Orchid Island Capital, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; the filing also reports fourth-quarter results. Orchid is an externally managed mortgage REIT investing mainly in agency residential mortgage-backed securities (RMBS), financed largely through short-term repurchase agreements.
Financial results and position
| Metric | 2019 / year-end | Comparison |
|---|---|---|
| Q4 net income; diluted EPS | $18.6 million; $0.29 | Q3 2019: net loss of $8.5 million; $(0.14) per share |
| Full-year net income (loss); diluted EPS | $24.3 million; $0.43 | 2018: net loss of $44.4 million; $(0.85) per share |
| Interest income / expense | $142.3 million / $83.7 million | 2018: $154.6 million / $70.4 million |
| Net interest income | $58.7 million | Down from $84.2 million in 2018 |
| Net interest spread | 1.61% GAAP; 1.88% economic | 2018: 2.26% GAAP; 2.18% economic |
| Net portfolio gains (losses) | $(24.0) million | 2018: $(116.6) million; 2019 included $38.0 million of unrealized RMBS gains and $51.2 million of derivative losses |
| Cash flows | $48.2 million operating cash flow; $278.7 million ending cash and restricted cash | Cash and restricted cash were $126.3 million at end-2018 |
| Assets; RMBS fair value | $3.88 billion; $3.59 billion | 2018: $3.40 billion; $3.01 billion |
| Repurchase borrowings; leverage | $3.45 billion; 8.8:1 liabilities-to-equity | 2018: $3.03 billion; 9.1:1 |
| Equity; book value per share | $395.5 million; $6.27 | 2018: $336.1 million; $6.84 |
Average RMBS yield fell to 4.14% from 4.32%, while average funding cost rose to 2.53% from 2.06%. Management attributed lower annual net interest income to reduced average RMBS balances and yield, and higher interest expense to increased funding costs. Economic net interest income, which adjusts for selected hedge effects, was $67.6 million, down from $81.4 million.
At year-end, repurchase agreements carried a 2.03% weighted-average borrowing rate and 25-day weighted-average remaining maturity. Collateral included approximately $3.60 billion of securities and $65.9 million of pledged cash. Unrestricted cash was $193.8 million and unpledged securities were approximately $6.6 million; restricted cash was $84.9 million. The company reported access to 22 repo counterparties and said facilities remained available on comparable terms through February 21, 2020.
Material changes and capital returns
- Net income rebounded from the 2018 loss, principally as RMBS valuation losses were much smaller and RMBS had unrealized gains. However, net interest income and the GAAP spread contracted.
- Year-end RMBS holdings rose to $3.59 billion from $3.01 billion. The portfolio was 97.6% pass-through securities and 2.4% structured RMBS; Fannie Mae represented 60.4% and Freddie Mac 39.6%.
- Mortgage principal repayments increased to $594.8 million from $373.9 million. Average prepayment speed for Q4 was 16.0%, versus 7.2% in Q4 2018.
- Book value per share declined 8.3% year over year, despite higher total equity. Shares outstanding increased to 63.1 million at year-end from 49.1 million, reflecting issuance and other share activity.
- The company issued 14.38 million shares in 2019 for $92.3 million net proceeds, including a 7 million-share follow-on offering. It repurchased 470,000 shares for approximately $3.0 million during the year.
- 2019 dividends declared were $0.96 per share, down from $1.07 in 2018. Tax reporting characterized $0.49 per share, or 51% of 2019 distributions, as return of capital; the company said estimated 2019 REIT taxable income had been fully distributed.
Outlook, risks and unusual items
Management described Q4 2019 as a recovery from the summer market sell-off, with tighter agency RMBS spreads and improving risk sentiment. It gave no quantified earnings, book-value, or dividend guidance. In discussing early 2020, management cited coronavirus-related uncertainty, falling interest rates, renewed prepayment concerns, and wider agency RMBS spreads; the duration and economic effects were unknown as of the February 21, 2020 filing date.
- Key exposures include interest-rate and yield-curve changes, mortgage-spread widening, prepayment and extension risk, short-term repo refinancing, collateral margin calls, and derivative/counterparty risk. The company’s own sensitivity analysis estimated that a 100-basis-point rate increase could reduce year-end 2019 book value by 17.09%; this is a model-based estimate, not a forecast.
- Repo funding is short-term, with all reported contractual obligations due within one year. Higher haircuts, lost financing, or margin calls could force asset sales at unfavorable prices.
- Agency guarantees cover principal and interest, not market value. GSE conservatorship and housing-finance reform, Federal Reserve balance-sheet actions, and the transition away from LIBOR could affect asset values, liquidity, and hedging.
- REIT qualification and the Investment Company Act exemption depend on compliance with asset, income, and distribution tests. Failure could materially affect taxes, operations, leverage, or distributions.
- Orchid is externally managed by Bimini Advisors, has no employees, and disclosed potential conflicts of interest. Non-renewal without cause can trigger a termination fee equal to three times the defined average annual management fee.
- No material pending legal proceedings or material capital-expenditure commitments were reported; the filing said there were no off-balance-sheet arrangements. The auditor issued an unqualified opinion, and management and the auditor reported effective internal control over financial reporting.
Investor verification points
- Check the subsequent-quarter effects of coronavirus-related rate moves, prepayment speeds, RMBS spreads, book value, and liquidity.
- Reconcile reported GAAP earnings with economic net interest income and the substantial 2019 derivative losses; review the assumptions and limitations of management’s non-GAAP measures.
- Assess whether dividends are supported by taxable income and recurring cash generation, given the 2019 return-of-capital characterization and the absence of a minimum dividend commitment.
- Monitor repo maturities, lender concentration, haircuts, pledged collateral, and the amount of cash available after margin requirements.
- Evaluate dilution and per-share effects of equity issuance, including the $200 million 2020 at-the-market authorization and shares sold after year-end.
- Review REIT and Investment Company Act compliance, LIBOR-to-SOFR transition exposure, and the terms and governance of the external management agreement.