Orchid Island Capital (ORC) 25 Oct 242024 Q3 Earnings call transcript

Good morning, and welcome to the third quarter 2024 earnings conference call for Orchid Island Capital. This call is being recorded today, October 25, 2024. 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. Beliefs 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 Security and Exchange Commission, including the company's more 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'd like to turn the conference over to the company's Chairman and Chief Executive Officer, Robert Cauley. Please go ahead.

Thank you, operator, and good morning. Thank you for joining us. Hopefully, everybody has had a chance to download the slide deck, so they can follow along with us.

Just to kind of start, I will start off, by going over our financial results for the quarter. Then I'll discuss the market developments that occurred during the quarter that shaped our performance and our decision-making with respect to the portfolio. Then we'll dive into the portfolio characteristics what we did during the portfolio, how we've positioned ourselves and then our outlook, and then there's a substantial appendix.

So we have a lot of information that is in the appendix that you can use. We won't necessarily go through that, that's just for your reference.

So with respect to our financial results, for the third quarter of 2024, Orchid had a net income of $0.24 per share. That's versus a $0.09 loss during the second quarter. Book value declined modestly from $8.58 to $8.40. The total return for the quarter was positive 2.1%, that's not an annualized number, and we declared 3, $0.12 dividends. The portfolio obviously, these are average balances did increase quite a bit during the quarter. I'll have more to say about that in a few minutes. The leverage ratio did expand slightly. That's predominantly just because of a slight tweak to the amount of TBAs that were short and a modest book-value decline.

Our speeds increased modestly during the quarter from 7.6% to 8.8% with the rally in rates, and our liquidity is relatively in line, up slightly versus where it was in the second quarter. Slide 7 just has our financial statements. I'll leave those for you to review. I'm not going to go over those. We'll be releasing our 10-Q later today, so you can have a much more in-depth dive into our financials at that time.

Now turning to the market developments, which shaped our results.

Just to kind of start, if you look back to where we were at the end of the second quarter, things were looking quite well for the mortgage market and for REITs, in general. Most of the data that the Fed paid attention to, inflation data and labor data was trending down. Most people were anticipating substantial Fed eases, and in fact, we got one. A 50 basis point cut in September, the curve was steepening and NIMs were expanding in this space, and the outlook was quite good for mortgages. With Fed reducing rates, the curve steepening, potential for banks to come in in a more meaningful way, things look quite good. That was until late in the quarter and things did change.

As you are well aware, late in September into October, we got some data that was kind of consistent with a quite robust and resilient economy, certainly not one that appears to be heading into a recession any time. It's quite resilient. We may have a soft lending, no lending, who knows, but it's certainly not as dire as it looked just a few months ago. And then most recently, as we approach the election, which is of course, a big wildcard for the markets. It appears that the market may be pricing in some probability of a Republican sweep. The significance of that is kind of twofold. Traditionally, Republican administrations tend to be more pro-growth.

So to the extent the economy is not as soft as we had thought and, maybe much more resilient and growing, that would, of course, add to that growth. And then, the second one would be just based on President Trump's pronouncements that they tend to be kind of, consistent with an expanding deficit. And that would, of course, put some upward pressure on rates as well.

So we're in this transition period now since the end of the quarter. There's a lot of uncertainty in the market at the moment. We don't know how the election is going to play out. We really don't know just how the economy is going to evolve. It looks, at the moment, as if it's going to be resilient and strong. GDP data comes out next week so we'll get to see, but it looks like it's somewhere around 3%.

So it's not a weak economy. And that means that rates are probably, not going to be rallying any meaningful amount anytime soon.

If you look on Page 9, you can see that the red line was where we were at the end of the second quarter. The green line there on the top-left, is where we were at the end of the third quarter, and the blue line was as of last Friday.

We are higher than that today. Rates have continued to sell off, although the last 2 days been some kind of a stabilization in there. And then the spread on the bottom, you can see is moved as we steepened, but still has a long way to go from what would be more traditional levels.

Turning to Slide 10. This is just the spread of mortgages to the 10-year treasury, the current coupon mortgage. And you can see, this is a 10-year data range here.

