Orchid Island Capital, Inc. quarterly report, Q3 FY2016

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Orchid Island Capital, Inc. — Q3 2016 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2016. Orchid is an externally managed REIT investing primarily in Agency residential mortgage-backed securities (RMBS), financed mainly with short-term repurchase agreements. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.

Financial results and position

  • Third-quarter results: Interest income was $22.4 million and interest expense was $4.0 million, producing net interest income of $18.4 million. Net income was $20.5 million, or $0.85 per share, versus a net loss of $9.4 million, or $0.42 per share, in Q3 2015.
  • Nine-month results: Interest income was $62.1 million, interest expense $10.6 million, and net interest income $51.4 million. Net income was $22.4 million, or $0.99 per share, compared with a $6.7 million net loss, or $0.34 per share, in the prior-year period.
  • Portfolio gains and derivatives: Q3 2016 net portfolio income was $22.8 million, including $6.6 million of derivative gains and $2.2 million of net RMBS losses. For the first nine months, net portfolio income was $29.0 million, including $32.6 million of derivative losses offset partly by $10.1 million of RMBS gains.
  • Interest spreads: Q3 GAAP net interest spread was 3.06%, versus 3.01% in Q3 2015; the company’s non-GAAP economic spread, which incorporates specified hedge effects, was 2.57% versus 2.83%. For the nine months, the respective spreads were 3.11% and 2.66%, compared with 3.12% and 2.98% in 2015.
  • Assets and equity: Total assets were $2.668 billion at September 30, up from $2.242 billion at December 31, 2015. RMBS at fair value totaled $2.501 billion; stockholders’ equity was $294.4 million.
  • Debt and liquidity: Repurchase agreements totaled $2.298 billion, up from $1.799 billion at year-end, at a 0.73% net weighted-average borrowing rate. Average remaining repo maturity was 13 days. Cash and cash equivalents were $110.9 million, restricted cash $16.9 million, and unpledged RMBS $97.4 million; the latter included securities expected to be pledged after settlement.
  • Cash flow: Nine-month operating cash flow was $14.1 million, investing cash flow was negative $290.5 million, and financing cash flow was positive $330.0 million. Cash increased $53.6 million to $110.9 million.
  • Dividends and shares: Dividends declared were $1.26 per share for the nine months through September 30. The company separately declared a $0.14-per-share dividend in October, payable October 31. Shares outstanding were 26.25 million at September 30, versus 21.75 million at December 31.

Material changes versus prior comparable periods

  • Net income improved sharply year over year in both Q3 and the first nine months, primarily reflecting a substantially smaller derivative loss in the nine-month comparison and a shift to derivative gains in Q3. The earnings improvement should therefore be considered alongside volatile fair-value and derivative results.
  • Nine-month interest income rose $12.3 million, while interest expense rose $5.7 million. Management attributed the changes to portfolio growth and higher asset yields, as well as increased borrowing balances and funding costs.
  • Average RMBS holdings for the first nine months increased to $2.177 billion from $1.895 billion; average portfolio yield rose to 3.80% from 3.50%. Average borrowings increased to $2.048 billion from $1.721 billion, and average GAAP funding cost rose to 0.69% from 0.38%.
  • The RMBS portfolio grew from $2.158 billion at year-end to $2.501 billion. Fixed-rate pass-through securities represented 93.3% of the portfolio at September 30; structured RMBS represented 4.7%.
  • Common stock issuance raised $47.1 million net during the first nine months. The new July 2016 at-the-market program permits up to $125 million of offerings; $87.4 million remained available at September 30.

Outlook, risks, and notable items

  • Management outlook: Management expected gradual rate increases and anticipated a possible 25-basis-point Federal Reserve increase in December 2016, conditional on economic data and financial conditions. This is management commentary, not formal earnings guidance.
  • Portfolio and prepayments: Management reported that mortgage securities performed well in Q3 and expected higher rates and seasonal effects to moderate prepayments. Q3 portfolio prepayment speed was 11.7%, compared with 10.2% a year earlier. Management also noted potential erosion of premiums on call-protected securities and said it had gradually reduced exposure.
  • Interest-rate exposure: The company relies on short-term financing for long-duration mortgage assets. Its model estimated that an immediate 100-basis-point rate increase would reduce portfolio value by 1.98% and stockholders’ equity by 16.83%; the filing cautions that actual outcomes may differ materially.
  • Funding and liquidity risks: Repo agreements are short-term and may not be renewed; lenders can increase collateral haircuts or demand margin. The company reported it had met all margin calls at September 30. Management said available repo facilities provided borrowing capacity it believed exceeded its needs.
  • Regulatory change: A final FHFA rule made the captive insurance subsidiary ineligible for FHLB membership. The $187.5 million of year-end FHLB advances had been refinanced through repos by September 30; the subsidiary must wind down its FHLB relationship by February 19, 2017.
  • Other disclosures: Management reported no known contingencies at September 30 and no material pending legal proceedings. The filing disclosed no material change in risk factors, no off-balance-sheet arrangements, and effective disclosure controls. The company remains externally managed by Bimini Advisors; the management agreement was renewed through February 20, 2017 and includes a termination fee if ended without cause.

Important facts for investors to verify

  1. Whether operating earnings and dividend capacity remain resilient as funding costs rise; review both GAAP results and the company-defined economic interest measures.
  2. How the large year-over-year earnings swing relates to realized and unrealized derivative and RMBS valuation changes, rather than recurring net interest income.
  3. Repo renewal terms, collateral haircuts, counterparty exposure, and liquidity available to meet margin calls, given the 13-day average repo maturity.
  4. Whether the modeled interest-rate sensitivity remains representative as rates, spreads, prepayments, and portfolio composition change.
  5. The effect of ongoing at-the-market share issuance and the post-quarter October dividend on per-share value and capital resources.
  6. Completion of the FHLB wind-down by the February 2017 deadline and continued access to replacement repo funding.