Orchid Island Capital, Inc. — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. The filing compares full-year 2013 with full-year 2012; the company completed its IPO in February 2013, so the periods reflect materially different portfolio scale and public-company status.
Business context and financial performance
Orchid is an externally managed mortgage REIT investing in agency residential mortgage-backed securities (RMBS), including pass-through securities and structured securities such as interest-only and inverse interest-only securities. It finances much of its pass-through portfolio with short-term repurchase agreements and uses Eurodollar futures to hedge some funding-rate exposure.
| Metric | 2013 | 2012 |
|---|---|---|
| Interest income | $9.20 million | $2.70 million |
| Interest expense | $1.13 million | $0.28 million |
| Net interest income | $8.07 million | $2.42 million |
| Net portfolio income, after RMBS and futures gains/losses | $0.97 million | $1.27 million |
| Operating expenses | $1.67 million | $0.73 million |
| Net income (loss) | $(0.70) million; $(0.23) per share | $0.53 million; $0.54 per share |
| Net interest spread, GAAP / economic | 2.51% / 2.47% | 3.17% / 3.00% |
Average RMBS holdings increased to $316.1 million from $74.9 million as IPO proceeds were invested, while average portfolio yield declined to 2.91% from 3.60%. Average repo borrowings rose to $284.5 million from $63.9 million. Average GAAP funding cost eased to 0.40% from 0.43%; economic cost, including period-attributed futures effects, was 0.44% versus 0.60%.
Balance sheet, cash flow and liquidity
- At year-end, RMBS fair value was $351.2 million, total assets were $363.6 million, repo liabilities were $318.6 million, total liabilities were $318.8 million, and stockholders’ equity was $44.8 million. The total-liabilities-to-equity leverage ratio was approximately 7.1 times, below management’s stated general expectation of less than 12 times.
- Cash and cash equivalents were $8.2 million; restricted cash was $2.4 million, primarily margin posted on futures. Repo collateral had fair value of approximately $337.0 million, and the weighted-average haircut was about 5.5%.
- Repo maturities ranged from 3 to 70 days, with a 15-day weighted-average remaining maturity. The company had facilities with 12 counterparties and funding in place with nine. It reported approximately $18.3 million of maximum counterparty exposure at risk under its stated measure.
- Operating cash flow was $10.1 million; investing cash flow was $(249.8) million and financing cash flow was $245.4 million. Investing activity included $687.6 million of purchases, $409.0 million of sales, and $30.8 million of principal repayments. Cash increased $5.6 million during the year.
- The company declared $1.395 per common share in dividends for 2013. It reported no minimum distribution commitment and said future distributions remain at the board’s discretion, subject to REIT requirements and available funds.
Material changes and unusual items
- RMBS portfolio fair value increased from $115.4 million at year-end 2012 to $351.2 million at year-end 2013. The portfolio was 93.1% pass-through RMBS and 6.9% structured RMBS at year-end.
- Rising interest rates and tapering expectations weighed on pass-through RMBS prices. 2013 included $11.9 million of total RMBS losses: $1.2 million realized and $10.7 million unrealized. Eurodollar futures produced a $4.8 million GAAP gain, partly offsetting the losses; these derivatives were not designated for hedge accounting.
- Management’s non-GAAP economic net interest income was $7.9 million in 2013, compared with $2.3 million in 2012. Economic measures attribute futures effects to the relevant period; the company cautions that its calculation may differ from other market participants’ and is not a substitute for GAAP results.
- The IPO raised $35.4 million gross in February 2013. After year-end, the company completed a secondary offering of 2.07 million shares for approximately $24.2 million net proceeds; those proceeds and shares were not included in the December 31, 2013 balance sheet.
- The company reported a 9.9% average portfolio prepayment speed for fourth-quarter 2013, down from 28.6% in fourth-quarter 2012. Its reported total portfolio effective duration was 4.188 at year-end 2013, versus 1.209 a year earlier.
Outlook, risks and contingencies
No numerical earnings, book-value, spread, or dividend guidance is provided. Management’s stated strategy is to allocate capital between pass-through and structured agency RMBS, seek to keep combined duration near zero, manage liquidity, and continue monthly distributions where supported by results and REIT requirements. Management said it believed liquidity and capital resources were sufficient for portfolio activity, debt repayments, and required REIT distributions.
- Key exposures include interest-rate and yield-curve changes, prepayment and extension risk, narrowing asset funding spreads, valuation uncertainty, leverage, margin calls, short-term repo renewal and counterparty risk. The filing’s year-end sensitivity analysis estimated a 5.07% decline in total RMBS fair value for an instantaneous 100-basis-point rate increase before considering other market effects; futures were modeled to gain 1.02% of notional in that scenario.
- Potential changes to Fannie Mae and Freddie Mac, Federal Reserve asset purchases, mortgage refinancing or modification programs, and financial regulation could affect RMBS pricing, liquidity, supply, and funding. The Federal Reserve announced purchase reductions beginning in January 2014, with further reductions announced for February.
- Orchid intends to qualify as a REIT beginning with its short 2013 tax year and to maintain an Investment Company Act exemption. Failure to meet the relevant tax or asset-composition tests could materially affect taxes, operations, and distributions. It reported approximately $5.2 million of capital-loss carryforwards and no 2013 income-tax provision.
- The company has no employees and depends on its affiliated manager, Bimini Advisors. The related-party management agreement, fee structure, resource allocation, and termination fee create potential conflicts. The filing says Bimini owned approximately 18.1% of Orchid’s shares as of February 21, 2014.
- Orchid reported no material pending legal proceedings against itself and no known contingencies at year-end. It also reported no off-balance-sheet arrangements or material capital-expenditure commitments. Bimini and certain subsidiaries were separately involved in ongoing legal proceedings.
Important facts for investors to verify
- Review the audited statements and notes for the causes and accounting treatment of the net loss, RMBS fair-value losses, and Eurodollar futures gains; distinguish GAAP results from management’s economic measures.
- Check current book value, portfolio duration and composition, repo leverage, haircuts, maturities, counterparties, and available liquidity against the December 31, 2013 figures; these measures can change quickly.
- Confirm the post-year-end offering’s use and effect on share count, book value per share, leverage, and earnings per share; the filing does not include the offering in its year-end balance sheet.
- Assess whether dividends are supported by recurring earnings and cash generation, and verify their tax characterization and sustainability rather than assuming the 2013 rate will continue.
- Monitor REIT qualification and Investment Company Act asset tests, Federal Reserve policy and housing-finance reforms, and the affiliated manager’s conflicts and contract terms.