So it's kind of hard to pick this up. But if you look at the extreme right, you can see the downward-sloping portion of that curve. That was Q3. We had a very good quarter going on, as I said until about mid-September, and we've since reversed. This number here on this table says 132 basis points. That number is now north of 142 this morning, so quite a reversal. With all the uncertainty in the market, people are just not buying mortgages in any meaningful way. We generally have widening pretty much every day. Monday of this week was quite severe. And until this uncertainty is resolved, it's just kind of a tough market for rates, and for mortgages in particular. Other spread products don't seem to be as affected as mortgages are, but it hasn't been a pretty run for mortgages of late. The bottom-left of Page 10 shows you, this is normalized prices for select coupons. And again, this data is through last Friday.

If you were to update that, those numbers will be closer to the 100 line meaning that, these coupons have given up a fair amount of the gains that they enjoyed during the third quarter. Roll activity is somewhat better in the higher coupons, not so much in the lowers, but generally rolls are a little bit better than when we last spoke.

Moving on to volatility, obviously, a very important driver of mortgage performance.

You can see on the far right side of the page that, we've been trending higher.

If you were to update this one again through today, it's still higher yet, up close to 130 on the MOVE index. And we've got meaningful events on the horizon. We've got a non-farm payroll report next day.

We have the election on the 5th, and then the Fed on the 7th, and whatever else comes data-wise after that.

So I would say the outlook for volatility in the near-term at least is to remain elevated. I don't expect to see that fall, and that's generally not good for mortgages. Slide 12, just gives you some picture of refinancing activity. And you can see we did have a bump either the top-left or the bottom-right, you do see that small bump, but it could be that was a short-lived phenomenon.

During third quarter, prepayment fears became very real. Spec pull pay-ups did benefit from that. People were really concerned about prepayment risk. But as of now, that's really not so much the case. And it remains to be seen how this plays out going forward, but for the moment, those peers are clearly abating. Slide 13, I'll just kind of leave this for your purview, one of my favorites. These numbers here, the blue line is just the GDP in the United States in nominal dollars. Nothing more in the red line is the money supply. And as you can see, for 10-plus years, growth, which would be represented by the slope of the lines of the blue line was incredibly stable. But since the pandemic, we've seen the money supply expand far above its trend growth line, and GDP has as well cause and effect you to debate. But I don't think there's any doubt that with the current level of deficits, the fact that money supply is elevated and we're seeing elevated growth levels, and consumer spending. It's possible that there is and to the extent that continues, it's really hard to see the economy weakening materially.

And so, what that means for rates remains to be seen, but I don't see it being supportive of a big rally.

Now that's kind of what's happened in the market and I'll just kind of turn to what we've done, how the portfolio has been repositioned, and how we've positioned ourselves going forward.

So we had the Fed pivot. We've been waiting for this for a long time, we finally got it. Not so much sure how much we're going to get of additional Fed easing, may not be much. That being said, we did raise $110 million to our ATM in this quarter that, represents a 20% increase in our share count. And by deploying those proceeds, we grew our portfolio likewise by about 20%.

So a pretty substantial growth for the quarter. And the way that we did that was basically acquire higher coupon mortgages. We've talked about in the past, how we wanted to build out a barbell portfolio.

Now we have fully done so.

In fact, now the portfolio has a very much up in coupon bias.

So the proceeds were deployed into 6.5% and 7% coupons. The result of that was to raise our average coupon, by 22 basis points from 4.72% to 4.94%. And the yield on the portfolio expanded, by around 38 basis points, 5.05% to 5.43%.

Now one thing being said is when we deploy these assets, most of this was front-loaded in the quarter to a large extent. We hedged those with predominantly longer duration swaps 7 years and 10 years. And as a result, with the rally during the quarter, we kind of underperformed and that's just a result of the fact that with the rally in rates, our hedges, which were, as I said, longer tenor swaps combined with assets that were shorter-duration assets, which rallied -- I'm sorry that which widened during the quarter as a result of prepay fears. That didn't do as well during the quarter. That being said, since quarter-end and rates selling off, it's probably allowed us to outperform a little bit.

So I'll say more about that in a moment.

So that's basically what happened with respect to the assets. Page 16, just shows you this in pictures. We've added upward coupons.

Now you can kind of clearly see on the far left that, there's kind of a bias to-upper coupons. But that being said, we have retained a substantial holding of discount securities, which have great characteristics in the event the market does rally back.

So the barbell is still in place. It just has an upper coupon bias.

