Orchid Island Capital, Inc. — Q3 2014 Form 10-Q
Business context and reporting period. This quarterly report covers the three and nine months ended September 30, 2014. Orchid is an externally managed mortgage REIT investing in Agency residential mortgage-backed securities (RMBS), funded primarily with short-term repurchase agreements and using derivatives to manage interest-rate exposure.
Financial performance and position
- Q3 results: Net interest income was $8.5 million; net income was $6.8 million, or $0.63 per diluted share, compared with a $1.0 million net loss, or $0.30 per share, in Q3 2013. Q3 expenses were $1.4 million.
- Nine-month results: Net interest income was $17.8 million and net income was $21.0 million, or $2.53 per diluted share, compared with a $2.1 million net loss, or $0.74 per share, in the prior-year period. Net portfolio gains were $24.0 million for the period.
- Interest margins: Q3 average RMBS yield was 3.62%, GAAP average funding cost was 0.32%, and net interest spread was 3.30% (3.29% on the company’s economic basis). For the nine months, the GAAP spread was 2.95%, versus 2.38% in 2013.
- Assets, debt and equity: At September 30, RMBS at fair value totaled $1.176 billion; repurchase-agreement debt was $1.256 billion; total assets were $1.501 billion; and stockholders’ equity was $172.8 million. The debt balance was approximately 7.3 times equity. The RMBS portfolio was 94.5% pass-through securities and 5.5% structured securities.
- Liquidity and cash flow: Cash and cash equivalents were $55.0 million, with another $7.8 million in restricted cash. Nine-month operating cash flow was $8.4 million; investing cash use was $1.006 billion and financing cash provided was $1.044 billion. Repo borrowings had a 0.34% weighted-average rate, 38-day weighted-average remaining maturity, and approximately 5.5% weighted-average collateral haircut.
- Dividends and capital: The company declared $0.54 per share in dividends during Q3 and $1.62 per share for the first nine months. It raised capital through public offerings and at-the-market sales; 13.0 million common shares were outstanding at September 30, versus 3.3 million at December 31, 2013.
Material changes versus comparable periods
- Compared with Q3 2013, Q3 2014 net income improved by $7.8 million. Higher net interest income reflected a much larger average portfolio and a higher reported asset yield; portfolio and derivative results also differed materially between periods.
- For the first nine months, net income improved by $23.1 million year over year. RMBS gains were $10.7 million, compared with RMBS losses of $10.6 million in 2013; derivative results were losses of $4.4 million, compared with gains of $4.1 million.
- RMBS fair value increased from $351.2 million at year-end 2013 to $1.176 billion at September 30, 2014, as the company deployed proceeds from share offerings using leverage. Repo debt rose from $318.6 million to $1.256 billion.
- The company reported a reduction in modeled portfolio effective duration, from 4.188 at December 31, 2013 to 3.074 at September 30, 2014. This measure excludes the effect of funding-cost hedges.
Outlook, commentary and risks
- Management stated that it believed available liquidity and capital were sufficient for investment activity, debt repayments and dividends required to maintain REIT qualification. It expected to continue financing operations through repurchase agreements; no earnings or dividend forecast was provided.
- Management identified interest rates, funding and hedging costs, prepayments, leverage, market values, and access to repo funding as key drivers. It warned that rising short-term rates could increase borrowing costs without a corresponding rise in asset income, while higher prepayments could hurt certain securities, especially interest-only and inverse interest-only holdings.
- A modeled instantaneous 100-basis-point rate increase showed a combined estimated fair-value decline of $18.7 million for RMBS and hedges; a 200-basis-point increase showed a $44.5 million decline. The filing cautions that actual results may differ materially as other market factors change.
- At September 30, the company reported approximately $74.1 million of maximum repo-counterparty exposure at risk. Repo agreements are short-term and can require additional collateral if pledged securities decline in value. Management also discussed uncertainty around Fannie Mae and Freddie Mac reform, federal policy and regulation.
- Subsequent events: Orchid’s common stock began trading on the NYSE on October 8, 2014. It also issued additional shares under its equity distribution agreement after quarter-end. The October dividend declaration is not included in September 30 financial statements.
- The company reported no material pending legal proceedings, no material changes to previously disclosed risk factors, and no material commitments for capital expenditures. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether portfolio income and gains can sustain dividends as the larger, leveraged RMBS portfolio evolves; declared dividends are not a guarantee of future distributions.
- Repo refinancing, counterparty concentration, collateral haircuts and margin-call liquidity, including the reported $74.1 million counterparty amount at risk.
- How rate movements, prepayments and structured-RMBS valuations affect book value; RMBS and swaptions use Level 2 fair-value inputs, including pricing services and broker quotes.
- The impact of share issuance and dilution, related-party management fees and expense allocations, and the company’s ability to maintain REIT qualification.
- Period comparisons: the company expanded significantly through equity issuance and leverage, so year-over-year earnings and per-share results reflect a substantially different portfolio and share base.