Orchid Island Capital - Earnings Call - Q4 2024
January 31, 2025
Executive Summary
- Q4 2024 GAAP EPS was $0.07 on net income of $5.6M; book value per share declined $0.31 to $8.09, and total return was 0.60% (dividends $0.36 offset book value decline).
- Net interest spread inflected positive to 0.40% (from -0.19% in Q3) as average cost of funds fell to 4.98%; economic interest rate spread improved to 2.57%.
- Liquidity strengthened to $353.6M (53% of equity), adjusted leverage moderated to 7.5x, and the company maintained the monthly dividend at $0.12 (declared again for January 2025).
- Management shifted hedges from TBA shorts to short Treasury futures and reiterated a barbell portfolio with an “up-in-coupon” bias; outlook calls for modest further Fed cuts and potential upward pressure on longer-term rates.
What Went Well and What Went Wrong
What Went Well
- Positive total return and spread improvement: “Orchid generated a positive return of 0.6%… our book value decline of $0.31 was offset by dividends… net interest spread increased to 0.40% in Q4”.
- Funding costs trended down: average cost of funds fell to 4.98% in Q4; management noted new repo levels trending ~4.45–4.46% more recently.
- Strong liquidity and diversified funding: liquidity at $353.6M; borrowing capacity across 25 lenders; adjusted leverage at 7.5x.
What Went Wrong
- Book value decline and lower GAAP gains: book value per share fell $0.31 QoQ; net realized/unrealized gains were $1.8M vs $21.2M in Q3.
- Agency RMBS sector headwinds: “Agency RMBS… one of the worst performing sectors” in Q4 as the curve re-steepened; convexity challenges in higher coupons remain a focus.
- YoY earnings compression: Q4 2024 net income $5.5M ($0.07 EPS) vs $27.1M ($0.52 EPS) in Q4 2023 as RMBS gains were far lower YoY.
Transcript
Operator (participant)
Good morning and welcome to the fourth quarter 2024 earnings conference call for Orchid Island Capital. This call is being recorded today, January 31, 2025. At this time the Company would like to remind the listeners that statements made during today's conference call relating to matters that are not historical facts are forward-looking statements subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Listeners are cautioned that such forward-looking statements are based on information currently available on the management's good faith belief with respect to future events and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in such forward-looking statements. Important factors that could cause such differences are described in the Company's filings with the Securities and Exchange Commission, including the Company's most recent Annual Report on Form 10-K.
The company assumes no obligation to update such forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking statements. Now I would like to turn the conference over to the Company's Chairman and Chief Executive Officer, Mr. Robert E. Cauley. Please go ahead, sir.
Robert E. Cauley (Chairman and CEO)
Thank you, operator, and good morning. Thank you for joining us today. Hopefully everybody has had a chance to download the slide deck and they can follow along with us during the call. As usual, we'll be following the slide deck loosely. And just to give you kind of an intro of how we plan to proceed, we are going to make one slight change this quarter. Jerry Sintes, our Controller, has joined us. He will go over the financial results. I'll walk you through the market developments which the things that occurred in the market that shaped our decision making and the positioning of the portfolio. And then Hunter, the Chief Investment Officer, will walk you through the portfolio and hedge positions and things that we did during the quarter with the portfolio.
So with that I will turn it over to Jerry and he will walk us through the financial highlights. Thank you.
Jerry Sintes (Controller)
Starting on page five, we are showing a net income of $0.07 per share.
Robert E. Cauley (Chairman and CEO)
For the fourth quarter.
Jerry Sintes (Controller)
Compared to $0.24.
Robert E. Cauley (Chairman and CEO)
Per share for the third quarter.
Jerry Sintes (Controller)
Book value decreased from $8.40 at Q3 end to $8.09 at December 31. Total return for the quarter was 0.6% on annualized and that includes a $0.36 dividend that we declared during the period. On page six we present some other portfolio metrics. For fourth quarter we had $5.3 billion in MBS assets. Our leverage ratio is decreased slightly to 7.3 times.
Jason Stewart (Analyst)
Equity.
Jerry Sintes (Controller)
Prepayment speeds increased to 10.5 CPR compared to 8.8 CPR in Q3, and our liquidity at 12/31 was approximately 53% of equity. On page seven we present year to date full year income of $0.57 per share compared to a loss of $0.89 per share for 2023. Book value went down from $9.10 at the end of 2023 to $8.09 at the end of 2024. Our total return for the year was 4.73% and our dividend for the year was $1.44. Our initial calculations show that 96% of that was paid out of taxable income and 4% out of return of capital. On page eight we present our financial statements for your review. We're not going to get into the detail of that here. And with that I'll turn it back over to Bob.