Now with respect to funding, one thing is clear with the Fed ease, we had an immediate benefit of that. It was roughly 30 basis points, which was felt in September. That's just more of an artifact of the fact that repos role.

And so, we don't get the immediate 50 basis points, but it has allowed our funding cost to drop. They had been remarkably stable, as you can imagine for some time. The data that's on this chart appears somewhat misleading. I don't want to dwell on this, but it says that, for instance, our average repo rate was 5.62% versus 5.34%. That's very misleading. It's just an artifact of how we do this.

As I mentioned, when we grew the portfolio this quarter, it was tending to be more front-loaded.

So we had that extra interest expense load, if you will, for the quarter. But the denominator in the calculation is just the average balance.

And so the average balance is kind of low, and it makes it look like our funding cost is higher. That's really misleading. And I think as we have a period of slower growth or no growth, those numbers will normalize. And what you'll see is that our repo funding costs, are lower than they were for prior quarters, roughly 40 basis points. But I do have to make one point, with respect to what we are seeing in the funding markets, and that is the fact that over quarter-end, month-end, year-end, there has been some expansion in the spread.

So for instance, when we enter into repo, it's a spread to Fed funds, or a spread to SOFR and those do expand over those periods.

So there is evidence that funding pressures are emerging. From what we hear from the Federal Reserve and various members of the Board, they don't seem to be concerned about that. What we do hear from the funding desk across the street, is that there is clear evidence that's starting to happen. Nothing too acute yet, but it's definitely happening and it does offset some of the benefit of the Fed cuts, at least over those periods.

So on average, it's going to eat into the 50 basis point easing, or whatever additional easing we get by some amount. The exact extent of that remains to be seen, but it's definitely out there. And the Fed is doing QT and so, there is being liquidity drain from the system, dealer balance sheets are quite full.

So we'll see how that plays out, something worth watching. With respect to our hedge positions, really not much change.

We continue to be heavily reliant on swaps. They cover a very high percent of our funding liabilities. And the combination of that with the migration up in coupon, which tend to be less rate-sensitive securities, the portfolio is slightly more defensive than it was at the end of the second quarter. Slide 10 just shows you the details of our hedges. One thing we have done, I will point out is in the top-left are SOFR futures. We've been opportunistic with respect to adding these. Whenever we've gotten really bad economic data, which caused the market to rally and the market to price in more Fed easing, we put a bunch of those in to try to lock that in.

And so, hopefully, that has been -- helps us in the future by kind of locking in some lower funding cost. Because the market has generally been very aggressive at pricing and Fed eases and been frustrated when they don't appear as expected. Otherwise, we did move some of our 5-year future shorts into a 5-year swap and combination of that and SOFR future shorts. And the rest of the expansion, which again is a product for the growth in the portfolio, we did add some 7-year swap positions, another $100 million. Slide 20 just shows you expected returns across the coupon stack. This is something we're always looking at. I'm not going to say anything about it other than just to point out that, we have to shape our decision-making. Slide 21 shows you our interest rate sensitivity and you can see based on this that there is a defensive bias to the portfolio at the moment, just as a result of the things I just mentioned. And you can see that we do a little better in a rally -- or a sell-off, which is not typical, less in a rally, and that's just because of the positioning. Speeds, we did take on a lot of higher coupon exposure, but by selecting kind of lower-quality spec pulls, and taking advantage of the newness of those securities, and the fact that they don't tend to prepay rapidly.

Our speeds weren't that high.

Our 7% securities, you can see had a high print in August, but the 3-month speeds versus the prior quarter not that elevated. And then, when you consider that we've seen rates sell off and we're heading into the summer, or the seasonal slowdown, it seems that these higher cost securities that we had, we're likely to experience slower speeds, which means they're going to have better carry.

So the combination of higher coupons in the portfolio, and higher coupons that are prepaying slower should be beneficial for the yields that we realize. And as I mentioned, we have a slight improvement in our funding costs.

So there has been some benefit to our NIM that we expect to realize going forward, not modest, but some.

