Orchid Island Capital, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Orchid is an externally managed mortgage REIT investing primarily in agency residential mortgage-backed securities (RMBS), financed largely through short-term repurchase agreements. Figures below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Financial performance and position
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Interest income | $27.3 | $36.5 | $62.9 | $68.9 |
| Net interest income | $22.8 | $14.0 | $41.9 | $27.6 |
| Net income (loss) | $48.8 | $3.5 | $(42.4) | $14.1 |
| Basic earnings (loss) per share | $0.74 | $0.07 | $(0.65) | $0.28 |
| Dividends declared per common share | $0.165 | $0.240 | $0.405 | $0.480 |
Q2 2020 net income included $37.6 million of total gains on RMBS, partly offset by $8.9 million of losses on derivatives and other hedging instruments. Management’s non-GAAP measure, net earnings excluding realized and unrealized gains and losses, was $20.0 million for Q2 and $37.0 million for the first half; these measures are not substitutes for GAAP results.
- Q2 average RMBS yield was 3.49%, versus 4.41% a year earlier. GAAP average funding cost was 0.60%, versus 2.90%; GAAP net interest spread was 2.89%. On management’s economic basis, Q2 spread was 2.12%.
- At June 30, RMBS fair value was $3.305 billion; repurchase-agreement borrowings were $3.175 billion. Cash and cash equivalents were $175.3 million, restricted cash $60.8 million, total assets $3.700 billion, and stockholders’ equity $346.0 million.
- Six-month cash flows: $12.1 million provided by operations, $227.3 million provided by investing activities, and $282.0 million used in financing activities. Cash, cash equivalents and restricted cash ended at $236.0 million, down $42.6 million from year-end.
- Repurchase borrowings had a 0.27% weighted-average rate and 30-day weighted-average remaining maturity at quarter-end. The weighted-average collateral haircut was approximately 4.9%. The company reported $10.7 million of unpledged securities.
Material changes and significant events
- COVID-19 market dislocations caused asset-price declines and margin calls in March. Orchid sold about $2.0 billion of RMBS during the first half, realizing $25.0 million of losses; approximately $1.1 billion of sales on March 19–20 generated $31.4 million of losses.
- Orchid terminated swaps with $1.2 billion aggregate notional and recorded approximately $54.5 million of mark-to-market losses through termination, most in Q1. First-half derivative and other hedge losses totaled $91.7 million.
- Despite the first-half GAAP net loss, Q2 earnings rebounded as RMBS fair-value gains and lower funding costs improved results. Equity was $346.0 million at June 30, compared with $395.5 million at December 31, 2019 and $308.1 million at March 31, 2020.
- Common shares outstanding rose from 63.1 million at year-end to 66.2 million at June 30. The January 2020 at-the-market program generated $19.4 million net proceeds through June 30.
- The RMBS portfolio shifted toward pass-through securities: structured RMBS were 1.1% of portfolio fair value at June 30, versus 2.4% at year-end. Portfolio effective duration declined to 2.010 from 2.780.
Outlook, risks and contingencies
- Management provided no numerical earnings or dividend guidance. It stated that economic recovery, renewed COVID-19 restrictions, government policy and market conditions remained uncertain; it could not estimate the pandemic’s duration or ultimate impact.
- Management expected interest rates to remain very low and mortgage prepayments to remain elevated, creating reinvestment and prepayment risks. It also noted that further refinancing capacity could increase prepayments.
- Key risks include RMBS spread widening, interest-rate and extension risk, short-term repo refinancing and margin-call risk, counterparty exposure, and reliance on Federal Reserve market support. The company warned that reducing or suspending Fed purchases could adversely affect its portfolio.
- As of June 30, Orchid said it had met all margin calls and believed liquidity was sufficient for investments, debt repayments and dividends needed to maintain REIT status. It cautioned that liquidity could deteriorate if collateral values fall, haircuts rise or repo facilities cannot be rolled over.
- The company reported no material pending legal proceedings, no material contingencies known to management, and no off-balance-sheet arrangements. Disclosure controls were deemed effective; no material change in internal control over financial reporting was reported.
- A $0.06 per-share dividend was declared July 15 for payment August 27, 2020; it was not reflected in the June 30 financial statements. The management agreement with Bimini Advisors was renewed through February 20, 2021.
Important facts for investors to verify
- Whether the post-quarter recovery in agency RMBS markets and repo financing persisted, and whether margin calls, collateral haircuts or borrowing terms changed.
- How portfolio marks, hedge positions and their reported losses translated into book value and economic funding costs; review the company’s non-GAAP definitions alongside GAAP results.
- Whether elevated mortgage prepayments materially affected asset yields, structured securities and future net interest income.
- Dividend sustainability relative to taxable income, liquidity needs and the declared July distribution.
- Share dilution and use of the remaining capacity under the $200 million at-the-market equity program.
- Potential effects of COVID-19, Federal Reserve actions, LIBOR transition and GSE policy developments on funding, hedging and asset valuations.