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ORC > SEC Filings for ORC > Form 10-Q on 4-Nov-2013All Recent SEC Filings

Show all filings for ORCHID ISLAND CAPITAL, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ORCHID ISLAND CAPITAL, INC.


4-Nov-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

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 any subsequent 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 Agency RMBS. Our investment strategy focuses on, and our portfolio consists of, two categories of Agency RMBS: (i) traditional pass-through Agency RMBS and (ii) structured Agency RMBS, such as CMOs, IOs, IIOs and POs, among other types of structured Agency RMBS. From inception through the closing of the initial public offering of our common stock, we were managed by Bimini. We are currently externally managed by Bimini Advisors, a registered investment adviser with the Securities and Exchange Commission ("SEC").

We were formed by Bimini in August 2010 and commenced operations on November 24, 2010. At December 31, 2012, Bimini was our sole stockholder. We completed our initial public offering on February 20, 2013. In that offering we raised $35.4 million from the sale of 2,360,000 shares of our common stock.

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 pass-through Agency 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 pass-through Agency RMBS and certain of our structured Agency RMBS through short-term borrowings structured as repurchase agreements. Pass-through Agency 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 intend to qualify and will elect to be taxed as a REIT under the Code commencing with our short taxable year ending December 31, 2013. We generally will not be subject to U.S. federal income tax to the extent that we annually distribute all of our REIT taxable income to our stockholders and qualify as a REIT.

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;

prepayment rates on mortgages underlying our Agency RMBS, and credit trends insofar as they affect prepayment rates, borrowing rates and exposure to our lenders;

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

competition for investments in Agency RMBS;

recent actions taken by the Federal Reserve and the U.S. Treasury; and

other market developments.

-17-

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.

We anticipate that, for any period during which changes in the interest rates for our adjustable rate assets do not coincide with interest rate changes on the corresponding liabilities, such assets will re-price more slowly than the corresponding liabilities. Consequently, changes in interest rates, particularly short term interest rates, may significantly influence our net income.

Our net income may be affected by a difference between actual prepayment rates and our projections. Prepayments on loans and securities may be influenced by changes in market interest rates and homeowners' ability and desire to refinance their mortgages.

Results of Operations

Described below are the Company's results of operations for the nine and three months ended September 30, 2013, as compared to the Company's results of operations for the nine and three months ended September 30, 2012.

Net (Loss) Income Summary

Net loss for the nine months ended September 30, 2013 was $2.1 million, or $0.74 per share. Net income for the nine months ended September 30, 2012 was $0.8 million, or $0.82 per share. Net loss for the three months ended September 30, 2013 was $1.0 million, or $0.30 per share. Net income for the three months ended September 30, 2012 was $0.5 million, or $0.56 per share.

The components of net (loss) income for the nine and three months ended September 30, 2013 and 2012, along with the changes in those components, are presented in the table below:

(in thousands)
                             Nine Months Ended September 30,                Three Months Ended September 30,
                           2013              2012         Change           2013              2012         Change
Interest income         $     6,393       $    2,225     $   4,168     $      2,551       $      697     $   1,854
Interest expense               (817 )           (183 )        (634 )           (294 )            (58 )        (236 )
Net interest income           5,576            2,042         3,534            2,257              639         1,618
(Losses) gains on MBS
and Eurodollar
futures                      (6,468 )           (682 )      (5,786 )         (2,853 )            141        (2,994 )
Net portfolio
(deficiency) income            (892 )          1,360        (2,252 )           (596 )            780        (1,376 )
Expenses                     (1,251 )           (558 )        (693 )           (401 )           (235 )        (166 )
Net (loss) income       $    (2,143 )     $      802     $  (2,945 )   $       (997 )     $      545     $  (1,542 )

-18-

GAAP and Non-GAAP Reconciliation

To date, we have used derivatives, specifically Eurodollar futures contracts, to hedge the interest rate risk on repurchase agreements in a rising rate environment. We have not elected to designate our derivative holdings for hedge accounting treatment under the Financial Accounting Standards Board (the "FASB") Accounting Standards Codification ("ASC") Topic 815, Derivatives and Hedging. Changes in fair value of these instruments are presented in a separate line item in our Statements of Operations. As such, for financial reporting purposes, interest expense and cost of funds are not impacted by the fluctuation in value of the Eurodollar futures contracts. In the future, we may use other derivative instruments to hedge our interest expense and/or elect to designate our derivative holdings for hedge accounting treatment.