Robert E. Cauley (Chairman and CEO)
Thanks, Jerry. Now turning to the market developments on slide 10, the biggest development and really it was quite a pivotal quarter, the fourth quarter that is, in that the curve, the Treasury curve, especially the cash curve, which had been inverted for two years, which by the way, I believe is a record period of inversion. Disinverted, if you will. The swap curve, as you can see on the right side of the page, is still slightly inverted and that's just because swap spreads have been trending negative in a meaningful way for some time, remains so. And so that curve is still slightly inverted, but the cash curve did disinvert and now is positively sloped. So mechanically how that came about. The Fed starting in September lowered the overnight rate by 100 basis points.
But more importantly, longer term rates went up quite meaningfully in the case of the 10-year by about 80 basis points. So the question is why? And I'm just going to briefly give you some highlight reasons why. We're probably all aware of them. But just to bring them into focus for the call, I guess I would highlight five things. The first would be the fact that the economy had just been strong all through 2024. GDP was 2%-3%, 3% plus. Retail sales as a proxy for consumer spending were very strong all throughout the year. Retail sales reported on a monthly basis generally exceeded expectations by economists almost all year. The labor market, which had been weakening, stopped doing so as the year came to an end. The labor market appeared to be at least leveling off if not improving.
The unemployment rate, which had been rising, stopped doing so and has settled in at a low level. Inflation, which has been very sticky. It's much lower than it had been when it peaked. But as we saw today it still seems to be stubbornly just above the Fed's target and not really making meaningful progress towards it. So it is kept the Fed from being overly aggressive and easing fiscal spending. Deficits are still very large. We don't expect those to decline. And I guess finally with the election results in the fourth quarter, the new administration Republican sweep the current administration has a very strong pro growth agenda and in fact may even use tariffs which probably if anything to the extent they are used might be inflationary at least in the near term. So for those reasons the curve has inverted.
I want to walk you through some more macro variables and then I'll finalize my comments by just kind of give you a summary of what these things mean for us specifically. So you can see on slide 10 the bottom, this is the spread between the 3-month Treasury Bill and the 10-Year Note. As of January 24th last Friday it's 31 basis points. So it is now in positive territory. Moving to slide 11. Looking more specifically at the mortgage market you can see a proxy for mortgage performance and trading levels. The spread to the 10-Year Treasury of the current coupon. While it's at maybe say local lows, it still remains at very attractive levels on an historic basis as of last Friday, 125 basis points.
Prior to the outset of COVID, trading levels there were typically in the 80 or so basis point range. And really the reason this is probably still the case is that one of the largest marginal buyers of mortgages, which would be banks, have not been huge buyers of late. And to the extent that were to change, I think there's a good chance we could trade back to those ranges.
Hunter Haas (CIO)
We saw pre-COVID with respect to.
Robert E. Cauley (Chairman and CEO)
Mortgage performance for the quarter on the bottom left. These are normalized prices. So the price of each coupon normalized to 100. As you can see with rates higher prices were down but since year end they've actually stabilized quite well with respect to the dollar roll market. They've all improved. Most of these rolls are now positive and that's generally a positive for the sector even though from what we understand a lot of money managers are overweight this sector. The fact that dollar rolls are strong, while it may not be good for spec investing, it is generally a good sign for the mortgage market when those rolls are attractive and carries present in the market with respect to volatility, obviously a very big driver of mortgage performance.
If you look at the bottom of the chart, you can see on a long term perspective we're still somewhat elevated but we're very much at the local lows. And I think there's reason to believe that we may see volume come off a little more in the near term. And the reason for that or the reason I have that view is that it seems the market and the Fed are kind of comfortable with the notion that they're not going to have to act very quickly and they have a lot of time to normalize rates. So absent any shock in the data or anything, I think we could see very stable rate environment for the next few months if that were to come past. That's obviously a positive for mortgages. Slide 13.
