ORC

Market Developments

• There has been a leadership transition at the Federal Reserve to Kevin Warsh, who has a strongly hawkish stance on bringing down persistent above-target inflation. This has pushed short-term interest rates higher while long-end rates held relatively firm, flattening the yield curve, a trend management expects may continue.
• Swap spreads have recently moved more negative, flattening the swap curve further, while 10-year current coupon spreads for mortgages have leveled off after a multi-year tightening trend that was favorable for mortgage assets.
• Interest rate volatility spiked after the outbreak of the Middle East war, and remains at the high end of the range seen since March 2026, with significant ongoing uncertainty around war-related developments.
• Refinancing activity remains extremely subdued and stable at low levels, with current 30-year mortgage rates near 6.75% or higher, and primary-secondary mortgage spreads are low but volatile.

Portfolio Positioning

• The company made only minor portfolio adjustments in Q2 2026, increasing its total share count by just 1.5% after minimal new capital raising.
• Management shifted the portfolio slightly to lower coupons, with the largest concentration now in 5.5% 30-year coupons (the overall portfolio is concentrated in 5%, 5.5%, and 6% coupons, the three nearest to par). This shift was driven by weak recent performance of specified pay pools at low refinancing rates, and positions the portfolio for upside if there is a market rally.

Hedging and Funding

• The hedge book was adjusted to align with the new portfolio composition: the company added $500 million in 5-year swaps and $300 million in 10-year swaps, increasing the share of repo funding covered by hedges from 72% to 91%, and the share of repo covered by swaps from 65% to 70%. The weighted average pay fixed swap rate rose slightly to 3.61% to reflect new higher-market-rate positions. A net-neutral long-short swaption position was also added to offset premium costs.
• Funding spreads have compressed significantly over recent months, resulting in repo funding costs of high single-digit to low double-digit spreads, driven by Fed bill purchases and high money market AUM. Management notes funding levels have drifted slightly higher recently due to increased Treasury bill issuance and a small decline in money market AUM, but does not see this as an ominous near-term development.

Preliminary Book Value Update

• As of the prior Friday before the call (including dividend accrual), book value was down 2.1% from quarter-end; as of the night before the call, it was down 4.3% including dividend accrual. Excluding dividend accrual, it was down 0.7% as of the prior Friday and 2.9% as of the night before the call.

• Management does not expect to be able to raise new capital in the near term, as Orchid Island Capital stock trades well below book value, and any future capital raising is likely to occur further down the line once market conditions stabilize.
• Prepayment speeds are expected to continue slowing as mortgage rates rise, offsetting typical seasonal factors that would push speeds higher.
• Economic funding costs are expected to remain fairly stable at current high hedge coverage levels, with only modest leakage from the 9% of unhedged funding that would slightly compress net interest spread if rates rise.
• The quarterly expense ratio, which rose to 2% in Q2, is expected to trend back down to ~1.7% (the level seen in prior quarters) after a one-off share-based bonus award for management that drove the Q2 increase.
• Return on incremental equity is expected to move higher as rates rise and mortgages cheapen, with ROEs likely increasing by roughly 1% from the current 16-17% range after market moves settle.
• Management expects any impact from curve flattening on the dividend will be modest, with no large dividend decrease anticipated.

Orchid Island Capital is exclusively focused on a 30-year mortgage investment portfolio, with no additional product segments reported. For Q2 2026: Q2 2026 earnings per share were $0.44, up from a loss of $0.11 per share in Q1 2026. End-of-quarter book value per share was $7.22, up from $7.08 at the end of Q1 2026. Total return for the quarter was 6.2%, compared to -1.3% in Q1 2026. The average portfolio size in Q2 2026 was $11.4 billion, a slight increase from approximately $11 billion at the end of Q1 2026. Prepayment speeds fell to 10.9% in Q2 2026, down from 14.7% in Q1 2026. Liquidity at the end of Q2 2026 was 53.7%, down slightly from 54.5% at the end of Q1 2026. The end-of-quarter economic leverage ratio fell to 7.3x, down from 7.9x at the end of Q1 2026. The portfolio's average coupon declined by 6 basis points, portfolio yield fell 1 basis point to 574 basis points, and net interest spread declined by 6 basis points after a 5 basis point increase in economic funding costs.

• Ongoing uncertainty from the Middle East war has kept market volatility elevated, and management expects volatility may rise further if the conflict escalates, driving additional increases in interest rates and declines in mortgage prices.
• There is high uncertainty around the path of Federal Reserve policy under the new chair, with the market facing unknowns around the timing and size of expected rate hikes, which adds to market volatility.
• The company's 91% hedge coverage of repo funding leaves 9% of funding unprotected against rate hikes, which will lead to some upward pressure on funding costs and modest downward pressure on net interest spread and the dividend if rates rise.
• The recent drift toward higher funding spreads after a period of very attractive funding levels could continue if Treasury bill issuance keeps increasing and money market AUM keeps declining, though management does not see this as a major immediate risk.
• Portfolio leverage has increased to ~7.73x from the 7.3x quarter-end level as book value has changed and mortgage assets have extended, requiring minor portfolio adjustments that management has not yet finalized.

Q: How will economic cost of funds trend in coming quarters if the Fed hikes rates, and how will this impact the dividend?

A: With 91% of repo funding hedged, cost of funds will remain fairly stable absent portfolio growth, providing significant protection against higher rates. There will be small upward pressure on average funding costs from the unhedged 9% portion, but the ultimate impact on the dividend depends on whether asset yields also rise. Modest spread compression is expected, but no dramatic dividend cut.

Q: Where are the most attractive opportunities in the mortgage coupon stack for incremental capital, and what ROEs are available now?

A: Current ROEs are in the 16-17% range and are expected to move higher as rates rise and mortgages cheapen. Once current market volatility settles, the most attractive coupons are likely to be in the 5% to 6.5% range, as higher coupon extension will push prices lower, and lower coupons do not offer sufficient carry for the firm's strategy. ROEs could rise by roughly an additional 1% after market moves are complete.

Q: If the yield curve continues to flatten, what will the impact be on the dividend given the 91% hedge coverage on funding and 70% swap coverage?

A: While there will be some leakage from incomplete hedging, management does not expect massive spread compression that would lead to a dramatic dividend decline. Mortgages are expected to cheapen only moderately, and the spread between asset yields and funding costs will not compress enough to cause large dividend cuts. The firm will only make marginal portfolio adjustments, not wholesale changes, to navigate this period.

Q: What drove the year-over-year increase in expenses, and will the 2% expense ratio persist?

A: The Q2 expense ratio increase was driven by a one-off 100% share-based bonus for management and staff, awarded for delivering multi-year improvements that brought the expense ratio well under 2%. This one-off award will not be repeated. The expense ratio is expected to trend back down to ~1.7% (the level of recent quarters), and further positive operating leverage is expected as the portfolio grows, given the tiered management fee structure that caps marginal fees at 100 basis points.