Orchid Island Capital, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. 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 figures are rounded.
Financial performance and position
- Q3 results: Interest income was $35.9 million and interest expense was $22.3 million, producing net interest income of $13.6 million. Net loss was $8.5 million, or $0.14 per share, versus a $3.0 million loss, or $0.06 per share, in Q3 2018. The quarter’s portfolio loss was $5.8 million, reflecting RMBS and derivative losses.
- Nine-month results: Interest income of $104.8 million less interest expense of $63.6 million yielded net interest income of $41.2 million. Net income was $5.7 million, or $0.10 per share, compared with a net loss of $18.0 million, or $0.34 per share, in the prior-year period. Net portfolio income was $13.3 million, versus a $9.0 million loss in 2018.
- Margins and funding: Nine-month GAAP net interest spread was 1.53%, down from 2.32% in 2018; Q3 spread was 1.41%, versus 2.11%. Management’s non-GAAP economic net interest income was $46.3 million for the nine months and $14.8 million for Q3. The company cautions that these non-GAAP measures are not substitutes for GAAP results.
- Assets, debt and equity: At September 30, RMBS at fair value totaled $3.821 billion; repurchase-agreement debt was $3.814 billion; stockholders’ equity was $392.0 million. The portfolio was primarily fixed-rate pass-through RMBS. The weighted-average repo borrowing rate was 2.36%, with a 36-day weighted-average remaining maturity. Total assets were $4.253 billion.
- Liquidity and cash flow: Cash and cash equivalents were $147.4 million, plus $54.8 million of restricted cash; unpledged securities were approximately $29.3 million. Nine-month operating cash flow was $24.4 million, investing cash flow was negative $788.5 million and financing cash flow was positive $840.1 million. Cash, cash equivalents and restricted cash increased $76.0 million to $202.2 million.
- Dividends and capital: Dividends declared were $0.24 per share for Q3 and $0.72 for the nine months. The company raised $92.3 million net from stock issuances during the nine months, including a 7.0-million-share follow-on offering that generated approximately $44.2 million net. Shares outstanding rose to 63.1 million from 49.1 million at year-end 2018.
Changes versus comparable periods
- Nine-month net income improved by $23.6 million year over year, helped by a $39.3 million unrealized gain on RMBS, compared with a $122.1 million unrealized loss in 2018. Derivative results swung to a $62.0 million loss from a $69.5 million gain.
- Despite the improved nine-month bottom line, net interest income fell $25.8 million. Management attributed the decline to lower average RMBS balances and yields, alongside a 72-basis-point rise in average GAAP funding cost; average borrowings were lower.
- Q3 interest income declined $3.1 million year over year, while interest expense rose $3.4 million. Average RMBS yields fell 43 basis points, and average funding costs rose 27 basis points.
- RMBS fair value increased to $3.821 billion from $3.015 billion at December 31, 2018. Repo debt increased to $3.814 billion from $3.025 billion. Net stock issuances contributed to the larger balance sheet.
Outlook, risks and notable items
- Management characterized Q3 markets as highly volatile, citing trade tensions, shifting growth and rate expectations, geopolitical events and disruption in overnight funding markets. The filing gives no earnings or dividend guidance.
- Management expected mortgage prepayments to remain elevated after rates fell to near historical lows. The reported portfolio prepayment speed was 16.4% in Q3 2019, compared with 8.6% in Q3 2018. Faster prepayments can reduce asset yields and particularly harm interest-only securities.
- Key exposures include interest-rate, mortgage-spread, prepayment and extension risk; short-term repo renewal and margin-call risk; and counterparty risk. Derivatives are used as economic hedges but are not designated for hedge accounting, so their fair-value changes flow through earnings.
- Management reported that all margin calls had been met at quarter-end and that repo facilities remained available on comparable terms through October 25, 2019, with maturities extending through April 9, 2020. These statements do not eliminate future refinancing, haircut or liquidity risk.
- Other matters to monitor include potential Fannie Mae and Freddie Mac reform, the transition from LIBOR to SOFR, and the company’s reliance on agency guarantees. The company reported no material pending legal proceedings, no known contingencies at quarter-end, and no material changes to previously disclosed risk factors. Disclosure controls were judged effective.
Investor verification points
- Review the sources and durability of nine-month earnings: RMBS valuation gains offset substantial derivative losses, and reported GAAP results differed from management’s non-GAAP economic measures.
- Track net interest spread, asset yields, repo borrowing costs and hedge performance as rates and funding conditions change.
- Assess leverage, collateral coverage, repo maturities, available unrestricted liquidity and sensitivity to margin calls or higher haircuts.
- Evaluate the sustainability of dividends relative to earnings, REIT taxable income and cash generation; the filing notes book income can differ from taxable income.
- Monitor elevated prepayments, RMBS spreads, agency policy developments and the benchmark-rate transition, including their effects on structured securities and portfolio values.