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MarketScreener Homepage  >  Equities  >  Nyse  >  Orchid Island Capital, Inc.    ORC

ORCHID ISLAND CAPITAL, INC.

(ORC)
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ORCHID ISLAND CAPITAL : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

07/31/2020 | 01:19pm EST
The following discussion of our financial condition and results of operations
should be read in conjunction with the financial statements and notes to those
statements included in Item 1 of this Form 10-Q. The discussion may contain
certain forward-looking statements that involve risks and uncertainties.
Forward-looking statements are those that are not historical in nature. As a
result of many factors, such as those set forth under "Risk Factors" in our most
recent Annual Report on Form 10-K and our quarterly reports on Form 10-Q, our
actual results may differ materially from those anticipated in such
forward-looking statements.



Overview



We are a specialty finance company that invests in residential mortgage-backed
securities ("RMBS") which are issued and guaranteed by a federally chartered
corporation or agency ("Agency RMBS"). Our investment strategy focuses on, and
our portfolio consists of, two categories of Agency RMBS: (i) traditional
pass-through Agency RMBS, such as mortgage pass-through certificates issued by
Fannie Mae, Freddie Mac or Ginnie Mae (the "GSEs") and collateralized mortgage
obligations ("CMOs") issued by the GSEs ("PT RMBS") and (ii) structured Agency
RMBS, such as interest-only securities ("IOs"), inverse interest-only securities
("IIOs") and principal only securities ("POs"), among other types of structured
Agency RMBS. We were formed by Bimini in August 2010, commenced operations on
November 24, 2010 and completed our initial public offering ("IPO") on February
20, 2013. We are externally managed by Bimini Advisors, an investment adviser
registered with the Securities and Exchange Commission (the "SEC").



Our business objective is to provide attractive risk-adjusted total returns over
the long term through a combination of capital appreciation and the payment of
regular monthly distributions. We intend to achieve this objective by investing
in and strategically allocating capital between the two categories of Agency
RMBS described above. We seek to generate income from (i) the net interest
margin on our leveraged PT RMBS portfolio and the leveraged portion of our
structured Agency RMBS portfolio, and (ii) the interest income we generate from
the unleveraged portion of our structured Agency RMBS portfolio. We intend to
fund our PT RMBS and certain of our structured Agency RMBS through short-term
borrowings structured as repurchase agreements. PT RMBS and structured Agency
RMBS typically exhibit materially different sensitivities to movements in
interest rates. Declines in the value of one portfolio may be offset by
appreciation in the other. The percentage of capital that we allocate to our two
Agency RMBS asset categories will vary and will be actively managed in an effort
to maintain the level of income generated by the combined portfolios, the
stability of that income stream and the stability of the value of the combined
portfolios. We believe that this strategy will enhance our liquidity, earnings,
book value stability and asset selection opportunities in various interest rate
environments.



We operate so as to qualify to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). We
generally will not be subject to U.S. federal income tax to the extent that we
currently distribute all of our REIT taxable income (as defined in the Code) to
our stockholders and maintain our REIT qualification.



The Company's common stock trades on the New York Stock Exchange under the symbol "ORC".

Impact of the COVID-19 Pandemic

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Beginning in March 2020, the global pandemic associated with the novel
coronavirus COVID-19 ("COVID-19") and related economic conditions began to
impact our financial position and results of operations. As a result of the
economic, health and market turmoil brought about by COVID-19, the Agency RMBS
market experienced severe dislocations. This resulted in falling prices of our
assets and increased margin calls from our repurchase agreement lenders.
Further, as interest rates declined, we faced additional margin calls related to
our various hedge positions. In order to maintain sufficient cash and liquidity,
reduce risk and satisfy margin calls, we were forced to sell assets at levels
significantly below their carrying values and closed several of our hedge
positions. The Agency RMBS market largely stabilized after the Federal Reserve
(the "Fed") announced on March 23, 2020 that it would purchase Agency RMBS and
U.S. Treasuries in the amounts needed to support smooth market functioning. As
of June 30, 2020, we had timely satisfied all margin calls. The following
summarizes the impact COVID-19 has had on our financial position and results of
operations through June 30, 2020.



?We sold approximately $2.0 billion of RMBS during the six months ended June 30,
2020, realizing losses of approximately $25.0 million. Approximately $1.1
billion of these sales were executed on March 19th and March 20th and resulted
in losses of approximately $31.4 million. The losses sustained on these two days
were a direct result of the adverse RMBS market conditions associated with
COVID-19.

