes we have made to the portfolio. Starting with our financial highlights for the quarter. Orchid Island generated net income per share of approximately $0.29. This includes $0.06 per common share of net realized and unrealized gains and losses on our assets, our agency RMBS assets as well as our derivative instruments including net interest income on our interest rate swaps. Earnings per share of $0.23 excluding all those times I just mentioned. Book value per share was $6.27 at December 31, an increase of $0.05 or 80 basis points from $6.22 at the end of the previous quarter. In the fourth quarter, the company declared $0.24 per share of common dividends. And since our initial public offering, we have declared $11.025 of dividends. Economic return for the quarter was $0.29 or 4.7% unannualized, 18.6% annualized. And the return for the year was 5.7%, a very generous return. Now before I move forward, I just want to provide some context for new investors and maybe reiterate in some basic facts for those who have been listening to us for a long time and just try and give you…

[Operator Instructions]. Your first question comes from the line of Christopher Nolan from Ladenburg Thalmann. Your line is open.

Hi guys.

Hi Chris.

Hi Bob. Can you comment, sorry, I missed it, but did you indicate that the higher asset yields were due to higher prepayment and amortization?

No, not that. Our yields on the portfolio have been coming down slightly because of the basically the shift down in coupon coupled with some realized higher prepayments and they have been coming down.

All right. And then I guess the second question I have is on the portfolio characteristics. Obviously, you have been investing, it seems like a big jump into 3.5 and 4s. And this seems to be, I mean, given the jump, how should I look at this in terms of your coming down from 4.5 and 5s to 3.5s and 4s? Because I am comparing the portfolio quarter-over-quarter and I see the big jump. It's just not clear to me exactly where you are taking stuff out of, aside from the 15-years.

Well, the CMOs. CMOs were reduced by half from, I think it was $605 million to a little under $3 million. 15-year 4s went from $403 million to less than $20 million. The big jump was in the 5 bucket. It was $808 million, $809 million. That was reduced by about $550 million. The 4.5 bucket basically just ran off. That went from $460 million to $430 million. So the CMO bucket, the 15-year 4 bucket and the 30-year 5 bucket were the big ones that shrank. And the adds, as you mentioned, were in the 3.5s and 4s. And that's we are just, like everybody else, we are trying to get some duration, while at the same time protecting yourself from prepay. So even though we bought lower coupons and we were buying a lot of low loan balance or 110k, 125k or New York. So the dollars are still somewhat high, but you do get good prepay protection from those assets, because at this point, today, as we speak, the 10-year is now broken through 150. We would expect prepay activities to remain very robust.

Yes. Chris, over $900 million of those purchases, those new purchases were in either 85k or 110k Max and that collateral is just simply not available in 4.5s and 5s. We did want to add some duration in the lower coupons as well because we think those are going to serve us well into a rally environment. And in general, the theme is just very simple. We expect, as I think Bob had a great new slide he was talking about showing the percentage of the mortgage universe that's on the cusp of being refinanceable. And so we want to improve the convexity of the portfolio in case we get a rally. So increase the duration, improve the convexity, invest in assets that will continue to increase in value, if and really frankly, as we have rallied. And then on the hedge side, stay very light and nimble. And we have done a few things on out-of-the-money payers that I think would serve us well in case we are wrong in that view, we will get a quick reversal to higher rates.

Okay. And thanks for the color. I guess the final question really is on your interest rate sensitivity. It seems to change so much dramatically quarter-over-quarter where a 50 bip increase can really impact the portfolio. How high should we expect the duration to go? Or do you expect the duration to stay at current levels in the first quarter? What do you think? What do you think about that?

Well, yes, I noticed what you are seeing in the sensitivity table, a negative $13 million in a selloff. Now it's positive $400,000 negative. And that of course reflects the down in coupon shift. Empirically, we have actually traded to a slightly positive duration on these. And let me just back up to what is the question. We have seen very consistently year-to-date and really throughout the last six months, when the market rallies we tend to bull flatten and when we selloff, we steepen. And so every time you get these rallies, where the market flattens, obviously mortgages do tend to go wide and do very poorly. And we have positioned the portfolio such that we don't do as bad as we used to when that happened. It's not ever a good thing, but we may have modest losses. That's with the empirical duration. The model duration is going to be, the model is going to capture the fact that we have longer duration assets on the books plus they are specified pools. So we are going to model and that's why these numbers are what they are. Who knows what the future holds, certainly with respect to the long end. But I think it's really, really hard to see a scenario where the Fed is going to tighten in the near term. So that's one risk we feel very comfortable taking. So we have to worry about the long end. And so Hunter had mentioned some of the swaptions we have done. And as I said, we have the IO book. When speeds get this fast, at some point prepay expectations with respect to IOs can only get so high. So those cash flows or expected cash flow shorten, it really can't shorten anymore. But in the meaningful backup, they can extend quite a bit. And so we feel comfortable owning those as a hedge against the move in the long end. And then the other thing which is more of a local move. What we have seen is, even in the fourth quarter when rates backed up, the market is, I would say, it has a bearish or a bullish bias to it. And that means that the market ignores economic good news and rallies when we have bad news. And that's reflected in the past for spec pools. Even though the market sold off in the fourth quarter, those payoffs did fairly well. Now we have an option coming up, options in two weeks and we are back at where we were during the January. I don't think that those are going to do very robustly. And they will outperform their hedge ratios in a selloff, as long as it's not too severe.

Okay. Thanks for taking my questions.

Your next question comes from the line of Jason Stewart from JonesTrading. Your line is open.

Great. Thanks. Good morning guys. My question is on the expectation for the cadence of prepayments. Bob, you noted that they were still high in the first quarter. But is your expectation that they decline sequentially, even if it's moderate decline? And then tick back up? I guess any color you could give us on how you expect that cadence to work out through the middle of this year, would be helpful.

I don't expect them to drop much at all. I mean, the drivers are day count and things like that. But certainly with the rally lately, I don't expect them to drop much. The only thing that's going to cause them I think to drop much is going to be burnout, really. It's just that these borrowers are exposed to refinancing opportunities now. There, I would assume, the various mortgage originators out there are ramping up capacity to refi more and more. And it's just a question of how fast they can work through the process.

Yes. I would just add to that. I think some of the incremental changes we have made in the portfolio might help us. If we are talking about a static set of assets, I don't actually expect them to be ramping up here in the next few months. But we have taken actions in the fourth and first quarter to improve the prepay profile of our portfolio. So I think we might see a modest downtick just related to that type of rotation. But in general, if we are talking about assets that were originated in 2018 or 2017 even, I think you could expect to see them increase speeds sequentially.

Okay. That's helpful. And then I just want to make sure I put some of your comments. so I see you little bit of equity in the first quarter. I think you noted that you added some assets, the basis is wider and leverage went up. So you have added better economic return assets in the first quarter to-date in excess of the equity that you have issued. Is that correct?

Yes. Slightly more, yes.

Okay. Thanks.

[Operator Instructions]. I am showing no further questions at this time. I would like now to turn the conference back to you, Mr. Robert Cauley, Chairman and Chief Executive Officer.

Thank you operator. Thank you everybody for the time. I appreciate you listening in today. To the extent you have additional questions or you happen to hear the replay, didn't hear us live, we will be in the office all day. You can field your questions. Our number is 772-231-1400. Otherwise, we look forward to talking to you next time. Thank you.

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