Orchid Island Capital, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019; unaudited. Orchid is an externally managed REIT investing primarily in Agency residential mortgage-backed securities (RMBS), financed largely through short-term repurchase agreements.
Financial performance and position
| Metric | Q2 2019 | Comparable period / period-end context |
|---|---|---|
| Interest income | $36.5 million | $38.6 million in Q2 2018 |
| Net interest income | $14.0 million | $22.0 million in Q2 2018 |
| Net income and diluted EPS | $3.5 million; $0.07 per share | $1.3 million; $0.03 per share in Q2 2018 |
| Net interest spread | 1.51% GAAP; 1.70% economic | 2.27% GAAP; 2.18% economic in Q2 2018 |
| Dividends declared | $0.24 per common share | $0.27 per share in Q2 2018 |
For the six months ended June 30, 2019, net income was $14.1 million, or $0.28 per share, versus a $15.0 million net loss, or $0.29 per share, in 2018. Net interest income was $27.6 million versus $46.8 million. The company reported $44.9 million of RMBS gains and $53.3 million of derivative losses for the half-year; these fair-value and realized items materially affect GAAP earnings.
At June 30, the RMBS portfolio was $3.53 billion at fair value, total assets were $3.73 billion, and stockholders’ equity was $359.7 million. Repurchase-agreement borrowings were $3.33 billion, with a 2.63% weighted-average borrowing rate and 58-day weighted-average remaining maturity. Cash and cash equivalents were $135.6 million, restricted cash $45.5 million, and unpledged RMBS $22.3 million. Management said it had met all margin calls.
Six-month cash flow: $15.6 million provided by operating activities, $274.9 million used in investing activities, and $314.2 million provided by financing activities. Cash, cash equivalents and restricted cash increased by $54.8 million to $181.1 million.
Material changes versus comparable periods
- Q2 net income rose to $3.5 million from $1.3 million, despite lower net interest income; improved RMBS results more than offset larger derivative losses compared with Q2 2018.
- For the first half, earnings improved from a loss to a profit, principally as RMBS results improved substantially; net interest income declined by $19.2 million.
- Management attributed lower interest income to a smaller average RMBS portfolio, partly offset by higher asset yields. Higher funding costs drove increased interest expense: the six-month average cost of funds rose to 2.73% from 1.78%, while average borrowings fell.
- RMBS fair value increased from $3.01 billion at December 31, 2018. The company raised net proceeds of about $37.0 million from public share offerings during the first half and issued another 1.77 million shares after quarter-end for about $11.1 million net.
- The annualized dividend rate declined: dividends declared were $0.48 per share for the first half of 2019 versus $0.58 in the first half of 2018. A further $0.08 dividend was declared July 17, payable August 30.
Outlook, risks and notable items
Management described the Federal Reserve’s policy outlook as shifting toward easing amid slower global growth, trade uncertainty and inflation below the Fed’s 2% target. At the time of filing, management expected a Fed rate cut at the July 31, 2019 meeting and noted market expectations for two or three 25-basis-point cuts during the rest of 2019. These were expectations, not company guidance.
Management reported a 2.0% total return for the Agency MBS market in Q2, but said the sector underperformed comparable-duration Treasuries by 0.70%. Falling rates, increased refinancing and prepayment concerns, and volatility were cited as pressures on MBS performance. Portfolio prepayment speed was 11.4% in Q2 versus 9.8% a year earlier.
- Key exposures include interest-rate and spread risk, mortgage prepayments and extension, short-term repo funding and rollover risk, margin calls, and counterparty credit risk. Repo lenders may increase collateral haircuts or decline to renew funding.
- Company-model sensitivity estimates at June 30 showed book-value impacts of -9.86% for a 100-basis-point rate decline and -18.82% for a 200-basis-point increase. Management cautioned that these are estimates for a static portfolio and actual results may differ materially.
- Management said the LIBOR-to-SOFR transition and potential housing-finance reform could affect investments and hedging. The effectiveness and market impact of newly introduced Uniform MBS remained uncertain.
- No material pending legal proceedings, known contingencies, material capital-expenditure commitments or off-balance-sheet arrangements were reported. No material changes to previously disclosed risk factors were reported. Disclosure controls were assessed as effective.
- The management agreement with affiliate Bimini Advisors was renewed through February 20, 2020, with one-year automatic extensions thereafter; termination without cause may require a fee equal to three times the average annual management fee.
Important facts for investors to verify
- Whether net interest income and the dividend remain supported as short-term funding costs, portfolio yields and prepayments change.
- Repo renewal terms, collateral haircuts, margin requirements and liquidity available under stressed market conditions.
- The sensitivity of book value and hedges to rate moves, MBS spread widening and changing prepayment assumptions.
- Share dilution and proceeds from the at-the-market offering, including post-quarter issuance, relative to per-share book value and earnings.
- Dividend sustainability and REIT distribution requirements; GAAP earnings can differ materially from REIT taxable income and the company’s non-GAAP measures.