We show the Mortgage Bankers rate and the refi index and you can see with rates now above 7% the refi activity is extremely low. The housing market is not doing all that well just because affordability is so low and that can and will likely continue to keep refinancing activity low and purchase activity for that matter. The primary secondary spread did spike down recently. We've seen that in the past. I don't think there's anything significant in that fact and I think given the state of the housing market, I don't expect that to be to drop much lower. I think it will remain in that level. Finally, slide 14. This is just one of my favorite slides. I don't want to read too much into it, but I would just point out to the fact that with elevated money supply we have seen GDP growth.
I'm not saying that there's necessarily cause and effect, but it does appear to be the case. We have had above normal growth. You can see this trend line going back all the way to 2009. By the way, this is just GDP and nominal dollars. The current growth rate is above that long-term trend, and if that continues to be the case, you would expect that the economy.
To continue to remain fairly strong.
So now as I mentioned, I want to just kind of go through all these developments and what they mean for us before I turn the call over to Hunter, he talks about the portfolio. First of all, with the curve steepening and funding levels lower, our cash interest expense has come down. So now our net interest income is positive absent the effective hedges. So we now have positive net interest spread which obviously is very good for income. Longer rates higher. That's been a very good development for us because we have an up in coupon bias to the portfolio. So that results in slower speeds. As we'll see later in the call, they have been in fact slowing, which just means we get better carry out of those securities. The investment environment.
As I mentioned, if you look at the spread of the current coupon mortgage as a proxy, is still at very attractive levels. Dollar rolls positive, that's another good development for the sector, and volatility has been low and coming off, and to the extent that continues, also a positive. So we're very constructive on the outlook for the market for Orchid and our business model, and looking forward, to the extent we do get an additional Fed cuts, not sure if we will or how many, they would be a positive of course as well, simply because that would lower our cash interest expense, and to the extent that that curve steepens enough and we get banks back into the market in a meaningful way, could also lead to tightening in the mortgage basis, which again would be good for Orchid and the business model.
With that I'll turn it over to Hunter. He's going to walk us through developments with the portfolio during the quarter.
Hunter Haas (CIO)
Thanks Bob.
Just want to start by sort of giving a little bit of background, chiming in on what some of the points Bob brought up, which are, you know, we see a pro growth agenda from this administration. We see if the market is largely priced out a lot of future Fed cuts. There's not too many more priced in, one or two last I looked. And so we're keeping with that sort of theme in the background back of your mind. I think we'll talk about what we've done in the portfolio. As you know, we've been building a barbell strategy. We continued with that in the third quarter. We're buying assets that tend to be a little bit shorter in nature. So up in coupon, we did put on a new 15-year 5 position. It was just $50 million in TBA.
That TBA has been trading very special. It's been a good trade for us. We covered some Fannie 3s shorts, basically. We sold some cheapest-to-deliver type of pools. We sold $190 million worth of New York and investor Fannie 3s that were paying at sort of deliverable speeds, and we covered $100 million of the short, and then we reinvested the remaining variants in New York five and five and a half as well as a new position in a Social Bond. We like those. We purchased one from one of the faster servicers, but we think they're good credit-like stories, so elbow-shift type of stories. Later in the quarter, we had to raise a little bit of capital. We purchased another 115-ish million of 200k Max and FICO 6 1/2 as it relates to developments that have occurred since year-end.
We have, we've purchased more five, let's see, $183 million 30-year 5.5% and almost $400 million 225k max 6.5%. And we'll talk about the hedge position on those in a moment. But again, this is consistent with the way we're trying to position the portfolio which is higher yielding assets. The Fannie 3.0% portfolio that was dominated last year, the 2023 fiscal year, we're starting to lighten up on that. Those assets have done very well. We liked them for a long time because they represented a very easy asset to hedge. They were mostly fully extended and they offered very wide spreads. We could even hedge some of them with TBAs because the dollar rolls were negative, so that picture has changed a little bit.
The Fannie 3s have improved over the course of 2024 and the dollar rolls have even spiked and are now trading positive. So we felt like it was time to take advantage of the fact that there's more spread in this market and have transitioned to a higher coupon focus. Again, we're positioning for a strong economy, potentially more inflation spike here and there. And so we're trying to keep the assets relatively short. You can see that on the next slide, slide 17. You can see kind of the migration of, if you look from right to left, our portfolio over the course of the last six months. So really building a large position in six, six and a half and also bolstering 7.5 and 5.5. But to a lesser extent, just briefly on funding costs.