?We terminated interest rate swap positions with an aggregate notional value of
$1.2 billion and incurred approximately $54.5 million in mark to market losses
on the positions through the date of the respective terminations. Approximately
$45.0 million of these losses occurred during the three months ended March 31,
2020.

?Our RMBS portfolio had a fair market value of approximately $3.3 billion as of
June 30, 2020, compared to $3.6 billion as of December 31, 2019. The June 30,
2020 balance represents an increase from the $2.9 billion balance as of March
31, 2020.

?Our outstanding balances under our repurchase agreement borrowings as of June 30, 2020 were approximately $3.2 billion, compared to $3.4 billion as of December 31, 2019 and $2.8 billion as of March 31, 2020.

?Our stockholders' equity was $346.0 million as of June 30, 2020, compared to $395.5 million as of December 31, 2019 and $308.1 million as of March 31, 2020.

Largely as a result of actions taken by the Fed in late March, Agency RMBS valuations have increased and the market for these assets has stabilized.




Bimini Advisors, LLC (our "Manager") has invoked its Disaster Recovery Plan and
its employees are working remotely. Prior planning resulted in the successful
implementation of this plan and key operational team members maintain daily
communication. We do not anticipate incurring additional material costs, nor
have we identified any operational or internal control issues related to this
remote working plan.



Capital Raising Activities



On August 2, 2017, we entered into an equity distribution agreement (the "August
2017 Equity Distribution Agreement") with two sales agents pursuant to which we
could offer and sell, from time to time, up to an aggregate amount of
$125,000,000 of shares of our common stock in transactions that were deemed to
be "at the market" offerings and privately negotiated transactions. We issued a
total of 15,123,178 shares under the August 2017 Equity Distribution Agreement
for aggregate gross proceeds of $125.0 million, and net proceeds of
approximately $123.1 million, net of commissions and fees, prior to its
termination in July 2019.



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On July 30, 2019, we entered into an underwriting agreement (the "Underwriting
Agreement") with Morgan Stanley & Co. LLC, Citigroup Global Markets Inc. and
J.P. Morgan Securities LLC, as representatives of the underwriters named
therein, relating to the offer and sale of 7,000,000 shares of our common stock
at a price to the public of $6.55 per share. The underwriters purchased the
shares pursuant to the Underwriting Agreement at a price of $6.3535 per share.
The closing of the offering of 7,000,000 shares of common stock occurred on
August 2, 2019, with net proceeds to us of approximately $44.2 million after
deduction of underwriting discounts and commissions and other estimated offering
expenses.



On January 23, 2020, we entered into an equity distribution agreement (the
"January 2020 Equity Distribution Agreement") with three sales agents pursuant
to which we may offer and sell, from time to time, up to an aggregate amount of
$200,000,000 of shares of our common stock in transactions that are deemed to be
"at the market" offerings and privately negotiated transactions. Through June
30, 2020, we issued a total of 3,170,727 shares under the January 2020 Equity
Distribution Agreement for aggregate gross proceeds of $19.8 million, and net
proceeds of approximately $19.4 million, net of commissions and fees.



Stock Repurchase Agreement



On July 29, 2015, the Company's Board of Directors authorized the repurchase of
up to 2,000,000 shares of our common stock. The timing, manner, price and amount
of any repurchases is determined by the Company in its discretion and is subject
to economic and market conditions, stock price, applicable legal requirements
and other factors. The authorization does not obligate the Company to acquire
any particular amount of common stock and the program may be suspended or
discontinued at the Company's discretion without prior notice. On February 8,
2018, the Board of Directors approved an increase in the stock repurchase
program for up to an additional 4,522,822 shares of the Company's common stock.
Coupled with the 783,757 shares remaining from the original 2,0000,000 share
authorization, the increased authorization brought the total authorization to
5,306,579 shares, representing 10% of the Company's then outstanding share
count. This stock repurchase program has no termination date.



From the inception of the stock repurchase program through June 30, 2020, the
Company repurchased a total of 5,665,620 shares at an aggregate cost of
approximately $40.4 million, including commissions and fees, for a weighted
average price of $7.10 per share. During the six months ended June 30, 2020, the
Company repurchased 19,891 shares of its common at an aggregate cost of
approximately $0.1 million, including commissions and fees, for a weighted
average price of $3.42 per share. The remaining authorization under the
repurchase program as of June 30, 2020 was 837,311 shares.