For the purpose of computing net interest income and ratios relating to cost of funds measures throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations, interest expense has been adjusted to reflect the effect of our Eurodollar hedges on our interest expense for each period presented. The adjustment to reflect this effect includes only the gains or losses on our Eurodollar futures contracts in effect for the applicable period, whereas the gains or losses on Eurodollar futures contracts reflected in our statements of operations include gains or losses for all Eurodollar futures contracts in effect as of the end of each period in accordance with GAAP. As of September 30, 2013, we have Eurodollar futures contracts in place through 2018. Since we have taken short positions on these contracts, when interest rates move higher the value of our short position may increase in value. The opposite would be true if interest rates were to decrease. In fact, if the relevant portion of the yield curve for which we have employed funding hedges is positively sloped and rates remain unchanged, we would expect the value of the short position to decrease in value. Adjusting our interest expense for the periods presented by the gains on all Eurodollar futures would not accurately reflect our economic interest expense for these periods. Combining the effects of the Eurodollar positions in place for only the periods presented with the interest expense on repurchase agreements reflects total economic interest expense on these obligations and the economic effect of our hedging strategy for the applicable period. Interest expense, including the effect of Eurodollar futures contracts for the period, is referred to as economic interest expense. Net interest income, including the effect of Eurodollar futures contracts for the period, is referred to as economic net interest income.

We believe that economic interest expense and economic net interest income provides meaningful information to consider, in addition to the respective amounts prepared in accordance with GAAP. The non-GAAP measures help us to evaluate our 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.

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 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.

-19-

The following table presents the effect of our hedging strategy on interest expense and net interest income for the nine and three months ended September 30, 2013 and 2012 and for each quarter during 2013 and 2012.

(dollars in thousands)
                                     GAAP         Effect of         Economic           GAAP             Economic
                                   Interest       Eurodollar        Interest       Net Interest       Net Interest
                                   Expense        Hedges(1)        Expense(2)         Income           Income(3)
Three Months Ended,
September 30, 2013                $      294     $        (28 )   $        322     $       2,257     $        2,229
June 30, 2013                            322               (4 )            326             2,107              2,103
March 31, 2013                           201              (65 )            266             1,211              1,146
December 31, 2012                         94              (62 )            156               379                317
September 30, 2012                        58              (28 )             86               639                611
June 30, 2012                             74              (10 )             84               695                685
March 31, 2012                            51               (4 )             55               708                704
Nine Months Ended,
September 30, 2013                $      817     $        (97 )   $        914     $       5,575     $        5,478
September 30, 2012                       183              (42 )            225             2,042              2,000

(1) Reflects the effect of Eurodollar futures contract hedges for only the period presented. For the three month periods ended September 30, 2013 and 2012, total gains (losses) on Eurodollar contracts recognized in our statements of operations for GAAP purposes were $(2,271,875) and $(14,250), respectively. For the nine month periods ended September 30, 2013 and 2012, total gains (losses) on Eurodollar contracts recognized in our statements of operations for GAAP purposes were $4,095,788 and $(39,500), respectively.

(2) Calculated by subtracting the effect of Eurodollar hedges from GAAP interest expense.

(3) Calculated by adding the effect of Eurodollar hedges to GAAP net interest income.

Net Interest Income

During the nine months ended September 30, 2013, we generated $5.5 million of economic net interest income, consisting of a combination of $6.4 million of interest income from MBS assets and $0.9 million of economic interest expense on repurchase liabilities. For the comparable period ended September 30, 2012, we generated $2.0 million of economic net interest income, consisting of $2.2 million of interest income from MBS assets offset by $0.2 million of economic interest expense on repurchase liabilities.

During the three months ended September 30, 2013, we generated $2.2 million of economic net interest income, consisting of a combination of $2.6 million of interest income from MBS assets and $0.3 million of economic interest expense on repurchase liabilities. For the three months ended September 30, 2012, we generated $0.6 million of economic net interest income, consisting of $0.7 million of interest income from MBS assets offset by $0.1 million of economic interest expense on repurchase liabilities.

-20-

The table below provides information on our portfolio average balances, interest income, yield on assets, average repurchase agreement balances, economic interest expense, economic cost of funds, economic net interest income and economic net interest spread for the nine months ended September 30, 2013 and 2012 and for each quarter in 2013 and 2012.