Bob alluded to the fact that we were, we had positive net interest income above our funding costs. Now in the third quarter we averaged roughly 562 for a repo funding rate. That came down to 498 in the fourth quarter, and more recently we're trending down to sort of a 445-446 type of levels where we're putting on new reposition. One other point I'd like to mention with respect to the funding portfolio, we have lines and MRAs in place with 27 entities and we recently executed. In the fourth quarter we executed our first indemnified repo. So I don't want to go into it too much, but we are actively pursuing cash providers directly through this indemnified repo program. So that's exciting development for us.
With respect to the hedge book, you know, again discussed the new securities that we added during the fourth quarter on the hedge side of the equation. We are also sort of focusing on this idea of a bear steepener, you know, stronger economy being our biggest risk really. So we're trying to address that risk by pushing some of the hedges farther out the curve. So in the fourth quarter we unwound. Sorry, we put on for the new purchases we put on, we did a combination of some 7-year swaps and roughly $320 million 5-year and 7-year FVs and TYs on futures we unwound. What we saw is roughly $425 million equivalent of SOFR futures.
So we think of those in swap terms. It was roughly $400 million, if you'll call, we put those on throughout the course of last year when the market was pricing in really deep Fed cuts through going out into 2025, 2026 and 2027. So we locked a lot of that stuff in with sort of an implied terminal Fed funds rate in the very low 3s. We unwound them at a time when the future cut was after the December meeting, after the December cut. And there was basically not much by way of cuts priced into the market at that point. So if the market reverses course, the economic data weakens a little bit here in the near term we'll look to reload those positions and capture more implied Fed cuts to the extent the market cooperates with us to do that.
Right now we're flat continuing on that theme into the first quarter of this year. We unwound $500 million legacy pay-fixed swaps which were very low strike, but again one of them was a two-year, five-month to expiry and one of them was a one-year, two-month to expiry. So keeping with that theme of getting a hedge out of the front end of the curve because there's not much by way of Fed cuts priced into that right now and pushing that out a little bit further, 5s, 7s, 10s is sort of the place where we like to hang out. So there might be a little bit of a duration mismatch with respect to some of the things that we've added because they're a little bit shorter in nature.
But again, we're trying to position ourselves to be, have our assets really sort of incrementally, the assets that we're buying with incremental capital be more in the sort of front to middle part of the curve and pushing our hedges out just slightly longer than that because we think that a sell-off, bear steepener scenario is one where companies like ours are going to suffer, mortgages will probably suffer in that environment, so we're trying to overhedge that a little bit. Conversely, a big rally we think mortgages will tend to do very well into that type of move, especially if it's a rally in rates that is driven by some kind of equity market selling off. That kind of thing could be very positive for bonds, so that's what we're trying to keep.
Robert E. Cauley (Chairman and CEO)
Our hedges.
Hunter Haas (CIO)
Going to the next slide. Couple of slides too much. I'll leave that for you. I would just like to point out on slide 22 we are extremely flat from a model duration perspective. About 0.28 is our duration gap. If you were to take these shocks and sort of average them and see what the resulting damage would be from those 2 plus or minus 50 on the $5.3 billion portfolio. So, so very flat model wise and again, leaning into a bear steepener. Not because we think that's necessarily what's going to happen, but because we think that's the scenario that would be the most painful for our portfolio. I'm not going to touch on 23 and I would like to turn it back over to Bob now to wrap up and give us this outlook.
Robert E. Cauley (Chairman and CEO)
Thanks, Hunter. Just kind of reiterating what we've already said with the barbell strategy we think is a very appropriate strategy for the market. We do have an upping coupon bias to it. We do have a kind of a bullish view of the market and the economy and we think the administration will be very pro growth and we think the risk of a recession is extremely low. That all being said, we also think that the Fed has made it quite clear that they have no compelling reason whatsoever to start or continue to ease aggressively. I think we'll see. We may not see any more. Who knows, it might be one or two. But we think that to the extent we do, that's a positive.
We don't see a reason for them to hike, and we expect long-term rates to be out of where they are, slightly higher under pressure. Deficit spending is probably here to stay, and inflation has been very sticky, and the growth of the economy is very strong. So very good carry for the bonds that we own. Higher rates are good for premiums, and as Hunter said, we moved our hedges off the curve. So to the extent we do get a more meaningful sell-off in the long end and those bonds start to extend, we have much longer duration hedges in place to help with the convexity of those. So that's pretty much it. I will turn the call over to questions. So operator, please instruct, and we will answer any and all questions.
