Orchid Island Capital, Inc. — Q2 2021 Form 10-Q
Reporting period: Three and six months ended June 30, 2021. Unless otherwise noted, amounts are in U.S. dollars; financial statement amounts below are in millions. Orchid is an externally managed mortgage REIT investing primarily in Agency residential mortgage-backed securities (RMBS), financed mainly with short-term repurchase agreements.
Financial performance
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Interest income | $29.3 | $27.3 | $56.1 | $62.9 |
| Interest expense | $1.6 | $4.5 | $3.5 | $21.0 |
| Net interest income | $27.7 | $22.8 | $52.6 | $41.9 |
| Net portfolio income (loss) | $(13.1) | $51.5 | $(39.0) | $(37.5) |
| Total expenses | $3.7 | $2.8 | $7.2 | $4.9 |
| Net income (loss) | $(16.9) | $48.8 | $(46.2) | $(42.4) |
| Net income (loss) per share | $(0.17) | $0.74 | $(0.50) | $(0.65) |
| Net interest spread, GAAP | 2.46% | 2.89% | 2.46% | 2.57% |
Q2 2021 net loss included $5.9 million of RMBS losses and $34.9 million of derivative losses. For the first half, RMBS losses were $102.2 million, partly offset by $10.6 million of derivative gains. Management also reported non-GAAP net earnings excluding realized and unrealized gains and losses of $24.0 million, or $0.24 per share, for Q2 and $45.4 million, or $0.49 per share, for the first half; these measures are not substitutes for GAAP results.
Balance sheet, funding and cash flow
- At June 30, RMBS fair value was $4.671 billion, compared with $3.727 billion at December 31, 2020. The portfolio was 97.9% pass-through securities and 2.1% structured RMBS.
- Repurchase-agreement borrowings were $4.515 billion, up from $3.596 billion. Stockholders’ equity was $553.8 million, up from $415.3 million; borrowings were about 8.2 times period-end equity.
- Cash and cash equivalents were $272.8 million and restricted cash was $106.9 million. Unpledged RMBS were approximately $5.7 million. Management said liquidity and capital resources were sufficient for investment, debt repayment and required REIT distributions.
- Repurchase borrowings had a 0.13% weighted-average borrowing rate, approximately 29-day average remaining maturity and approximately 5.0% weighted-average collateral haircut. Orchid reported 23 repo counterparties and said it met all margin calls through June 30.
- Six-month operating cash flow was $38.6 million; investing cash use was $1.064 billion; financing cash flow was $1.106 billion. Net cash, cash equivalents and restricted cash increased $80.2 million to $379.7 million.
- Common shares outstanding rose to 117.5 million from 76.1 million at year-end, primarily following public offerings and at-the-market sales. Net proceeds from common stock issuance were $221.7 million in the first half. Through July 30, the company sold an additional 5.56 million shares for approximately $28.2 million net.
- Dividends declared were $0.195 per share in Q2 and $0.390 per share in the first half. A further $0.065-per-share dividend was declared July 14, payable August 27.
Material changes and management commentary
- Compared with Q2 2020, Q2 2021 moved from $48.8 million net income to a $16.9 million net loss, primarily reflecting the reversal from RMBS and hedge gains to losses. Net interest income improved by $4.9 million as lower funding costs more than offset lower asset yields.
- For the first half, net interest income increased $10.7 million year over year despite a 131-basis-point decline in average RMBS yield; average RMBS holdings increased by approximately $1.071 billion. Average GAAP funding cost declined to 0.17% from 1.37%.
- Average RMBS yield was 2.60% in Q2, versus 3.49% a year earlier. The average economic cost of funds, including designated hedge effects in management’s non-GAAP calculation, was 0.61% in both Q2 2021 and Q2 2020; economic net interest income was $22.6 million versus $17.0 million.
- Management described a strong economic recovery but noted elevated inflation, supply and labor constraints, uncertainty over the COVID-19 delta variant, and potential changes in Federal Reserve asset purchases. It said Agency RMBS underperformed many other markets in Q2, partly amid concern that Fed purchases could be reduced.
- No numerical company earnings or portfolio guidance was provided. Management expected to continue financing activities primarily through repurchase agreements and to manage asset allocation and hedges as market conditions change.
Risks, contingencies and unusual items
- Interest-rate sensitivity modeling estimated that a 100-basis-point rate increase would reduce book value by 19.96% at June 30, 2021; a 200-basis-point increase implied a 49.61% decline. These are model-based estimates for a static portfolio and actual outcomes may differ materially.
- Key exposures include rate and spread movements, prepayments and extension risk, repo renewal and margin calls, liquidity, derivative effectiveness, and counterparty default. Repo agreements are short-term and lenders may increase haircuts or decline to roll financing.
- COVID-19-related market dislocations had previously caused falling asset prices and margin calls. Orchid reported that it had satisfied all margin calls by quarter-end, but said pandemic-related conditions could still materially affect future results, financial condition and liquidity.
- Fair values for RMBS and derivatives rely on estimates and market inputs; management identified fair value as a significant accounting estimate. The securities were classified as Level 2 fair-value measurements.
- The company reported no material pending legal proceedings, no known contingencies at June 30, and no material changes to the risk factors in its 2020 Form 10-K. Disclosure controls were assessed as effective; no significant internal-control changes were reported.
Most important facts for investors to verify
- Whether RMBS valuations, derivative marks and the reported Q2 portfolio and hedge losses are consistent with market conditions and the company’s stated valuation methods.
- How much of reported net interest income is sustainable after considering hedge costs, asset yields, prepayments and changes in short-term funding rates.
- Repo renewal terms, collateral haircuts, margin requirements and available liquidity, especially given the short average maturity of borrowings.
- The effects of further equity issuance on per-share book value, earnings and dividends; verify share count and post-quarter ATM sales.
- Whether the dividend remains supported by REIT taxable income and cash generation; GAAP earnings and REIT taxable income may differ.
- The assumptions behind interest-rate sensitivity estimates and the possible effects of Fed policy, spread widening, prepayments, LIBOR transition and Agency-market support.