Orchid Island Capital, Inc. quarterly report, Q2 FY2023

Orchid Island Capital, Inc. — Q2 2023 Form 10-Q

Reporting period: Three and six months ended June 30, 2023. Orchid is an externally managed mortgage REIT investing primarily in agency residential mortgage-backed securities (RMBS), financed largely through short-term repurchase agreements. Amounts below are in U.S. dollars; financial statement figures are unaudited.

Key financial metrics

Metric	Q2 2023	Six months 2023
Interest income	$39.9 million	$77.9 million
Interest expense	$48.7 million	$90.9 million
GAAP net interest income (expense)	$(8.8) million	$(13.0) million
Net portfolio income	$15.1 million	$23.6 million
Operating expenses	$4.8 million	$9.8 million
GAAP net income	$10.2 million; $0.25 per share	$13.8 million; $0.35 per share
Dividends declared per common share	$0.48	$0.96

Non-GAAP interest measures: Economic net interest income, which incorporates the period’s effect of specified hedges, was $14.7 million in Q2 and $29.7 million for the six-month period. Economic net interest spread was 1.28% and 1.37%, respectively. These measures are not substitutes for GAAP results.
Balance sheet at June 30: RMBS fair value was $4.374 billion; total assets $4.731 billion; total liabilities $4.241 billion; and stockholders’ equity $490.1 million.
Debt and leverage: Repurchase agreements totaled $4.202 billion, at a 5.26% weighted-average borrowing rate and 25-day weighted-average remaining maturity. Adjusted leverage was 8.6:1 and economic leverage 8.1:1.
Liquidity: Cash and cash equivalents were $198.2 million, with $51.1 million of restricted cash. The company also reported $5.9 million of unpledged securities available for liquidity purposes. Six-month operating cash flow was $13.3 million; cash, cash equivalents and restricted cash ended at $249.3 million.

Changes versus the comparable 2022 period

Q2 net income of $10.2 million compared with a $60.1 million net loss in Q2 2022; six-month income of $13.8 million compared with a $208.9 million net loss. The improvement largely reflected much smaller RMBS fair-value losses and the absence of the prior-year realized RMBS sale loss; derivative gains remained material.
Funding costs sharply increased: Q2 average GAAP cost of funds rose to 4.88% from 0.80%; for the six-month period it rose to 4.81% from 0.46%. GAAP net interest income consequently became negative despite higher asset yields.
Average RMBS yield increased to 3.81% in Q2 from 3.31%, while average RMBS holdings declined to $4.187 billion from $4.261 billion. For the six-month period, average holdings fell to $3.978 billion from $4.903 billion.
At quarter-end, RMBS were up from $3.540 billion at December 31, 2022, while repurchase agreements increased from $3.378 billion. Adjusted leverage rose from 7.7:1 and economic leverage from 6.3:1 at year-end.
Common shares outstanding increased to 43.9 million from 36.8 million at year-end. The company issued 7.45 million shares through its at-the-market program in the first half, generating $79.0 million net; it also repurchased 373,041 shares for approximately $4.0 million.
Six-month principal repayments on RMBS fell to $138.4 million from $279.5 million. The reported three-month portfolio prepayment rate for Q2 was 5.3%, down from 9.4% a year earlier.

Outlook, risks and notable items

Outlook: No formal earnings or financial guidance was provided. Management described persistent inflation, strong labor markets and expectations for elevated interest rates as market concerns. It said softer inflation and labor-market data could support lower future rates and agency RMBS performance; persistently strong data could keep the yield curve inverted and RMBS performance muted.
Market conditions: Management reported that agency RMBS returned negative 0.5% in Q2 but outperformed comparable-duration SOFR swaps by 1.0%. It also discussed bank-failure-related RMBS liquidations and the resolved U.S. debt-ceiling impasse as factors affecting market sentiment.
Funding and liquidity risks: Short-term repo financing exposes the company to refinancing, higher-haircut and margin-call risks. Management said it met all margin-call requirements at June 30 and believed liquidity and capital resources were sufficient. Repo facilities can be terminated or repriced, and forced asset sales could result in losses.
Market and valuation risks: Interest-rate, mortgage-spread, prepayment and extension movements can affect asset values, funding costs and hedge effectiveness. The filing’s modeled sensitivity shows that a 100-basis-point rate increase could reduce estimated book value by 9.87% at June 30, 2023; management cautions actual results could differ materially.
Contingencies and controls: Management reported no known contingencies at June 30 and no material pending legal proceedings. It reported effective disclosure controls and no material changes in internal control over financial reporting.
Other notable items: The company adopted reference-rate-reform accounting guidance as certain derivatives transitioned from LIBOR to SOFR; adoption had no material financial-statement impact. A $0.16-per-share dividend declared July 12 for payment August 29 was subsequent to quarter-end and not included in June 30 financial statements.

Important facts for investors to verify

Whether investment income and hedge performance can sustain dividends given negative GAAP net interest income and materially higher funding costs.
Repo renewal terms, borrowing rates, collateral haircuts, margin requirements and liquidity available under stressed market conditions.
RMBS fair values, spread sensitivity and the assumptions underlying modeled interest-rate and prepayment sensitivities.
The effect of share issuance and repurchases on per-share equity and returns; the filing text does not provide a clear quarter-end book value per share.
Dividend coverage under REIT taxable-income requirements, which can differ from GAAP income.
Management agreement costs and related-party arrangements with Bimini Advisors, including the agreement’s renewal and termination provisions.