So to summarize, looking back, looking forward, as I said, we did get the pivot, but it may not be what the market was hoping for. It may not be the extent of easing that we had hoped, or expected not too long ago. That being said, we have continued to both employ our barbell strategy, but now with an up-in coupon bias, which I think is well suited for the market conditions today. And the market for arguably 2 years now has continued to overestimate the weakness in the economy, and the extent and timing of Fed rate cuts. We really just haven't seen those play out. And in the fourth quarter so far, as a result of these developments and mortgage spreads, have given back a fair amount of what we have gained in the third quarter. But that being said, we're very comfortable with our positioning and our hedge structure. We think we have some modest NIM expansion here. And as I said, there's a lot of uncertainty in terms of where we go from here. But to the extent that rates do continue to back up, we do have a very high-yielding portfolio. We might be able to continue to maintain that yield, therefore, dividend level with potentially less leverage if this continues, just because of that NIM expansion.

So that's kind of like it for the quarter. That's how we see things evolving. And with that, I think we can turn the call over to questions, operator.

[Operator Instructions] Our first question comes from the line of Jason Weaver of JonesTrading.

First, Robert, you touched on this during your remarks, but taking into account the 30 years that you bought in the 6s and up into the 7s and the short TBAs and low coupons. Does this reflect a view that you expect little relief in benchmark mortgage rates over the next 12 months? And does it change the favorability of the barbell strategy at all going forward?

Well, we do a bias to a higher coupon.

And so, we don't -- it's hard to have a firm view on rates going forward just because the data just tends to be so volatile. And as we saw in September, you can get whipsawed. I would say one thing I think though is that, if you look at where rates are, where they can go from here, there's certainly for them to go higher.

So to the extent the economy is stronger, inflation reemerges, deficits keep growing, they can go higher. I don't see the potential for rates to go the same magnitude lower.

Let's say that we're totally amidst here and the economy is going to go into a recession in the -- it's going to cut to -- the funding level is going to go to neutral, whatever that is. I mean, we won't even know what that is.

If you look at the dot clot, that could be 2.5% to 3.5%.

Let's say it's 3%, if they were to cut to 3%, where do you think the rest of the curve shakes out? I mean, the tenure in that scenario should be much less than 4 and we're a little over 4 now.

So the outlook going forward, I think is kind of asymmetric.

So that's why we like this kind of up in coupon bias. But because of the uncertainty, we don't want to just throw in the towel on lower coupons, because we saw in the third quarter, you can have a rally and the higher coupons will underperform.

You want to add to that?

Yes. The lower coupon strategy is nothing to write home about during times when spreads are relatively tight. They -- do have lower yields, lower carry for the portfolio. But when we get environments like now, where I like to look at mortgage spreads versus current coupon mortgages versus 7s or 10-year swaps, and we're getting back to the wides of the year.

And so, now is the time when we really like to have those on. In the event, we get rates turn-around and rally, and spreads tighten, we would expect the most spread duration positivity out of those, where the higher coupons are going to underperform again into that rally.

So we have intentionally had a sort of a more conservative bias, I guess. It felt like the economy is very strong.

As Bob alluded to earlier, we've opportunistically tried to lock in the aggressive amount of Fed rate. At one point, I think we were pricing in 6 or 7 Fed cuts over the next 9 months to 12 months. We were pretty -- we're pretty opportunistic about locking those in to via SOFR futures.

And so, we like our positioning. It wasn't looking all that great for us through the third quarter, but now rates have turned around and sold off and widened.

And so, we feel like the strategy is continuing to work.

Got it. That's a helpful color. And then on the same dimension on the other side, looking at the swap position, it looks like your hedge ratio actually came down a bit, even though dollar duration is not that much changed coming into September. Any color you can give us there regarding sort of risk appetite into year-end around the election? I mean any comments about the -- you made some comments around expecting volatility ahead in the next few months?

Yes. Well, we did add to this -- we grew the portfolio by 20%, but our swap book positions did not grow by that amount. That's where we added to the SOFR futures trying to lock in some of that funding. We've seen a lot of movement in swap spreads on the front end of the curve, which kind of offsets the effectiveness of those hedges. And volatility, I would -- it's really hard to see that dying off anytime soon. And as long as that is elevated, mortgages are going to not perform well.

Going forward, it's hard to have a lot of conviction in anything. We were at a conference earlier this summer. And Kevin Warsh was speaking and you may recall, he was a Fed Governor, quite a bright lad. And he made a comment about economic data. Basically, his point was that data has no business having any numbers to the right of the decimal point. In other words, what he meant was very in exact science. And he says, I know every one of you guys out there in this room are waiting with breath for the next non-farm payroll number. He says they're not really good at this stuff. And it's probably going to get revised multiple times. And it is very much economics is the -- in exact science. And it's really just in this year, we've seen so much volatility in data, data being revised, GDI, those domestic investments revised up the savings rate and revised up by 200 basis points, just causes a lot of volatility. And we have a data-dependent fit.

