Orchid Island Capital, Inc. — Q2 2018 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2018. Orchid is an externally managed mortgage REIT investing primarily in agency residential mortgage-backed securities (RMBS), financed largely with short-term repurchase agreements. It seeks returns from net interest income and regular monthly distributions. Financial amounts below are in U.S. dollars; millions unless stated otherwise.
Financial performance and position
- Q2 results: Net income was $1.3 million, or $0.03 per share, compared with a $9.6 million net loss, or $0.26 loss per share, in Q2 2017. Net interest income was $22.0 million, down from $25.8 million.
- First-half results: Net loss was $15.0 million, or $0.29 per share, versus a $7.2 million loss, or $0.21 per share, in the first half of 2017. Net interest income fell to $46.8 million from $51.4 million.
- Interest spreads: Q2 2018 GAAP net interest spread was 2.27%, compared with 2.84% a year earlier; the company’s non-GAAP economic spread was 2.18%, versus 2.38%. For the first half, GAAP spread was 2.43% versus 3.01%, and economic spread was 2.21% versus 2.56%.
- Portfolio and valuation: RMBS fair value was $3.690 billion at quarter-end, down from $3.745 billion at December 31, 2017. First-half RMBS realized and unrealized losses totaled $112.6 million. Derivatives generated $56.9 million of gains, partially offsetting those losses.
- Balance sheet and leverage: Total assets were $3.908 billion, liabilities $3.499 billion, and stockholders’ equity $409.2 million. Repurchase agreements totaled $3.450 billion, approximately 8.4 times equity. RMBS effective duration was 3.421, excluding funding hedges.
- Funding and liquidity: Quarter-end repo weighted-average borrowing rate was 2.07%, up from 1.54% at year-end 2017; average remaining repo maturity was 37 days. Cash and cash equivalents were $137.9 million, restricted cash $31.1 million, and unpledged securities $45.4 million. The company reported meeting all margin calls.
- Cash flow: First-half operating cash flow was $77.4 million; investing cash use was $30.1 million and financing cash use was $125.0 million. Cash, cash equivalents and restricted cash decreased $77.7 million to $169.0 million.
- Distributions and equity: Dividends declared were $0.27 per share in Q2 and $0.58 per share for the first half, versus $0.42 and $0.84 in the comparable 2017 periods. The company repurchased 1.07 million shares in Q2 for about $7.7 million, at a weighted-average $7.19 per share.
Material changes versus comparable periods
Interest income increased year over year as the portfolio grew and asset yields rose, but higher short-term funding costs and greater borrowings reduced net interest income and spreads. In the first half, RMBS losses were substantially larger than in 2017, while derivative gains improved sharply from the prior-year derivative loss. Q2 returned to a small GAAP profit, unlike Q2 2017, when RMBS and derivative losses drove a net loss. The first-half net loss nevertheless widened year over year.
Outlook, commentary, and risks
- Management described U.S. economic growth as strong and expected gradual Federal Reserve tightening; it cited the Fed’s then-current projections of two additional rate increases in 2018 and three in 2019. These are management’s discussion of Fed expectations, not company earnings guidance.
- Management said trade tensions, European and emerging-market developments, and a flattening yield curve were constraining longer-term rates and contributing to market uncertainty. It noted that a very narrow yield-curve spread can signal recession concerns.
- Management reported Agency MBS index returns of approximately 0.24% for Q2 and negative 1.0% for the first half of 2018. It cautioned that further yield-curve compression could pressure Agency RMBS returns and demand.
- Key exposures include interest-rate and spread risk, mortgage prepayment and extension risk, short-term repo refinancing and margin-call risk, and counterparty risk. A 100-basis-point rate increase was modeled to reduce book value by 4.52%; a 200-basis-point increase by 14.80%. Management cautioned that actual results may differ materially from these estimates.
- The company said liquidity and capital resources were currently sufficient for operations, debt repayment, investments and REIT distributions, while noting repo agreements can be renewed on less favorable terms or not renewed. No material pending legal proceedings or reported contingencies were disclosed, and no material capital-expenditure commitments or off-balance-sheet arrangements were reported.
- The management agreement with affiliate Bimini Advisors was renewed through February 20, 2019, with automatic one-year extensions thereafter. The company disclosed related-party management fees and expense reimbursements.
Most important facts for investors to verify
- Whether net interest income and economic spread can withstand further increases in repo funding costs.
- How RMBS valuations, book value, and margin requirements respond to interest-rate and mortgage-spread movements.
- Repo renewal terms, counterparty concentration, and available liquidity under stressed markets.
- Whether dividends are supported by REIT taxable income and recurring portfolio economics, rather than assumed from GAAP earnings alone.
- The effect of share repurchases and any further equity issuance on per-share book value and shareholder returns.