Orchid Island Capital, Inc. — FY 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015; filed February 25, 2016. Orchid is an externally managed mortgage REIT investing primarily in Agency residential mortgage-backed securities (RMBS), funded mainly with short-term repurchase agreements. Its portfolio includes pass-through securities and structured securities such as interest-only and inverse interest-only securities.
Financial performance and position
| Metric | FY 2015 | FY 2014 |
|---|---|---|
| Interest income | $68.8 million | $31.8 million |
| Interest expense | $7.3 million | $3.0 million |
| Net interest income | $61.5 million | $28.8 million |
| RMBS and derivative gains/(losses) | $(52.6) million | $0.2 million |
| Net income | $1.1 million; $0.05 per share | $24.5 million; $2.48 per share |
| Operating expenses | $7.9 million | $4.5 million |
| Cash from operating activities | $30.7 million | $11.6 million |
| Dividends declared per share | $1.92 | $2.16 |
- At year-end, assets were $2.24 billion, including $2.16 billion of RMBS; liabilities totaled $1.99 billion and stockholders’ equity was $253.3 million. Book value per share was $11.64, down from $13.06 in 2014.
- Year-end borrowings were $1.99 billion, comprising $1.80 billion in repurchase agreements and $187.5 million in Federal Home Loan Bank advances. The leverage ratio was 7.9:1, versus 6.6:1 a year earlier. Management generally expected leverage below 12:1.
- Cash and cash equivalents were $57.2 million; unpledged securities were approximately $62.4 million. Reported net cash decreased by $35.9 million during the year. Cash-flow statement totals: operating activities provided $30.7 million, investing activities used $650.0 million, and financing activities provided $583.3 million.
- Average RMBS yield was 3.52% versus 3.39%; average GAAP funding cost was 0.41% versus 0.34%; and average interest-rate spread was 3.11% versus 3.05%. Including hedging effects, economic funding cost rose to 0.58% from 0.36%, and economic spread narrowed to 2.94% from 3.03%.
Material changes and notable items
- Net income fell sharply as $29.7 million of RMBS losses and $22.9 million of derivative losses more than offset higher net interest income. In 2014, the company reported $14.2 million of RMBS gains and $13.9 million of derivative losses.
- The portfolio expanded: year-end RMBS fair value increased to $2.16 billion from $1.55 billion, and average RMBS holdings more than doubled. The company issued $83.3 million net through its at-the-market equity program and repurchased 1.22 million shares for approximately $10.8 million.
- Fixed-rate pass-through RMBS represented 92.7% of the portfolio at year-end, compared with 91.2% in 2014. Total annualized prepayment speed in the fourth quarter was 9.0%, up from 7.8% in the fourth quarter of 2014.
- The monthly dividend was reduced from $0.18 to $0.14 per share beginning July 2015. Fourth-quarter dividends were $0.42 per share, versus $0.54 in each 2014 quarter.
- The FHLB system’s January 2016 rule barred captive insurers from membership and new advances. Orchid said it had replaced the $187.5 million outstanding advances with repurchase-agreement borrowing and believed existing facilities provided adequate capacity.
Outlook, risks and contingencies
- Management described the investment environment as challenging, citing a relatively tight yield curve, mortgage-spread volatility, low Agency MBS issuance, and uncertainty about economic growth and Federal Reserve policy. It anticipated gradual further Federal Reserve rate increases, but stated that portfolio positioning was unlikely to change materially during 2016. No numerical earnings or dividend guidance was provided.
- Key exposures include interest-rate and spread movements, prepayment and extension risk, short-term funding renewal and margin calls, leverage, hedge effectiveness, counterparty risk, and potentially illiquid structured securities. A rise in funding rates without a corresponding rise in asset yields could compress margins; falling security values or higher haircuts could trigger collateral needs or forced sales.
- The company accounts for RMBS and derivatives at fair value, with changes recognized in earnings; management cautions that valuation models and sensitivity estimates depend on assumptions and may differ from actual outcomes. Its year-end rate-shock analysis estimated that a 100-basis-point rise would reduce book value by 17.9%, assuming a static portfolio and no change in mortgage spreads.
- REIT qualification and the Investment Company Act exemption depend on ongoing asset, income, ownership, and distribution tests. The company must generally distribute at least 90% of REIT taxable income. It reported distributing all estimated 2015 REIT taxable income; GAAP net income is not equivalent to taxable income.
- The manager is an affiliate, receives equity-based fees regardless of portfolio performance, and a no-cause nonrenewal by Orchid entails a termination fee. The filing also identifies potential conflicts from shared personnel and competing asset allocations. No material pending company legal proceedings or known contingencies were reported.
Important facts for investors to verify
- Whether the large 2015 fair-value and derivative losses reflect continuing exposure, and how hedging positions and results have changed since year-end.
- Current book value per share, portfolio composition and duration, leverage, repo maturities, haircuts, and available unencumbered liquidity.
- Whether funding costs and mortgage spreads are compressing net interest income, and whether the current dividend is supported by taxable income and cash generation.
- The replacement and ongoing terms of funding after the FHLB advances were refinanced, including any change in counterparties or borrowing costs.
- Current REIT and Investment Company Act compliance, manager-related fees and conflicts, and the status of the share-repurchase authorization.