So we have a Fed that's making all the decisions, based on data that's extremely volatile and subject to revision.

So it's really hard to see volatility remaining low. And in the election, it's been chaotic to say the least.

So who knows, it's a pass-up. We don't know who's going to win. We don't know who's going to control the House or the Senate. We don't even know when they're going to finalize the results.

So it could be bumpy for a while.

Yes. With respect to the profile of the portfolio, I think that just reflects a little -- we try to have a -- we try to not be myopic about quarter-to-quarters and have a little bit of a house view and lean one direction or another. We were leading to sort of the -- and we were in the -- very much in the camp of rates seem to have come down really fast and -- but at the same time.

We have to make adjustments in delta hedge as needed when hedge ratios were coming way down.

So we did trim some hedges some into the rally and we haven't reversed course quite yet.

So we're just -- we're just really trying to fine-tune more than anything. I wouldn't say it's reflective of any change in our core position, but mortgages start getting shorter whenever we have big rallies, and we got to make sure we don't get too far offsides with respect to, how the portfolio is hedged.

Our next question comes from the line of Mikhail Goberman from Citizens JMP.

Bob, your recent statement just now that going forward, it's hard to have a lot of conviction in anything I think can be applied to a lot of things.

So I think that's very much on point there. If I can start with just an update on book value, I know you guys mentioned that you might be -- you might have outperformed a bit since the end of the quarter?

Yes. We calculate an estimate every day, and as of yesterday were from 3.7% quarter-to-date.

I'm sorry, 3-point?

No, no down 3.7%, most of that's occurred in the last 5 or 6 days. And spread widening in the -- just in the mortgage market has overwhelmed the positive effect of our slight duration bias.

Right.

Just looking at your prepared remarks and the press release, the statement here that you continue to view a bear steepening in the yield curve, as the greatest risk to the portfolio. If I could just maybe drill down and into your thoughts around that, if that situation were to come to pass, how would that affect your portfolio construction as well as the hedge portfolio?

Well, I think the -- as I said, the bear steepening and extension of mortgages, especially the higher coupons.

We have a higher coupon bias.

So the fear would be if you get a big bear steepening, those premiums or not even big premiums, 2, 3 point premiums all of a sudden start drifting down the price rates, and become discounts potentially so they could extend. That's why the hedges were a lot of 7-year to 10-year swap hedges. But I also think with the modest improvement we've seen in our NIM that we could try to take the leverage down some and maintain that yield. And we already -- we have one of the highest yields in the space, as you know.

So it's not like we need to expand that.

We have no reason to do that. And especially given all the uncertainty that's out there.

So if we could pay the same dividend yield and have less leverage that would be desirable, especially if we do see that bear steepening. Even the rally, as we mentioned, it was kind of -- the reason the market rally was more in anticipation of something that didn't happen. Had that happened, like, let's say, the next 3 months of data were horrible. And the Fed were going to ease aggressively, then that's going to change our outlook and positioning, but we didn't see that.

And so, we're -- that's why we still see the risk of a bear steepening as being the most severe.

And just kind of piggybacking on that leverage, question, economic leverage 7.6% at the end of the quarter. Is that -- with respect to your comments just now maybe drifting to a 6 handle, if situation like that arose?

Yes. The way we've done that in the past generally, is not so much outright selling. It's usually a combination of adding TBA shorts and/or not investing paydowns, just to let the portfolio shrink a little bit. And depending on how it played out, if it was a sudden [ and violent ], there's usually nothing you can do. It's usually over before you know it. But if it is a slow-growing higher, that's how we would approach it.

We have some cushion with the -- particularly in the 6%, 6.5% and 7% buckets of it.

I think that those will continue to do well. It's been a little bit frustrating for us, because those particular coupons underperformed into the rally in the third quarter, and have not really reversed course into the sell-off.

I think that's just, due to the uptick in volatility and uncertainty.

So we still like the strategy even though those particular coupons aren't, really ripping like we would have expected them to into a sell-off.