(dollars in thousands)
                           Average                         Yield on                                             Average        Economic       Economic
                             MBS                           Average            Average           Economic        Economic         Net            Net
                          Securities       Interest          MBS            Repurchase          Interest        Cost of        Interest       Interest
                           Held(1)        Income(2)       Securities       Agreements(1)       Expense(3)        Funds        Income(3)        Spread
Three Months Ended,
September 30, 2013       $    335,467     $    2,551             3.04 %   $       305,196     $        322           0.42 %   $    2,229           2.62 %
June 30, 2013                 349,704          2,429             2.78 %           312,591              326           0.42 %        2,103           2.36 %
March 31, 2013                237,820          1,412             2.38 %           210,194              266           0.51 %        1,146           1.87 %
December 31, 2012              91,094            473             2.08 %            80,256              156           0.78 %          317           1.30 %
September 30, 2012             64,378            697             4.33 %            53,698               86           0.64 %          611           3.69 %
June 30, 2012                  73,559            769             4.18 %            62,407               84           0.54 %          685           3.64 %
March 31, 2012                 70,585            759             4.30 %            59,157               55           0.37 %          704           3.93 %
Nine Months Ended,
September 30, 2013       $    307,664     $    6,392             2.77 %   $       275,993     $        914           0.44 %   $    5,478           2.33 %
September 30, 2012             69,507          2,225             4.27 %            58,421              225           0.51 %        2,000           3.76 %

(1) Portfolio yields and costs of borrowings presented in the table above and the tables on pages 22 and 23 are calculated based on the average balances of the underlying investment portfolio/repurchase agreement balances and are annualized for the quarterly periods presented. Average balances for quarterly periods are calculated using two data points, the beginning and ending balances. Average balances for the year to date periods are calculated as the average of the average quarterly periods.

(2) Interest income presented in the table above includes only interest earned on the Company's MBS investments and excludes interest earned on cash balances, and excludes the impact of discounts or premiums on MBS investments, as discounts or premiums are not amortized under the fair value option. Interest income and net portfolio interest income may not agree with the information presented in the statements of operations.

(3) Economic interest expense and economic net interest income presented in the table above and the table on page 23 includes the effect of Eurodollar futures contract hedges for only the period presented. For the three month periods ended September 30, 2013 and 2012, total gains (losses) on Eurodollar contracts recognized in our statements of operations for GAAP purposes were $(2,271,875) and $(14,250), respectively. For the nine month periods ended September 30, 2013 and 2012, total gains (losses) on Eurodollar contracts recognized in our statements of operations for GAAP purposes were $4,095,788 and $(39,500), respectively.

Interest Income and Average Earning Asset Yield

Our interest income for the nine months ended September 30, 2013 and 2012 was $6.4 million and $2.2 million, respectively. We had average MBS holdings of $307.7 million and $69.5 million for the nine months ended September 30, 2013 and 2012, respectively. The yield on our portfolio was 2.77% and 4.27% for the nine months ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012, there was a $4.2 million increase in interest income due to a $238.2 million increase in average MBS, partially offset by a 150 basis point decrease in the yield on average MBS for the nine months ended September 30, 2013 when compared to the nine months ended September 30, 2012.

Our interest income for the three months ended September 30, 2013 and 2012 was $2.6 million and $0.7 million, respectively. We had average MBS holdings of $335.5 million and $64.4 million for the three months ended September 30, 2013 and 2012, respectively. The yield on our portfolio was 3.04% and 4.33% for the three months ended September 30, 2013 and 2012, respectively. For the three months ended September 30, 2013 as compared to the three months ended September 30, 2012, there was a $1.9 million increase in interest income due to a $271.1 million increase in average MBS, partially offset by a 129 basis point decrease in the yield on average MBS for the three months ended September 30, 2013 when compared to the three months ended September 30, 2012.

-21-

The table below presents the average portfolio size, income and yields of our respective sub-portfolios, consisting of structured MBS and PT MBS.

