Orchid Island Capital, Inc. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Orchid is an externally managed mortgage REIT investing primarily in agency residential mortgage-backed securities (RMBS), financed largely through short-term repurchase agreements. Unless stated otherwise, dollar amounts below are in millions.
Financial performance and position
- Q3 results: Net income was $26.0 million, or $0.20 per diluted share, versus $28.1 million, or $0.42 per share, in Q3 2020. Net interest income increased to $32.6 million from $25.2 million; net portfolio income was $29.7 million versus $30.9 million.
- Nine-month results: Net loss was $20.2 million, or $0.19 per share, compared with a $14.4 million loss, or $0.22 per share, in the prior-year period. Net interest income rose to $85.2 million from $67.1 million, but net portfolio loss was $9.3 million versus a $6.6 million loss. The 2021 loss included $107.4 million of unrealized RMBS losses, partly offset by $15.9 million of gains on derivatives and other hedges.
- Interest economics: For the first nine months, average RMBS yield declined to 2.64% from 3.67%, while GAAP average funding cost fell to 0.15% from 0.99%. Economic net interest income, a company-defined non-GAAP measure that includes specified hedge effects, was $74.8 million versus $49.6 million. These non-GAAP measures are not substitutes for GAAP results.
- Balance sheet at September 30: RMBS at fair value totaled $5,601.4 million; total assets were $6,177.1 million. Repurchase agreements were $5,213.9 million, total liabilities $5,446.5 million, and stockholders’ equity $730.6 million. Repurchase debt was about 7.1 times equity. Cash and cash equivalents were $424.1 million, plus $51.1 million of restricted cash. The company reported $180.6 million payable for unsettled securities purchases.
- Cash flows: Nine-month operating cash flow was $61.2 million; investing activities used $1,843.1 million and financing activities provided $1,957.6 million. Cash, cash equivalents and restricted cash increased $175.7 million to $475.2 million.
- Dividends and equity: Dividends declared were $0.195 per share for Q3 and $0.585 per share for the first nine months. Common shares outstanding rose from 76.1 million at year-end 2020 to 153.3 million at September 30, largely reflecting equity offerings. At October 28, 161.2 million shares were outstanding.
Material changes versus comparable periods
- Q3 net income declined $2.0 million year over year despite $7.4 million higher net interest income; RMBS and derivative results were $8.6 million less favorable.
- For the first nine months, net interest income increased $18.1 million, primarily as lower funding costs outweighed a lower RMBS yield. However, RMBS and derivative results together were $20.8 million less favorable year over year.
- RMBS at fair value increased from $3,726.9 million at December 31, 2020 to $5,601.4 million at September 30, 2021; repurchase agreements rose from $3,595.6 million to $5,213.9 million. Equity offerings generated $398.7 million net proceeds during the nine months.
- Portfolio effective duration increased from 2.36 to 3.35. Three-month portfolio prepayment speed was 12.4% in Q3 2021, down from 17.0% in Q3 2020.
Outlook, risks and unusual items
- Management described inflation, supply constraints, COVID-19 and the uncertain pace of economic recovery as key macroeconomic factors. It expected Federal Reserve asset-purchase tapering to begin in 2021 and conclude around mid-2022; management noted the possibility of earlier or greater-than-expected rate increases.
- Management said liquidity and capital resources were currently sufficient and that repurchase borrowing capacity exceeded needs. All margin calls had been met; weighted-average repo haircut was approximately 5%, and repo borrowings had a 30-day weighted-average remaining maturity. These short-term financings remain exposed to renewal, haircut and collateral-value changes.
- Interest-rate sensitivity modeling estimated that a 100-basis-point rate rise would reduce portfolio value by 2.89% and book value by 22.14%; a 200-basis-point rise implied reductions of 7.37% and 56.54%, respectively. These are model-based static-portfolio estimates, assume no mortgage-spread changes, and actual results may differ materially.
- Other key exposures include RMBS spread risk, prepayment and extension risk, derivative margin calls, counterparty risk, and potential changes to Federal Reserve support or agency policy. The filing notes that IO and IIO securities can be particularly vulnerable to faster prepayments.
- The filing reported no material pending legal proceedings, no material changes to previously disclosed risk factors, and no material capital-expenditure commitments. Disclosure controls were assessed as effective. The manager agreement was renewed through February 20, 2022 and includes a termination fee provision.
Important facts for investors to verify
- How much of the nine-month GAAP loss reflects fair-value movements, and how the company-defined non-GAAP earnings measure reconciles to GAAP.
- The effect of significant share issuance on per-share book value, earnings and dividend sustainability; confirm the post-quarter share count and subsequent ATM proceeds.
- Current repo financing availability, maturities, haircuts, collateral coverage and liquidity available for potential margin calls.
- Assumptions and limitations underlying interest-rate sensitivity estimates, including changes in mortgage spreads, prepayments and hedging effectiveness.
- Dividend coverage relative to taxable income and cash generation, noting that REIT distribution requirements are based on taxable income rather than GAAP earnings.