I think that there's a good chance that we get past some of these -- we get some of this uncertainty behind us, and we'll start to see those firm up. If rates stay at current levels, those will be great assets to own. The carrier will be fantastic on them. And I think what Bob is alluding to in this bear steepener being a -- the worst case sort of for the portfolio is one where we blow through even going back towards 5% on 10s, and it's going to be a substantial move.

So we feel like we have adequate time to prepare for that. It's going to be probably a grind as opposed to a -- just opposed to a quick shock.

So will be watching and reacting.

Our next question comes from the line of Jason Stewart of Janney Montgomery Scott.

Clarification on repo cost at quarter end, the 5.24% number was an average. Could you give us quarter end or was that -- did I misunderstand that?

Now the quarter-end, the actual average as of that date was 5.24%, and then would have been coming down. But it's just -- we grew so fast and the growth was so front-loaded. The way we present that number in there is, you just take the total interest expense divided by the average balance. And since the balance grew by 20% for the quarter, I think the average repo balance was a little under -- $4.8 billion. But in fact, our repo balance was north of $4.8 billion at the end of July.

So the interest load was for more of a quarter.

So it makes it look like our average repo expense is higher, but it's been stable. I mean, the Fed had moved for months-and-months.

So we were running somewhere in the 5.5 range, and then it came down about 30 basis points in September. We did have, as I mentioned, funding spreads were elevated over quarter end, but we'll get more of that in October and November, and then we'll see what year-end brings. But there's -- so it's down 30 to 40 basis points depending on the day you look at it, consistent with Fed easing 50 and spreads on average a little higher than they had been, because of what appears to be some tightness in funding. We'll see how that plays out, as I mentioned. When you speak the Head of the San Francisco Fed, I think it's [ Mary Logan ], who used to run the [indiscernible]. In her mind that there are no issues and that they should ignore any talk from the markets that these things exist and that they're going to continue full head steam with QT. That's not consistent with what we hear from people who live in the repo funding markets day-in and day-out. There's balance sheet constraints that are out there.

Yes, And it's -- just to give some context to -- whereas we were maybe funding at anywhere 14 to 16 over SOFR for several, several months that's gapped out and maybe is pushing 18 or 20 now.

So we'll see -- we'll, of course, are watching and it could -- those things could change, especially coming into year-end. But a handful of basis points right now, which is material, but where our book is resetting is basically high -- very high very high 4s, low-5s as the new sort of Fed funds levels are kind of, are going to impact our rolling repo position.

Let me just give you some added color on that.

So let's say this week, the market expects a pretty high probability cut in November and less so in December, but there's a lot of uncertainty around that, right? So if you look at the Fed fund futures curve through the balance of the year, it's consistent with what you see on the work screen, right? So you're going to have something north of one ease. But you also know, for instance, that there could be some year-end funding pressure.

So what would be a 3-month repo today, it should factor in a combination of market pricing for certain eases. And also maybe some funding pressure over year-end. And if you go out and talk to dealers, you can get quite a wide range of levels that they're going to offer you. All reflecting a combination of that uncertainty and their bias. And that can be quite wide. We got that as we saw that as low as 4.88% and north of 5%.

So that's -- those are -- that's what we're seeing.

Okay.

Now Hunter that was -- Hunter you got it on the head there.

So 18 to 20 over SOFR. I mean, I'm seeing GC like 4.90 and 18 to 20 over puts you at 5, and with 25 days average maturities, I mean, you should have rolled most of your repo by now.

So like the marginal repo going through the quarter now should be closer to that 5-level, and we'll see where it goes from here?

Well, we got a Fed meeting in a couple of weeks or 2.

So we'll see what happens. Market is still pricing in pretty good probability of 25 more.

So we'll see how that goes. And as we alluded to earlier, we've -- we put a lot on that -- we put a lot on that September contract coming into the fourth quarter.

So I think we have like $900 million with the rate -- with at least what was it --

100, over 125.

125 basis points of eases baked into the market at the time we put those on.

Yes. In this year?

And we're looking at -- probably 80 now, yes.

Got it. And then the other question was just on where you see marginal ROEs? I mean, if we look at 3Q was a relatively good quarter for mortgages and then you look at pretty much any metric, plus 2.2% total return. It looks like it's a 17.1% dividend on-book at the end of the quarter plus the cost to operate.