Factors that Affect our Results of Operations and Financial Condition

A variety of industry and economic factors may impact our results of operations and financial condition. These factors include:

?interest rate trends;

?the difference between Agency RMBS yields and our funding and hedging costs;

?competition for, and supply of, investments in Agency RMBS;

?actions taken by the U.S. government, including the presidential administration, the Fed, the Federal Housing Financing Agency (the "FHFA"), the Federal Open Market Committee (the "FOMC") and the U.S.Treasury;

?prepayment rates on mortgages underlying our Agency RMBS and credit trends insofar as they affect prepayment rates; and

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?other market developments.


In addition, a variety of factors relating to our business may also impact our results of operations and financial condition. These factors include:

?our degree of leverage;

?our access to funding and borrowing capacity;

?our borrowing costs;

?our hedging activities;

?the market value of our investments; and

?the requirements to qualify as a REIT and the requirements to qualify for a registration exemption under the Investment Company Act.



Results of Operations



Described below are the Company's results of operations for the six and three
months ended June 30, 2020, as compared to the Company's results of operations
for the six and three months ended June 30, 2019.



Net (Loss) Income Summary



Net loss for the six months ended June 30, 2020 was $42.4 million, or $0.65 per
share. Net income for the six months ended June 30, 2019 was $14.1 million, or
$0.28 per share. Net income for the three months ended June 30, 2020 was $48.8
million, or $0.74 per share. Net income for the three months ended June 30, 2019
was $3.5 million, or $0.07 per share. The components of net (loss) income for
the six and three months ended June 30, 2020 and 2019, along with the changes in
those components are presented in the table below:



(in thousands)
                                 Six Months Ended June 30,        Three Months Ended, June 30,
                                 2020       2019      Change      2020          2019      Change
Interest income              $   62,929$   68,888$  (5,959)$    27,258$      36,455$ (9,197)
Interest expense               (21,002)   (41,323)     20,321     (4,479)      (22,431)    17,952
Net interest income              41,927     27,565     14,362      22,779        14,024     8,755
(Losses) gains on RMBS and
derivative contracts           (79,457)    (8,418)   (71,039)      28,749       (7,670)    36,419
Net portfolio (loss) income    (37,530)     19,147   (56,677)      51,528         6,354    45,174
Expenses                        (4,897)    (5,017)        120     (2,756)       (2,821)        65
Net (loss) income            $ (42,427)$   14,130$ (56,557)$    48,772$       3,533$  45,239

GAAP and Non-GAAP Reconciliations




In addition to the results presented in accordance with GAAP, our results of
operations discussed below include certain non-GAAP financial information,
including "Net Earnings Excluding Realized and Unrealized Gains and Losses",
"Economic Interest Expense" and "Economic Net Interest Income."



Net Earnings Excluding Realized and Unrealized Gains and Losses

We have elected to account for our Agency RMBS under the fair value option. Securities held under the fair value option are recorded at estimated fair value, with changes in the fair value recorded as unrealized gains or losses through the statements of operations.

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In addition, we have not designated our derivative financial instruments in
hedge accounting relationships, but rather hold them for economic hedging
purposes. Changes in fair value of these instruments are presented in a separate
line item in the Company's statements of operations and are not included in
interest expense. As such, for financial reporting purposes, interest expense
and cost of funds are not impacted by the fluctuation in value of the derivative
instruments.



Presenting net earnings excluding realized and unrealized gains and losses
allows management to: (i) isolate the net interest income and other expenses of
the Company over time, free of all fair value adjustments and (ii) assess the
effectiveness of our funding and hedging strategies on our capital allocation
decisions and our asset allocation performance. Our funding and hedging
strategies, capital allocation and asset selection are integral to our risk
management strategy, and therefore critical to the management of our portfolio.
We believe that the presentation of our net earnings excluding realized and
unrealized gains is useful to investors because it provides a means of comparing
our results of operations to those of our peers who have not elected the same
accounting treatment. Our presentation of net earnings excluding realized and
unrealized gains and losses may not be comparable to similarly-titled measures
of other companies, who may use different calculations. As a result, net
earnings excluding realized and unrealized gains and losses should not be
considered as a substitute for our GAAP net income (loss) as a measure of our
financial performance or any measure of our liquidity under GAAP. The table
below presents a reconciliation of our net income (loss) determined in
accordance with GAAP and net earnings excluding realized and unrealized gains
and losses.