Operator (participant)
To ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q and A roster. Our first question comes from Jason Stewart with Janney Montgomery Scott. Your line is open.
Jason Stewart (Analyst)
Hey, thank you guys for all the details today. If we could start with a book value update year to date, if you don't mind.
Hunter Haas (CIO)
Sure.
Robert E. Cauley (Chairman and CEO)
Just because some of our peers have already announced this week and I believe in all cases they gave book value as of last Friday. Just so we can have an apples to apples comparison, our book value was unchanged as of last Friday. In fact, our daily estimate, which is not a GAAP or not an audited number, but just an estimate, was literally unchanged to the penny as of last Friday. $8.09 this week. Mortgages have had a good run. So we're up about 1% this week.
Jerry Sintes (Controller)
Got it.
Jason Stewart (Analyst)
Okay, thank you for.
Robert E. Cauley (Chairman and CEO)
If I could just shift.
Jason Stewart (Analyst)
To ROE, where you see ROEs on a go forward basis, maybe on an economic basis, and if you don't mind footing that. Thanks for the taxable income number. That's helpful. Footing that to where you see taxable income, and I guess I'm coming at it. I'll just start there and we'll follow up, if you don't mind.
Robert E. Cauley (Chairman and CEO)
Yeah. Well, as I mentioned, the way we ended the quarter, net interest income is positive. So. So even though for the year the taxable income number was we pretty much covered, as I said, 96% of the dividend. The trend was positive. So I think we ended the year, the fourth quarter was probably a higher percentage. So we're entering the year on a good note there. ROEs, you were just saying we could get as well north of 150, maybe 200. If we could get to 200. Obviously our leverage has been on the low end of the range. We didn't stress that point on the call, but we're in the low to mid 7s even today, still in the low, like seven and a quarter. If we were to stay there close to 200 over, that's 14s plus the unlevered return.
So you're comfortably into the mid teens at a relatively low leverage level.
Hunter Haas (CIO)
The swap curve is very flat. So we will leg in leverage as I guess, kind of, the basis moves around. So where things have tightened up a little bit so we're on the tighter end. But when we think about the investment environment, swap curve is very flat. So pick your point and it's going to be low 4% pay fix.
Robert E. Cauley (Chairman and CEO)
Right.
Hunter Haas (CIO)
I think 6% yields are achievable with an up-in-coupon strategy, especially if in some sort of specified pool that's going to pay relatively slow. High fives to low sixes. I think 200 basis points is.
Robert E. Cauley (Chairman and CEO)
Right in the sweet spot.
Hunter Haas (CIO)
Pick your leverage ratio from that point.
Robert E. Cauley (Chairman and CEO)
Right. And I would say the risk to that is a rally, obviously because we have an upper bias. So to the extent we do get a rally, the economy softens, whatever, then those numbers are a little probably not obtainable. But the way we see things evolving, we think that that is doable.
Jason Stewart (Analyst)
Got it. Okay. And then on the ATM program, do you have handy what the discount to book was for the issuance in the fourth quarter?
Robert E. Cauley (Chairman and CEO)
No, I don't have it. I think for the year we were around $0.17. For the fourth quarter we were running around. We try to, I think we've said in the past, you know, when we're close to book or above what we'll sell. I think we were generally in the 97.5%-99.5% range when we were selling. We didn't sell a ton of stock in the third or the fourth quarter. I think it was 36 million. So we had done much more in the third, the fourth quarter. The impact on book, I'm guessing is less than $0.01.
Jason Stewart (Analyst)
Okay. I guess Bob, where I'm kind of coming to all this is I'm trying to figure out how much book value degradation you're willing to sort of accept. I mean, if we have an 18 to what is the dividend on book? 17.8% dividend on book. I guess based on the numbers you gave, you're very close to that on a taxable basis.
Robert E. Cauley (Chairman and CEO)
Just sort of how you're thinking about.
Jason Stewart (Analyst)
Maintaining the dividend, which is obviously it's a great yield, but it's definitely north of where some of your peers are pegging ROEs and just trying to put together how you're thinking about the dividend versus maintaining or growing book value. And I know there's a taxable element.
Robert E. Cauley (Chairman and CEO)
To that, but that's really, I guess.
Jason Stewart (Analyst)
I'm trying to go high level to that question.