So do marginal ROEs hit that level? How are you thinking about marginal ROEs in your mind relative to the dividend?

I think they're probably -- they've expanded slightly. But as I said, we're not looking push the dividend yield.

So I would say there -- I don't have the number in front of me, it got to be very high teens.

So you figure for our yield, 5.5% versus something in the mid-2s, you've got close to 300% over on a hedged basis, depending on where you want to set your leverage if we're not going to be pushing it.

So it's -- we can clearly get to those kind of high-teen numbers.

Yes. But with the -- par coupon mortgages, right now, we sit hedging with 10 years spread of -- for 190 some basis points over 10-year SOFR swaps.

So that's definitely a high-teen operating environment.

And just one more on that. I mean, how do, you weigh in your mind the potential to sort of build book value in the sense that, let's say, we are at 20% and you're paying out 17%.

And so, there is marginal growth in book if you didn't pay such a high dividend payout. Do you feel like you get credit for that dividend yield? Or do you feel like how do you weigh the potential of retaining that capital?

That's actually a very topical discussion point with us and the Board of late. And it's possibly more so in '25 than '24. That was -- the last time we had this discussion, we were thinking we're going to get more easing than it appears we are.

So the question, do you retain that? Do you consider paying some tax? Our view generally is you don't get rewarded for that.

If you pay a special dividend, they tend to get discounted.

If you pay tax, nobody seems to they might give you any benefit for that either, which tends to drive people to pay out what they earn. But I think that, especially if we're in a rising rate environment, to the extent we can retain any, it's something we'll give a very serious consideration. Yes.

I think we're going to transition from an environment where we were slightly over-distributing to an environment where we're maybe under-distributing for a little bit. And then, we'll have to make a decision into '25, as to what to do to the extent that we have tax obligations. A lot of this is stemming from the fact that our pay fixed swap rate is very low.

And so -- but it's already been mark-to-market for GAAP purposes, but for tax, we are going to have distribution requirements that we're going to have to maintain.

So I wouldn't expect to change anytime soon as Bob alluded to, I think we can let the leverage slide down a little bit and maintain the dividend rate. And then, at the end of '25, we'll have to just take stock of where we sit with respect to our tax obligations and make a decision how we want to handle to the -- to the extent that we have some -- have under-distributed throughout the year.

Okay.

Yes.

Our next question comes from the line of Christopher Nolan of Ladenburg Thalmann & Co.

I had a follow-up to that previous question in terms of the yield and so forth. Bob, when you're talking to the Board or when you have discussions with the Board. How do you guys tend to look at overall performance? Because the dividend yield is quite high, but the book value has been declining down as you guys for various reasons, including hitting the ATM pretty hard.

Just give a little color in terms of how you guys look at shareholder returns?

Well, we always look at relative total perform or total return. When we saw opportunities to grow the portfolio, we were willing to run the ATM. We did so at very modest discounts to book. And I think given where returns are, it was -- it was very much justified. Obviously, now that's not the case.

So we're not going to be using that. We in fact actually bought back some shares very late in the quarter when we traded down. But no, it's always total return on a relative basis. There were times when we were anxious to grow the portfolio to gain scale.

So we ran the leverage on the high-end. We had a high dividend, as you well know, one of the highest yields in the space and that allowed us to grow and reach some scale. That's not so much the case now. We were raising money in the ATM in Q2 and Q3, because we thought we were on the verge of a Fed easing cycle, potentially an aggressive easing cycle, a steepening of the curve, an environment where it would be very attractive for both book value performance, and net interest margin. Not so much sure that's the case now.

As a result, we'll pull back from that even to the point of as Hunter just alluded to, maybe even looking at slightly under-distribution.

So there was a time when we were more aggressive with our duration, our leverage and the dividend to try to grow, but that's probably behind us for the time being, and maybe for quite a while, we'll see.

Now it's more of a defensive posture. And in all cases, the Board would look at total return, but they also given what we were trying to do, for instance, as I just said, grow the portfolio and run that leverage on the high-end with that caveat, they understood that.

So to the extent, we were running higher leverage than everybody else, and we got a violent sell-off and we underperformed. They are aware of that, because they were part of the decision.

Okay. And then also, Hunter, do you guys have an adjusted economic EPS number, which includes hedge income and discount accretion?

