Orchid Island Capital, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. Orchid is an externally managed mortgage REIT investing primarily in agency residential mortgage-backed securities (RMBS), funded largely with short-term repurchase agreements.
Financial performance and position
| Metric | Q1 2018 / March 31, 2018 | Comparable period / prior date |
|---|---|---|
| Interest income | $39.9 million | $32.3 million in Q1 2017 |
| Interest expense | $15.1 million | $6.7 million in Q1 2017 |
| Net interest income | $24.8 million | $25.6 million in Q1 2017 |
| Net income (loss) | $(16.4) million; $(0.31) per share | $2.4 million; $0.07 per share in Q1 2017 |
| Net interest spread | 2.58% GAAP; 2.24% economic | 3.19% GAAP; 2.75% economic in Q1 2017 |
| Cash and cash equivalents | $127.2 million; restricted cash $36.8 million | $214.4 million and $32.3 million, respectively, at December 31, 2017 |
| Total assets / stockholders’ equity | $4,122.7 million / $429.5 million | $4,023.3 million / $462.2 million at December 31, 2017 |
| Repurchase agreements | $3,619.3 million; 1.86% weighted-average borrowing rate | $3,533.8 million; 1.54% at December 31, 2017 |
| Operating cash flow | $41.6 million provided | $17.6 million provided in Q1 2017 |
| Dividends declared | $0.31 per share for the quarter | $0.42 per share in Q1 2017 |
The RMBS portfolio was $3,745.8 million at fair value, nearly unchanged from year-end. Its weighted-average coupon was 4.24%. The company reported $80.1 million of realized and unrealized RMBS losses, partly offset by $42.0 million of derivative gains. GAAP net interest income less operating expenses was not enough to offset portfolio and derivative valuation and realized losses.
Investing activities used $190.6 million of cash; financing activities provided $66.4 million. Cash, cash equivalents and restricted cash together declined $82.7 million to $164.0 million. The company’s short-term repo obligations were all classified as maturing within one year in its contractual-obligations table.
Material changes versus comparable periods
- Net results reversed from Q1 2017 income of $2.4 million to a Q1 2018 loss of $16.4 million. RMBS losses rose to $80.1 million from $16.3 million; derivative results improved to a $42.0 million gain from a $4.4 million loss.
- Interest income increased $7.6 million, reflecting a larger average portfolio and a higher average asset yield (4.27% versus 4.11%). Interest expense increased $8.4 million as average borrowings grew and funding costs rose; average GAAP cost of funds increased to 1.69% from 0.92%.
- Economic net interest income declined to $21.8 million from $22.4 million, and economic net interest spread fell to 2.24% from 2.75%.
- At March 31, RMBS effective duration was 3.769 years versus 2.989 years at year-end. The filing’s model estimated a 9.60% decline in book value for an immediate 100-basis-point rate increase, versus 13.05% at year-end; estimates assume a static portfolio and unchanged mortgage spreads.
- Average mortgage prepayment speed declined to 7.7% from 9.9% in Q1 2017. The structured RMBS share of the portfolio rose to 4.0% from 3.2% at year-end.
Outlook, risks and notable items
- Management described a difficult first quarter for agency mortgages: Treasury yields and LIBOR rose, volatility increased, and mortgage spreads widened. Management said mortgage performance had improved to some extent early in Q2, but expected a flattening yield curve and further Federal Reserve rate increases to remain headwinds to mortgage returns.
- Management discussed market expectations for additional Fed rate hikes in 2018 and the Fed’s balance-sheet reduction, which could reduce demand for agency RMBS. Higher short-term rates may raise repo funding costs; higher long-term rates may reduce RMBS values and extend mortgage cash flows.
- Principal risks include interest-rate, spread/basis, prepayment, extension, liquidity and counterparty risks. Repo financing is short-term and subject to renewal, haircut and margin-call risk. Management reported that all margin calls had been met at quarter-end and stated that it believed liquidity and capital resources were sufficient.
- At quarter-end, the company had $127.2 million of unrestricted cash and cash equivalents and $102.1 million of unpledged securities. Repo collateral included securities and approximately $28.6 million of pledged cash. The reported aggregate repo counterparty amount at risk was approximately $220.7 million.
- The board expanded the stock-repurchase authorization in February 2018; no shares were repurchased during the quarter. The company had 5,306,579 shares remaining under authorization at March 31.
- On April 11, 2018, the company declared a $0.09-per-share dividend payable May 10; this was not recorded in the March 31 financial statements. The filing also reports $0.40 per share of 2018 year-to-date dividends including that post-quarter declaration, while Q1 statements report $0.31 declared for the quarter.
- The company reported no material pending legal proceedings, no material commitments for capital expenditures and no off-balance-sheet arrangements. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Key facts for investors to verify
- Whether RMBS fair-value losses and spread widening persist, and how mortgage prices respond to interest rates, Fed policy and market supply and demand.
- Whether asset yields can keep pace with rising repo costs, and how hedging performance affects economic net interest income and book value.
- Repo rollover terms, collateral haircuts, margin requirements and liquidity available to meet potential calls; confirm the status of facilities beyond the quarter-end disclosures.
- The sustainability of monthly dividends relative to REIT taxable income, cash generation and book value; distinguish the quarter’s $0.31 declaration from the $0.09 declared after quarter-end.
- How much of reported earnings and book-value movement reflects realized results versus fair-value estimates. RMBS and derivatives were valued using Level 2 inputs, including independent pricing sources and broker quotes.