Orchid Island Capital, Inc. quarterly report, Q3 FY2022

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Orchid Island Capital, Inc. — Q3 2022 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2022. Orchid is an externally managed mortgage REIT investing primarily in agency residential mortgage-backed securities (RMBS), financed largely with short-term repurchase agreements and using derivatives as economic hedges. Share and per-share figures reflect the August 30, 2022 1-for-5 reverse stock split.

Financial performance and condition

  • Q3 results: Interest income was $35.6 million and interest expense $21.4 million, producing net interest income of $14.2 million. Net loss was $84.5 million, or $2.40 per share, versus net income of $26.0 million, or $1.00 per share, in Q3 2021. Q3 net interest spread was 1.51% on a GAAP basis and 2.10% on the company’s non-GAAP economic basis.
  • Nine-month results: Interest income was $112.7 million; interest expense was $32.2 million; net interest income was $80.5 million. Net loss was $293.4 million, or $8.31 per share, versus a $20.2 million loss, or $0.95 per share, in the comparable 2021 period. Economic net interest income, a company-defined non-GAAP measure, was $86.3 million.
  • Primary earnings driver: For the first nine months, RMBS realized and unrealized losses totaled $825.5 million; derivative gains were $466.4 million. Together, these produced $359.1 million of losses on RMBS and derivative contracts. In Q3, the corresponding net loss was $93.5 million.
  • Balance sheet at September 30: Total assets were $3.81 billion, including $3.20 billion of RMBS; total liabilities were $3.41 billion; stockholders’ equity was $400.4 million. At December 31, 2021, these were $7.07 billion, $6.51 billion, $6.30 billion, and $768.1 million, respectively.
  • Funding and liquidity: Repurchase-agreement debt was $3.13 billion, down from $6.24 billion at year-end 2021. The period-end weighted-average borrowing rate was 3.00%, with 29 days’ average remaining maturity and approximately 4.6% weighted-average collateral haircut. Unrestricted cash and cash equivalents were $214.2 million; restricted cash was $66.8 million. Management said available liquidity and capital were sufficient for operations, debt repayments, and dividends, while noting exposure to margin calls and funding-market conditions.
  • Cash flows, nine months: Operating activities provided $290.7 million; investing activities provided $2.73 billion, primarily reflecting RMBS sales; financing activities used $3.19 billion, including repo repayments and dividends. Cash, cash equivalents, and restricted cash decreased $169.5 million to $281.0 million.
  • Dividends: Q3 dividends declared were $0.545 per share; the financial statements report $1.995 per share for the nine months. A further $0.16 per share dividend was declared October 12 for payment November 28 and was not recorded as a liability at quarter-end.

Material changes versus the prior comparable period

  • Q3 net interest income fell $18.4 million year over year as interest expense rose $19.8 million, partly offset by $1.4 million higher interest income. Average cost of funds rose to 2.48% from 0.13%; average RMBS holdings declined to $3.57 billion from $5.14 billion.
  • For the nine-month period, net interest income decreased $4.7 million. Higher portfolio yields lifted interest income, but higher funding costs more than offset that benefit. Average cost of funds increased to 1.00% from 0.15%.
  • RMBS valuation losses and realized sale losses increased substantially amid rising rates and wider agency-RMBS spreads. Portfolio fair value fell to $3.20 billion from $6.51 billion at year-end; equity fell to $400.4 million from $768.1 million.
  • The company reduced repo borrowings and sold RMBS during the period. Its portfolio’s reported effective duration increased to 5.800 from 3.390 at year-end 2021; these figures exclude funding-cost hedges.

Outlook, risks, and notable items

  • Management described persistent, broad inflation, further expected Federal Reserve rate increases, market volatility, reduced liquidity, and sharply wider agency-RMBS spreads. The filing cites market expectations for a terminal Fed Funds rate of approximately 4.53% as of September 30 and 4.85% as of October 26; these are market expectations, not company guidance.
  • Key risks include interest-rate and spread movements, extension and prepayment risk, short-term repo refinancing and haircut changes, margin calls, derivative effectiveness, and counterparty performance. Management’s September 30 sensitivity analysis estimated that a parallel 100-basis-point rate increase would reduce portfolio market value by 1.00% and equity by 8.01%; actual results could differ materially, and the analysis assumes no change in mortgage spreads and a static portfolio.
  • The Fed had ended net asset purchases and begun balance-sheet runoff, which management said could weigh on agency-RMBS demand and pricing. Management also discussed possible recession and ongoing uncertainty in domestic and global markets.
  • No material pending legal proceedings or reported contingencies were identified. Management reported disclosure controls were effective and no significant quarterly change in internal control over financial reporting.
  • After quarter-end, the board increased the stock-repurchase authorization by 4.3 million shares. Through October 27, the company had repurchased 1.64 million shares for approximately $14.2 million at a weighted-average $8.64 per share. Shares outstanding were 33,422,207 on October 27, versus 35,066,251 at September 30.

Important facts for investors to verify

  • Reconcile GAAP losses with management’s non-GAAP “net earnings excluding realized and unrealized gains and losses” and “economic net interest income”; the company cautions these measures are not substitutes for GAAP results and may not be comparable across issuers.
  • Assess how further rate increases, spread widening, and slower mortgage prepayments could affect RMBS valuations, hedge offsets, book equity, and margin requirements.
  • Review short-term repo renewal, counterparty, collateral, and liquidity exposure, including the consequences of additional margin calls or higher haircuts.
  • Confirm post-quarter share repurchases, the expanded authorization, and the subsequent dividend declaration when assessing capital, share count, and distributions.
  • Note that the filing gives no company-specific earnings or dividend forecast; dividend requirements depend on REIT taxable income, which can differ from GAAP income.