Orchid Island Capital, Inc. — FY 2021 Form 10-K
Reporting period: Fiscal year ended December 31, 2021. The filing also reports fourth-quarter results. Orchid is an externally managed mortgage REIT investing primarily in Agency residential mortgage-backed securities (RMBS), funded largely through short-term repurchase agreements and hedged with derivatives.
Financial results and key metrics
| Metric | 2021 | 2020 |
|---|---|---|
| Interest income | $134.7 million | $116.0 million |
| GAAP net interest income | $127.6 million | $91.0 million |
| GAAP net income (loss) | $(64.8) million; $(0.54) per share | $2.1 million; $0.03 per share |
| Economic net interest income, a non-GAAP measure | $109.3 million | $67.6 million |
| Average RMBS yield | 2.73% | 3.45% |
| Average economic cost of funds | 0.54% | 1.51% |
| Annual dividends declared per share | $0.78 | $0.79 |
GAAP results include fair-value movements on RMBS and derivatives. The company reported $177.1 million of combined losses on RMBS and derivative contracts, including $198.5 million of unrealized RMBS losses, partly offset by derivative gains. Economic net interest income adjusts for certain hedge effects and is not a GAAP substitute.
Fourth quarter: GAAP net loss was $44.6 million, or $0.27 per share. Net earnings excluding realized and unrealized gains and losses, a non-GAAP measure, were $38.0 million, or $0.22 per share. GAAP net interest income was $42.4 million; economic net interest income was $34.4 million. Average asset yield was 2.93%, and the economic net interest spread was 2.23%.
Balance sheet, funding and cash flow
- At year-end, total assets were $7.07 billion, including $6.51 billion of RMBS at fair value. Stockholders’ equity was $768.1 million, versus $415.3 million in 2020.
- Repurchase agreement borrowings were $6.24 billion, up from $3.60 billion. Total liabilities to equity were approximately 8.2x. The company generally expected leverage below 12x but had no formal maximum leverage limit.
- Cash and cash equivalents were $385.1 million; restricted cash was $65.3 million. Unpledged securities available for liquidity were approximately $4.7 million. The weighted-average repo borrowing rate was 0.15%, and remaining average maturity was 27 days. Weighted-average collateral haircut was approximately 4.9%.
- Operating cash flow was $96.4 million; investing cash outflow was $3.02 billion; financing cash inflow was $3.07 billion. Cash, cash equivalents and restricted cash increased by $150.9 million to $450.4 million.
- RMBS holdings grew from $3.73 billion to $6.51 billion. Effective duration increased from 2.36 to 3.39, before considering funding-cost hedges. The portfolio was 96.7% pass-through RMBS and 3.3% structured RMBS at year-end.
Changes versus the prior year
- Results shifted from $2.1 million of net income in 2020 to a $64.8 million net loss in 2021, primarily reflecting substantial fair-value losses on RMBS.
- Net interest income rose $36.6 million as average RMBS holdings increased by $1.57 billion and average funding costs declined. However, average RMBS yield fell 72 basis points.
- Equity increased alongside substantial share issuance: 100.8 million shares were issued in 2021, raising $514.1 million net. Shares outstanding rose to 177.0 million from 76.1 million.
- Annual dividends declared per share edged down to $0.78 from $0.79, while total 2021 dividends declared increased to $97.6 million as the share count grew.
- Three-month portfolio prepayment speed declined to 11.4% at year-end from 20.1% a year earlier.
Outlook, risks and unusual items
- Management expected short-term funding costs to rise materially during 2022 and potentially into 2023 as the Federal Reserve withdrew accommodation and raised rates. It warned that higher funding costs and slower premium amortization could reduce net interest income, potentially meaningfully.
- The Federal Reserve had begun tapering asset purchases and, as of the filing’s February 2022 discussion, was expected to begin rate increases soon. Reduced Fed demand for Agency RMBS, a flattening yield curve and geopolitical developments, including the Ukraine crisis, could affect markets and results.
- Key risks include interest-rate and spread movements, mortgage prepayments and extension risk, repo renewal and margin calls, liquidity and leverage, derivative and counterparty exposure, and uncertain fair-value estimates. A sharp decline in collateral values or higher haircuts could force asset sales at unfavorable prices.
- COVID-19 market disruption had previously caused unusually high margin calls. The company said it had met all margin-call requirements by December 31, 2021, but cautioned that a sufficiently rapid or deep increase could harm liquidity.
- The company intends to pay regular monthly dividends but has no minimum distribution commitment. Dividends remain at the Board’s discretion and depend on results, liquidity and REIT requirements.
- The company reported no material pending legal proceedings. The auditor issued unqualified opinions on the financial statements and internal controls; valuation of the $6.5 billion Level 2 RMBS portfolio was identified as a critical audit matter.
Most important facts for investors to verify
- How much of the 2021 loss reflected noncash fair-value changes, and how should GAAP and non-GAAP hedge-adjusted results be compared?
- Whether rising repo rates, changing asset yields and the company’s hedge positions affect future net interest income and book value as management anticipated.
- Current leverage, repo maturities, haircuts, unencumbered liquidity and exposure to margin calls, including TBA and derivative requirements.
- Whether dividends are supported by REIT taxable income and cash generation, rather than being inferred from GAAP earnings alone.
- The dilution and use of proceeds from 2021 equity issuance, and the effect of the larger share count on per-share results and book value.
- Valuation assumptions and sensitivity to rates: the filing’s year-end estimate showed a 100-basis-point rate increase could reduce book value by 13.91%, subject to stated model limitations.