Robert E. Cauley (Chairman and CEO)
I would say that the trend this year was, as I said, was in our favor. So it obviously depends on where the stock's trading and we don't want to do much of a discount. But if we're going to be earning those kind of levels on a GAAP basis or a taxable basis, I guess you should say, and we can maintain that dividend level. We're not foreseeing an increase absent meaningful steepening of the curve. But if we can maintain that level and basically earn what we pay and with some upside, I think, as I mentioned, I think mortgages are still attractive. We've been staying there for a while. Who knows how long they stay that way. But there is upside which would offer some book value appreciation potential.
But if we can earn this dividend on a taxable income basis and with minimal cost on the book value. If you're selling shares to the ATM, I would plan to continue to do so. Okay.
Hunter Haas (CIO)
I would add that the money that we've, the assets that we've been acquiring with the incremental capital are adding to the earnings power of the portfolio. So and that's not to say that the legacy portfolio is, you know, worse. It's just, you know we have that, we have that lower coupon part of our barbells already built, not really expect it to grow much. And so the growth has been in higher income earning assets. So you know, as you've seen over.
Robert E. Cauley (Chairman and CEO)
the course of the year we've added.
Hunter Haas (CIO)
A lot to six and 6.5% coupons. Six is largely when they are kind of hanging out around par. So I don't think our numbers are that far. 200 basis points over at seven times leverage is over 16.5% return. Plus we're still earning almost 4.5% on unlevered capital in money market funds.
Robert E. Cauley (Chairman and CEO)
Right.
Hunter Haas (CIO)
I think high teens is kind of.
Robert E. Cauley (Chairman and CEO)
Where we're at right now. And also wishful thinking maybe, but it would be nice to see the stock trade at a lower yield as a result of price appreciation. I mean to the extent we're earning this dividend and we're paying out 96% of the dividend on taxable earnings trending higher, you would think that the stock should not be trading at a discount. I don't control that obviously. But we've seen our peers, especially this week. All now, I believe, Dynex, Annaly, and AGNC has joined the agency trading at a premium to book. And I think that that is in our case justified. Haven't seen it yet, but I think it's very much justified given what we just said about the nature of the dividend we're paying. So that would be helpful in a meaningful way for us to the extent that would have come true.
Jason Stewart (Analyst)
Yeah, I guess I would just pull that all together. I don't think the stock should trade at discount to book either. Especially if you're using front assets, shorter duration assets, you're hedging the long part of the curve. You should have a pretty good risk profile. I guess where I'm struggling is I don't think anybody but the peers have noted ROEs close to 20. I mean, they're mostly in the 16%-18% range.
Operator (participant)
So I guess.
Robert E. Cauley (Chairman and CEO)
That's what we said. There was 200 over, but Hunter was saying 16%. 16%.
Hunter Haas (CIO)
That's on incremental capital as well. We have part of portfolio that doesn't. You know, what we're discussing is, or what I was trying to articulate was what we've been doing with incremental capital is putting it to work in some of the higher earning assets. So across the entire portfolio, ROE blends out a little bit lower than that. But I think there's no reason why we couldn't continue to add in the upper coupon portion of the book. And I think it fits our strategy right now.
Robert E. Cauley (Chairman and CEO)
Yeah. And just to walk you through the marginal return on capital, just so we're clear, swap spreads are all right in the very low 4% range. So that's our hedge instrument. And we can get yields on assets in the very high fives, if not six. So you're close to 200 over. Using a fairly conservative leverage multiple of seven and a quarter on round up to 200 over, that gets you in that 14% plus range. Plus the return on levered capital, it gets you up to about 16%. So that's what we're saying is the return on marginal capital today is around 16%. And that's reflective of the fact that we started 2024 with a lower yielding portfolio and still managed to pay out $1.44 dividend, 96%, which was taxable income. I think that trajectory plus the return of marginal capital, we're comfortable where we are.
I think the stock should trade at a premium to book for that reason. Whether or not it does, I don't have any control over that. We're comfortable with where we are.
Jason Stewart (Analyst)
Okay. All right. I appreciate the help walking through that. Thank you.
Robert E. Cauley (Chairman and CEO)
Yep.
Operator (participant)
Thank you. Our next question comes from Jason Weaver with JonesTrading. Your line is open.
Jason Weaver (Analyst)
Hey, guys, good morning. Thanks for taking my question, Bob. Hey, Bob, I appreciate your comments on the outlook, but I'm interested in your thoughts on what's priced in.
