Orchid Island Capital, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; balance-sheet comparisons are with December 31, 2015. Orchid is an externally managed REIT investing primarily in leveraged, government-agency residential mortgage-backed securities (RMBS).
Financial results and position
- Interest and earnings: Interest income was $20.5 million, up from $14.6 million; interest expense was $3.3 million, up from $1.3 million. Net interest income increased to $17.1 million from $13.3 million. The company reported a net loss of $4.6 million, or $0.21 per share, versus net income of $5.5 million, or $0.33 per share, in Q1 2015.
- Portfolio and margin: RMBS fair value was $1.977 billion at quarter-end, down from $2.158 billion. Average RMBS holdings were $2.068 billion. Portfolio yield was 3.96%, compared with 3.62% a year earlier; GAAP net interest spread was 3.28%, versus 3.26%. Including current-period hedge effects, economic net interest income was $15.2 million and economic spread was 2.89%; these are non-GAAP measures.
- Trading and hedges: RMBS realized and unrealized gains totaled $8.0 million. Derivative losses were $27.6 million, including $26.5 million on interest-rate futures, resulting in a net portfolio loss of $2.4 million before expenses. Total expenses were $2.2 million, up from $1.7 million.
- Liquidity, debt and equity: Cash and cash equivalents were $65.6 million, with another $17.8 million in restricted cash. Repurchase-agreement borrowings were $1.939 billion, up from $1.799 billion; their weighted-average rate was 0.69%, and average remaining maturity was 15 days. Stockholders’ equity was $239.8 million, down from $253.3 million. Repo borrowings were about 8.1 times quarter-end equity.
- Cash flow: Operating activities used $11.9 million; investing activities provided $76.2 million; financing activities used $56.0 million. Cash increased $8.3 million to $65.6 million.
- Dividends and shares: The company declared $0.42 per share during Q1, versus $0.54 in Q1 2015. It declared an additional $0.14 per share on April 13, payable April 29, after quarter-end. Shares outstanding were 21.77 million at March 31.
Changes versus comparable periods
- Net results reversed from Q1 2015 profit to a Q1 2016 loss, chiefly as derivative losses more than offset higher net interest income and RMBS gains.
- Interest income rose with a larger average portfolio and a higher reported asset yield; average borrowings and borrowing costs also increased. Economic cost of funds rose to 1.07% from 0.44% a year earlier, reflecting hedge losses attributed to the current period as well as higher borrowings.
- Year-over-year average RMBS holdings increased to $2.068 billion from $1.613 billion, supported by 2015 equity issuance. Quarter-end RMBS declined from December, while repo debt increased and the company repaid its $187.5 million of FHLB advances.
- Quarterly dividends declared fell to $0.42 per share from $0.54. The filing’s year-to-date dividend table includes the post-quarter $0.14 declaration; it should not be read as the amount declared by March 31.
Outlook, risks and notable items
- Management described the outlook for 2016 as challenging and uncertain, citing volatile markets, mixed economic signals and uncertainty about Federal Reserve policy. It expected any rate increases to proceed slowly and said portfolio positioning was unlikely to change materially, while reserving the ability to adjust strategy.
- Management warned that higher short-term rates could raise repo funding costs and compress margins; falling rates and faster mortgage prepayments can also affect asset values and reinvestment yields. Prepayment speeds averaged 8.2% in Q1 2016 versus 9.7% in Q1 2015.
- Key exposures include interest-rate, spread, prepayment, extension, liquidity and counterparty risks. Short-term repo funding creates rollover and margin-call risk; lenders may increase haircuts or decline to renew. Management reported meeting all margin calls during the quarter and said it believed available liquidity and other repo facilities were adequate.
- A January 2016 FHFA rule barred captive insurers from new FHLB advances and required the subsidiary to wind down FHLB membership. The company refinanced the subsidiary’s outstanding advances through repo agreements during Q1 and stated it did not expect the change to materially adversely affect core operations.
- Management reported no material pending legal proceedings, no material capital-expenditure commitments and no off-balance-sheet arrangements. Disclosure controls were assessed as effective, with no significant quarterly change in internal control over financial reporting.
Investor verification points
- Assess whether recurring net interest income can cover operating costs and dividends after the effect of hedge losses; distinguish GAAP results from management’s non-GAAP economic measures.
- Review repo renewal, counterparty concentration, collateral haircuts and margin-call capacity, given the 15-day average repo maturity and high leverage.
- Verify the sensitivity of portfolio equity to rate and spread changes; the filing’s modeled scenarios are estimates based on assumptions and exclude changes in mortgage spreads.
- Track dividend coverage using REIT taxable income, which can differ from GAAP earnings, and distinguish Q1’s $0.42 declaration from the post-quarter $0.14 declaration.
- Monitor the FHLB membership wind-down deadline and the company’s continued access to replacement funding.