We did not put that in that table in there. We found when we did it in the prior 2 quarters that it generate -- tended to generate more questions than answers and we've kind of gotten away from that. But I don't know if it's in the Q, which is coming out a little later today. I don't think we have that.

If you call, I can try to get you that. I don't have it on top of my head.

[Operator Instructions] Our next question comes from the line of Eric Hagen of BTIG.

So how do you guys think about the size of the proportion of the TBA position right now? And if mortgage spreads were wider, do you feel like that would potentially lead you to raise your leverage or adjust -- maybe adjust the TBA? How do you guys think about that topline position?

It's also a question of where we do the TBA shorts, might start considering moving those to higher coupons given that they may be the most vulnerable, as I mentioned, to a bear-steepener. It was easy to do them with 3s just, because it's a -- those are fully extended and those are pretty good hedge instruments. But I think as we're looking at a potential for a steepening curve or a steepener or bear-steepener, it might be more in the higher coupons.

Yes.

We are always looking at the role levels and implied funding to get us sense for -- if something is rich or cheap, there's been opportunities to sort of buy specified pools, edge them with TBAs and have the TBAs actually contribute a little bit to the earnings picture.

We also like to look at depending where we are in the rate cycle, now that we're bumping up kind of to back towards the higher end, at the convexity of the stack and use those -- use the convexity of short TBAs, to benefit us in the event we turn around. And have a rally to build in a little bit of protection, like that's what Bob was alluding to about the upper coupons of finding the -- finding something in the stack that has the worst convexity.

As we approach kind of the higher end of the rate range, so that if we do turnaround and get sort of -- some sort of a relief for rally, would help with the underperformance of the higher coupon mortgages, which are also going to have worse convexity in that environment.

And also, we had a lot of 3 shorts on for quite a while and that role is very negative for a long, long time, so it's easy to put that on.

That's helpful color. I appreciate that. I actually want to ask you about the IO and derivative position.

You guys have been pretty active there in the past. How do you -- how do you see that position maybe -- are getting toggled, or adjusted going forward. And even the supply of agency derivatives in a -- in this environment, or if the shape of the curve were to change from here?

It's interesting you say, we're doing a lot of tire kicking, running a lot of different strats.

I think in general, I don't love the profile of the legacy lower coupon IOs, they have good yields, but they're kind of a mess from a hedging perspective.

We are sort, or at least were at the point where we did have some -- some actual 2-sided risk with some of the more recent production. I have been -- or we have been very hesitant about doing too much in IOs, especially in the really high-coupon space, just because I think when you know if we ever get back to an environment, where mortgage rates are pushing 5%, 5.5%. I'm not sure that the models are really dialed in for the refi explosion that's going to occur, for the production that's been created over the last couple of years.

So I tend to kind of think there's some uncertainty around there. Also, though, we have seen some fast speeds, particularly in Ginnie space.

And so, there has been a cheapening there.

And so given all of what I just said, there are some opportunities and we're looking, we just haven't jumped in quite yet. And then of course, this more recent sell-off is making it less compelling. But I think that over kind of the medium-term, we'll look to opportunistically add when we can find the kinds of mortgage derivatives that have the profiles that we like.

So something that is either a little bit in the money or kind of at the money, and has some real upside so that we can use it to mitigate some of the duration of the portfolio, while simultaneously providing a little bit of yield.

And there's still huge demand for floaters on the CMO desk.

So there were inverses being created and those were very popular a few months ago with everybody thinking we were getting a big easing cycle coming. They've cheapened up obviously.

Yes. I've looked at some -- we've looked at some inverses as well. And I think there's still a lot of Fed cuts priced into the next year.

So I think, there could be to the extent that the market reins on the Fed easing parade. There could be some vulnerability in inverse IO space, but they will definitely have their moment. I just don't think it's quite yet.

I'm showing no further questions at this time. I would now like to turn it back to Robert Cauley, for closing remarks.

Thank you, operator, and thank you, everybody. To the extent, anybody has any questions that come up after the call, or if you're just listening to the replay and didn't have a chance to ask a question, feel free to call. Chris, I know you probably want to give us a shout to try to get you that number. Otherwise, we look forward to talking to you all again at the end of the fourth quarter. Have great holidays and be well. Thank you.

Thank you for your participation in today's conference. This does conclude the program.

You may now disconnect.