Jerry Sintes (Controller)
So, could you speak to how you?
Jason Weaver (Analyst)
See the incremental risk to spreads under the Fed moving towards more of a holding pattern versus possibly even reversing to a more hawkish stance.
Robert E. Cauley (Chairman and CEO)
I think the market and the Fed are fairly in line in terms of the number of eases depending on the day between one and two over the course of a year. And inflation we saw today, I think the three- and six-month annualized numbers are still in the low 2s. They're not there. So I think what's priced in is what we agree with. We're very consistent with that view. The hawkish outcome would be if it reaccelerates and in which case you'll probably see potential of pricing in hikes, but also probably a sell off in the long end. And that's what we're kind of talking about how we're positioning with our barbell strategy. We're using lower coupon higher or higher coupon low duration mortgages hedged long. So as Hunter said, that's what we see as the greatest risk is a turnaround where the market bear steepens.
That's how we're positioned hedge-wise.
Jason Weaver (Analyst)
In that case, if we were to move more hawkishly and that caused, say, a decline in the equity market causing a flight to quality, would that be beneficial to MBS spreads as well?
Robert E. Cauley (Chairman and CEO)
How do you see that shaping? The problem is when those kind of scenarios play out, you always get a spike in volume and that's never good for mortgages. You'd start to see the market sell off and repricing the Fed and you'd have a volume spike. So in the short term it would be probably detrimental to mortgages and REITs in general. If we settled in at a much higher rate environment with a steeper curve at the end of that, that would be a very good investment opportunity. Stable carry environment, but getting there would probably be painful.
Jerry Sintes (Controller)
Got it, got it.
Jason Weaver (Analyst)
Thank you very much.
Operator (participant)
Thank you. Our next question comes from Eric Hagan with BTIG. Your line is open.
Robert E. Cauley (Chairman and CEO)
Hey Eric.
Eric Hagen (Analyst)
Hey, good morning guys. Good to hear from you. So is there a level of yield curve steepness where you might have more appetite to deliberately extend your duration gap to maybe express more of a view on rates or spreads? And historically, what would you say is the widest duration gap you guys have deployed in the portfolio?
Robert E. Cauley (Chairman and CEO)
Model?
Duration gap? I don't know, year and a half maybe. We've been talking about that this week about mortgages. Had a good run. Is this the time to maybe extend the duration a little bit? But days like today, we're probably going to see a lot of profit taking. It's still very much relative value asset. There's not a huge marginal buyer out there. Banks are fairly active, but not as meaningfully as they've been in the past. Money managers are generally considered overweight. The sector and mortgages lagged corporates in the fourth quarter. So are they going to have a huge run? Not without I think the banks coming back in a meaningful way and they're just not there. And I think you need a steeper, meaningfully steeper curve for them to get meaningfully back in.
And then there's the whole issue about balance sheet constraints and do they have the capacity to do so? Certainly with deficits running where they are these options growing slowly over time. The fact is that the debt of the government has grown much faster than the equity capital basis of the banks. So you can do the math, eventually they just don't have room. Ryan. Okay, that's.
Eric Hagen (Analyst)
Yeah, sure.
You know, I think I heard you guys say you don't expect a lot of spread widening in the current coupons if long term rates are coming down. Can you maybe unpack that a little bit and share why you don't expect, you know, a lot of widening when? There seems to be a lot of. Maybe refi risk in these higher coupons. Appreciate you guys, thank you.
Robert E. Cauley (Chairman and CEO)
Yep, yeah, convexity is quite poor. That's why we have paid gotten some spec pools where we can. We've actually moved into some slightly higher quality low balance versus like the cheaper, cheapest forms. The problem is you have high gross WAC in these pools, 100 basis points over the net. And we saw briefly last fall that when they got the money they prepaid fast. So to have up to quality, that's.
The other side of the barbell really that we've been talking about, and mortgage spreads are still relatively wide by historic standards. The really low coupon stuff has tightened up a little bit. We have been focusing on, like, five and five and a half, which not crazy about as like a coupon but in specified pool space. Some higher quality stuff there like we put on some New Yorks.
Those are.
Solidly discount coupons right now, and so the payoffs on those pools is relatively low, so that half of the portfolio, little less than half of the portfolio, the 3s, the 3 and a halfs, the fours, 4 and a halfs, the fives, the 5 and a halfs. We expect those to do well into that rally scenario. The longer duration stuff like the Fannie 3s will just grind. We would expect them to grind tighter as rates came down and spreads tightened and offset some of the erosion in book that would come from the higher coupon portfolio lagging.
