Orchid Island Capital, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Orchid is an externally managed mortgage REIT investing primarily in agency residential mortgage-backed securities (RMBS), financed largely with short-term repurchase agreements.
Financial and operating highlights
- Q2 results: Net loss was $2.8 million, or $0.14 per share, versus net income of $10.6 million, or $1.17 per share, in Q2 2014. Six-month net income was $2.7 million, or $0.14 per share, versus $14.2 million, or $2.01 per share, in the prior-year period.
- Interest income and margins: Q2 interest income was $16.8 million and net interest income was $15.2 million. The GAAP net interest spread was 3.12%; the company’s non-GAAP economic spread, incorporating current-period hedging effects, was 2.98%. For the first six months, net interest income was $28.5 million and the GAAP/economic spreads were 3.19%/3.08%.
- Portfolio and valuation: RMBS at fair value totaled $2.175 billion at June 30, up from $1.549 billion at year-end 2014. The portfolio was 94.5% pass-through RMBS and 5.5% structured RMBS. Q2 RMBS realized and unrealized losses totaled $15.2 million; six-month losses totaled $8.9 million.
- Hedging: Derivative losses were $0.8 million in Q2 and $13.2 million for the six months. The company does not apply hedge accounting, so derivative fair-value changes are recorded in earnings.
- Debt and liquidity: Repurchase-agreement borrowings were $2.014 billion, with a 0.39% net weighted-average borrowing rate and 18-day weighted-average remaining maturity. Cash and cash equivalents were $100.5 million; restricted cash was $23.1 million; unpledged securities were approximately $59.0 million. Stockholders’ equity was $284.1 million.
- Cash flows: Six-month operating cash flow was $10.3 million, investing cash outflow was $643.5 million, and financing cash inflow was $640.5 million. Cash and cash equivalents increased $7.3 million to $100.5 million.
- Dividends and equity: The company declared $0.18 per share monthly through June (six-month total $1.08 per share). It issued about 6.2 million shares through its at-the-market program during the first half, generating approximately $83.1 million net proceeds. Shares outstanding rose from 16.7 million at year-end to 23.0 million at June 30.
Changes versus comparable periods
- Q2 2015 results reversed from prior-year profit to a loss, as RMBS valuation losses and derivative losses more than offset higher net interest income.
- Six-month net income declined to $2.7 million from $14.2 million. Net interest income increased substantially as the company deployed equity proceeds into a larger, leveraged portfolio; average RMBS holdings rose to $1.769 billion from $680.7 million.
- Higher rates in Q2 pressured RMBS prices. The company reported that mortgage rates rose and average prepayment speed increased to 15.3% from 8.1% in Q2 2014. Portfolio effective duration increased to 3.214 from 2.291 at year-end 2014.
- Repurchase borrowings increased to $2.014 billion from $1.437 billion at year-end. The weighted-average repo rate rose to 0.39% from 0.36%.
Outlook, risks, and notable items
- Management described continued interest-rate and bond-market volatility, with market expectations at June 30 pointing to possible Federal Reserve rate increases later in 2015. It expects rate movements and economic data to remain important drivers; the filing provides no earnings or dividend guidance.
- Key exposures include interest-rate, mortgage-spread, prepayment, extension, liquidity, and counterparty risks. Short-term repo financing must be rolled over and may require additional collateral or higher haircuts during market stress. Management reported $122.9 million of aggregate repo counterparty exposure at June 30.
- Management’s model-based sensitivity estimate indicated that a 100-basis-point rate increase could reduce book value by 17.90%; the estimate assumes a static portfolio and unchanged mortgage spreads and is not a forecast. Actual results may differ materially.
- The company noted that persistently elevated or faster prepayments could hurt asset values and net interest margin, while rising short-term rates could increase funding costs. Interest-only and inverse-interest-only securities are particularly sensitive to prepayments.
- On July 29, 2015, the board authorized repurchases of up to 2 million common shares; the program does not require the company to buy shares. A July dividend of $0.14 per share was also declared after quarter-end and is not included in June 30 financial statements.
- The company reported no material pending legal proceedings, no material changes to previously disclosed risk factors, and no off-balance-sheet arrangements. Disclosure controls were assessed as effective.
Investor facts to verify
- How much of the Q2 and first-half earnings decline reflects recurring portfolio economics versus fair-value movements in RMBS and derivatives.
- The sustainability of the dividend relative to realized earnings, REIT taxable income, and cash available for distribution.
- Repo rollover capacity, collateral haircuts, margin-call liquidity, and the concentration and recoverability of counterparty exposures.
- The assumptions behind reported duration and interest-rate sensitivity, particularly the large modeled book-value impact under a 100-basis-point increase.
- The effects of faster prepayments, higher funding costs, and continued share issuance or the newly authorized repurchase program on per-share value.