Orchid Island Capital, Inc. — Q2 2016 Form 10-Q
Business and period. Orchid is an externally managed mortgage REIT investing primarily in agency residential mortgage-backed securities (RMBS), financed largely through short-term repurchase agreements. This filing covers the quarter and six months ended June 30, 2016; balance-sheet comparisons are with December 31, 2015.
Financial performance and condition
- Q2 results: Net income was $6.5 million, or $0.29 per diluted share, versus a net loss of $2.8 million, or $0.14 per share, in Q2 2015. Net interest income was $15.9 million, compared with $15.2 million.
- First-half results: Net income was $1.9 million, or $0.08 per share, versus $2.7 million, or $0.14 per share, in H1 2015. Net interest income rose to $33.1 million from $28.5 million.
- Portfolio and returns: RMBS fair value was $2.223 billion, up from $2.158 billion at year-end; 95.9% was pass-through RMBS and 4.1% structured RMBS. H1 average asset yield was 3.81%, versus 3.55% a year earlier. Q2 GAAP net interest spread was 2.99%; the company’s non-GAAP economic spread, including current-period hedge effects, was 2.55%.
- Hedge and valuation effects: H1 derivative losses were $39.2 million, partly offset by $12.3 million of realized and unrealized RMBS gains. Q2 derivative losses were $11.6 million, while RMBS gains were $4.3 million. The filing attributes RMBS pressure in part to wider mortgage-spread differentials and derivative losses to higher implied forward rates.
- Expenses and distributions: H1 expenses were $4.3 million, up from $3.7 million. Dividends declared were $0.84 per share in H1, versus $1.08 in H1 2015; Q2 dividends were $0.42 per share. A further $0.14 dividend was declared July 13 for payment July 29, after quarter-end.
- Balance sheet and funding: Total assets were $2.317 billion and stockholders’ equity $243.7 million, compared with $2.242 billion and $253.3 million at year-end. Repurchase agreements were $2.061 billion, up from $1.799 billion; their weighted-average borrowing rate was 0.69%, versus 0.64% at year-end. Outstanding repo maturities averaged 19 days, with a 5.3% weighted-average collateral haircut.
- Liquidity and cash flow: Cash and cash equivalents were $65.4 million and restricted cash $19.0 million; the MD&A separately cites $64.7 million of unrestricted cash, so the precise unrestricted amount is not fully clear from the presented text. Unpledged securities were about $43.7 million. H1 operating cash flow was negative $2.8 million, investing cash flow negative $51.7 million, and financing cash flow positive $62.7 million; cash increased $8.1 million.
- Leverage and capital: The company refinanced its $187.5 million of FHLB advances through repurchase agreements during H1. It issued 646,753 shares through its at-the-market program in Q2 for net proceeds of $6.6 million. Shares outstanding were 22.43 million at June 30 and 22.78 million on July 28.
Changes, outlook, and risks
- Compared with H1 2015, higher average RMBS holdings and asset yields lifted interest income, but funding costs also rose: average GAAP cost of funds increased to 0.67% from 0.36%, and economic cost of funds to 1.09% from 0.47%. Economic net interest income was $28.9 million versus $27.6 million.
- Management described volatile rates and mortgage spreads during Q2, followed by some market stabilization in early Q3. It expected low global rates, gradual Federal Reserve normalization, and continued mortgage-market volatility; it said portfolio positioning was unlikely to change materially during 2016. The filing provides no numerical earnings or dividend guidance.
- The FHFA rule bars the captive insurance subsidiary from continued FHLB membership. The subsidiary’s advances were repaid/refinanced, and the company reported no longer having access to FHLB advances; management did not expect the change to materially harm core operations.
- Key risks include rising short-term funding rates, spread widening, prepayment and extension risk, repo renewal and haircut changes, collateral or derivative margin calls, and counterparty default. The company reported meeting all margin calls at June 30. Its interest-rate sensitivity estimates are model-based and assume a static portfolio and unchanged mortgage spreads.
- No material pending legal proceedings, known contingencies, or off-balance-sheet arrangements were reported. Management said disclosure controls were effective and there were no significant quarterly changes in internal control over financial reporting.
Important facts for investors to verify
- How much of reported earnings and book-value performance reflects RMBS gains versus losses on futures, swaps, and other derivatives; review the economic-interest non-GAAP reconciliation alongside GAAP results.
- Whether repo funding remains available on comparable terms as short maturities roll, and how changes in rates, collateral values, or haircuts could affect liquidity and leverage.
- Whether the 0.84-per-share H1 dividend and subsequent $0.14 declaration are supported by REIT taxable income and sustainable cash generation; GAAP earnings and REIT taxable income may differ.
- How elevated prepayments and mortgage spreads affect asset yields, structured RMBS values, and the effectiveness of the company’s hedges.
- The post-quarter share issuance and its effect on share count, equity, and per-share results; also confirm the precise unrestricted cash figure, which differs between the balance sheet presentation and MD&A.