So.
That's the other side of the strategy we didn't really talk about too much today because we're like we said, we sort of have been thinking and focusing on the bear steepener, strong economy type of scenario. But there's definitely still a large portion.
Of the portfolio that's designed to do.
Well, in our rally.
And I'll just add one thing we have seen in this backdrop is that the loan balance pools, premium loan balance pools, I'm sorry, discount loan balance pools have performed very well, especially with any seasoning and they're very much in demand as a result. But you know, we've seen not so much the very lowest loan balance, even like the 150s pay very well as discounts, you know, mid teens. So those are pretty attractive returns.
Operator (participant)
Thank you. Our next question comes from Mikhail Guberman from Citizens JMP. Your line is now open.
Robert E. Cauley (Chairman and CEO)
Hey Mikhail.
Mikhail Guberman (Director)
Hey guys. Hope everybody's doing well.
Just to clear up the current book.
Value that you mentioned, does that include today's dividend or are we going up 1% and then taking the dividend out?
Robert E. Cauley (Chairman and CEO)
No, that's inclusive of the dividend. So up 1% this week.
Mikhail Guberman (Director)
Great, and you know, obviously you guys covered a lot of territory. I guess if I could just maybe get your thoughts on MBS, your outlook for MBS supply and how any potential GSE reform might affect that. And just in general, any thoughts on any potential regulatory changes coming down the pike with the new administration? Thanks.
Robert E. Cauley (Chairman and CEO)
Yeah, that's certainly getting a lot of press now. Regulatory reform that is. I don't think it's going to happen. That's just my personal view.
I think that, given the fact that housing is at an all-time low in terms of affordability and rates are high, anything that would make that worse I think is just political capital that's not worth spending. You have a new administration, you know, they've talked about what they want to do. You know, they're talking about tariffs and tax cuts. You know, that doesn't seem to me like that's the place they want to spend their capital making the housing market less affordable. You know, that it may happen, but I give it a low probability in terms of supply. I think it's, you know, I've already.
Started to see a few of the.
Street shops lower their estimates for the year. I think that probably continues.
Hunter Haas (CIO)
Yeah, I think that the banking sector is already in. This has a lot of fresh scars on it. And given the regulatory environment that they're dealing with, I don't think it would be very likely to see the GSEs privatized. And now all of a sudden you have an enormous portion of their holdings become private label credit. I don't see how they would be able to comply. Those two concepts of like Basel III and GSE privatization are kind of not congruent with one another.
Robert E. Cauley (Chairman and CEO)
Yeah, I mean, that's a great point. Nobody makes that point at all. I mean, if you were.
If you.
Actually, we used to have a chart in here, in the back. Yeah, we do. If you look at slide 26, give you a second to get there, that.
Hunter Haas (CIO)
Shows.
Robert E. Cauley (Chairman and CEO)
Mortgage-backed security holdings by commercial banks and the Fed. If all of a sudden you change the risk weighting on all those, that would be devastating for the banks all of a sudden. These are no longer agencies, they're private label, and that would be very challenging, especially given where the environment we're in, where bank balance sheets are fairly constrained as it is. I just having to take up more capital through all of that would be very challenging to do.
The one type of entity that stepped into the bank's place as they lost deposits were money managers, which often have very strict investment guidelines. I think it would create a lot of chaos, I guess, is what I'm getting at.
Mikhail Guberman (Director)
Great.
Thank you for your thoughts, guys. Best wishes going forward.
Thanks.
Robert E. Cauley (Chairman and CEO)
Yep.
Hunter Haas (CIO)
Thanks, Mikhali.
Operator (participant)
Thank you. As a reminder to ask a question, please press Star 11 on your telephone again, that is Star 11 to ask a question. I'm showing no further questions at this time. I would now like to turn it back to Mr. Robert Cauley for closing remarks.
Robert E. Cauley (Chairman and CEO)
Thank you, operator.
Thanks, everybody. If anybody does have any questions that come up after the call, please feel free to call. Or if you listen to the replay, the office number is 772-231-1400. Always willing to take any calls otherwise. We look forward to speaking with you at the end of the first quarter. Thank you.
Operator (participant)
This concludes today's conference call. Thank you for participating. You may now disconnect.