                     Net Earnings Excluding Realized and Unrealized Gains and Losses
(in thousands, except
per share data)
                                                                                 Per Share
                                                    Net Earnings                             Net Earnings
                                                     Excluding                                Excluding
                                     Realized and   Realized and              Realized and   Realized and
                            Net       Unrealized     Unrealized      Net       Unrealized     Unrealized
                           Income     Gains and      Gains and      Income     Gains and      Gains and
                           (GAAP)     Losses(1)        Losses       (GAAP)       Losses         Losses
Three Months Ended
June 30, 2020           $   48,772$       28,749$       20,023$     0.74 $         0.43           0.31
March 31, 2020            (91,199)      (108,206)         17,007     (1.41)         (1.68)           0.27
December 31, 2019           18,612          3,840         14,772       0.29           0.06           0.23
September 30, 2019         (8,477)       (19,428)         10,951     (0.14)         (0.32)           0.18
June 30, 2019                3,533        (7,670)         11,203       0.07         (0.15)           0.22
March 31, 2019              10,597          (748)         11,345       0.22         (0.02)           0.24
Six Months Ended
June 30, 2020           $ (42,427)$     (79,457)$       37,030$   (0.65)$       (1.21) $         0.56
June 30, 2019               14,130        (8,418)         22,548       0.28         (0.17)           0.45



(1)Includes realized and unrealized gains (losses) on RMBS and derivative financial instruments, including net interest income or expense on interest rate swaps.

Economic Interest Expense and Economic Net Interest Income




We use derivative and other hedging instruments, specifically Eurodollar, Fed
Funds and Treasury Note ("T-Note") futures contracts, short positions in U.S.Treasury securities, interest rate swaps and swaptions, to hedge a portion of
the interest rate risk on repurchase agreements in a rising rate environment.



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We have not elected to designate our derivative holdings for hedge accounting
treatment. Changes in fair value of these instruments are presented in a
separate line item in our statements of operations and not included in interest
expense. As such, for financial reporting purposes, interest expense and cost of
funds are not impacted by the fluctuation in value of the derivative
instruments.



For the purpose of computing economic net interest income and ratios relating to
cost of funds measures, GAAP interest expense has been adjusted to reflect the
realized and unrealized gains or losses on certain derivative instruments the
Company uses, specifically Eurodollar, Fed Funds and U.S.Treasury futures, and
interest rate swaps and swaptions, that pertain to each period presented. We
believe that adjusting our interest expense for the periods presented by the
gains or losses on these derivative instruments would not accurately reflect our
economic interest expense for these periods. The reason is that these derivative
instruments may cover periods that extend into the future, not just the current
period. Any realized or unrealized gains or losses on the instruments reflect
the change in market value of the instrument caused by changes in underlying
interest rates applicable to the term covered by the instrument, not just the
current period. For each period presented, we have combined the effects of the
derivative financial instruments in place for the respective period with the
actual interest expense incurred on borrowings to reflect total economic
interest expense for the applicable period. Interest expense, including the
effect of derivative instruments for the period, is referred to as economic
interest expense. Net interest income, when calculated to include the effect of
derivative instruments for the period, is referred to as economic net interest
income. This presentation includes gains or losses on all contracts in effect
during the reporting period, covering the current period as well as periods in
the future.



We believe that economic interest expense and economic net interest income
provide meaningful information to consider, in addition to the respective
amounts prepared in accordance with GAAP. The non-GAAP measures help management
to evaluate its financial position and performance without the effects of
certain transactions and GAAP adjustments that are not necessarily indicative of
our current investment portfolio or operations. The unrealized gains or losses
on derivative instruments presented in our statements of operations are not
necessarily representative of the total interest rate expense that we will
ultimately realize. This is because as interest rates move up or down in the
future, the gains or losses we ultimately realize, and which will affect our
total interest rate expense in future periods, may differ from the unrealized
gains or losses recognized as of the reporting date.



Our presentation of the economic value of our hedging strategy has important
limitations. First, other market participants may calculate economic interest
expense and economic net interest income differently than the way we calculate
them. Second, while we believe that the calculation of the economic value of our
hedging strategy described above helps to present our financial position and
performance, it may be of limited usefulness as an analytical tool. Therefore,
the economic value of our investment strategy should not be viewed in isolation
and is not a substitute for interest expense and net interest income computed in
accordance with GAAP.



The tables below present a reconciliation of the adjustments to interest expense
shown for each period relative to our derivative instruments, and the income
statement line item, gains (losses) on derivative instruments, calculated in
accordance with GAAP for each quarter of 2020 to date and 2019.

© Edgar Online, source Glimpses

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