(dollars
in
thousands)
                         Average MBS Held                            Interest Income                       Realized Yield on Average MBS
                PT          Structured                       PT        Structured                      PT            Structured
                MBS            MBS            Total         MBS            MBS          Total          MBS               MBS            Total
Three Months Ended,
September
30, 2013     $ 314,096     $     21,371     $ 335,467     $  2,412     $       139     $  2,551          3.07 %              2.60 %        3.04 %
June 30,
2013           326,977           22,727       349,704        2,514             (85 )      2,429          3.08 %             (1.51 )%       2.78 %
March 31,
2013           223,191           14,629       237,820        1,415              (3 )      1,412          2.54 %             (0.06 )%       2.38 %
December
31, 2012        84,617            6,477        91,094          597            (124 )        473          2.82 %             (7.66 )%       2.08 %
September
30, 2012        56,519            7,859        64,378          410             287          697          2.90 %             14.59 %        4.33 %
June 30,
2012            65,320            8,239        73,559          593             176          769          3.63 %              8.56 %        4.18 %
March 31,
2012            61,936            8,649        70,585          530             229          759          3.43 %             10.56 %        4.30 %
Years Ended,
September
30, 2013     $ 288,088     $     19,576     $ 307,664     $  6,341     $        51     $  6,392          2.93 %              0.35 %        2.77 %
September
30, 2012        61,258            8,249        69,507        1,533             692        2,225          3.34 %             11.17 %        4.27 %

Interest Expense and the Cost of Funds

We had average outstanding repurchase agreements of $276.0 million and $58.4 million and total economic interest expense of $0.9 million and $0.2 million for the nine months ended September 30, 2013 and 2012, respectively. Our average economic cost of funds was 0.44% and 0.51% for nine months ended September 30, 2013 and 2012, respectively. There was a 7 basis point decrease in the average economic cost of funds and a $217.6 million increase in average outstanding repurchase agreements during the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012.

We had average outstanding repurchase agreements of $305.2 million and $53.7 million and total economic interest expense of $0.3 million and $0.1 million for the three months ended September 30, 2013 and 2012, respectively. Our average economic cost of funds was 0.42% and 0.64% for three months ended September 30, 2013 and 2012, respectively. There was a 22 basis point decrease in the average economic cost of funds and a $251.5 million increase in average outstanding repurchase agreements during the three months ended September 30, 2013 as compared to the three months ended September 30, 2012.

Since all of our repurchase agreements are short-term, changes in market rates directly affect our interest expense. Our average economic cost of funds was 23 basis points above average one-month LIBOR and 2 basis points above average six-month LIBOR for the quarter ended September 30, 2013. The average term to maturity of the outstanding repurchase agreements increased from 15 days at December 31, 2012 to 24 days at September 30, 2013.

-22-

The table below presents the average repurchase agreements outstanding, economic interest expense and average economic cost of funds, and average one-month and six-month LIBOR rates for the nine months ended September 30, 2013 and 2012 and for each quarter in 2013 and 2012.

(dollars in
thousands)
                                                                                                        Average             Average
                                                                                                       Economic            Economic
                  Average                                                                            Cost of Funds       Cost of Funds
                 Balance of       Economic          Average           Average         Average         Relative to         Relative to
                 Repurchase       Interest         Economic          One-Month       Six-Month       Average One-        Average Six-
                 Agreements       Expense        Cost of Funds         LIBOR           LIBOR          Month LIBOR         Month LIBOR
Three Months
Ended,
September 30,
2013            $    305,196     $      322                0.42 %          0.19 %          0.40 %              0.23 %              0.02 %
June 30, 2013        312,591            326                0.42 %          0.20 %          0.43 %              0.22 %             (0.01 )%
March 31,
2013                 210,194            266                0.51 %          0.21 %          0.48 %              0.30 %              0.03 %
December 31,
2012                  80,256            156                0.78 %          0.22 %          0.59 %              0.56 %              0.19 %
September 30,
2012                  53,698             86                0.64 %          0.23 %          0.70 %              0.41 %             (0.06 )%
June 30, 2012         62,407             84                0.54 %          0.24 %          0.74 %              0.30 %             (0.20 )%
March 31,
2012                  59,157             55                0.37 %          0.26 %          0.76 %              0.11 %             (0.39 )%
Nine Months
Ended,
September 30,
2013            $    275,993     $      914                0.44 %          0.20 %          0.44 %              0.24 %              0.00 %
September 30,
2012                  58,421            225                0.51 %          0.25 %          0.73 %              0.26 %             (0.22 )%

Gains or Losses

The table below presents our gains or losses for the nine and three months ended
September 30, 2013 and 2012.

(in thousands)
                              Nine Months Ended September 30,                  Three Months Ended September 30,
                            2013               2012         Change           2013              2012          Change
Realized (losses)
gains on sales of MBS   $      (1,491 )     $      116     $  (1,607 )   $       (667 )     $        -      $    (667 )
Unrealized (losses)
gains on MBS                   (9,073 )           (758 )      (8,315 )             86              156            (70 )
Total (losses) gains
on MBS                        (10,564 )           (642 )      (9,922 )           (581 )            156           (737 )
Gains (losses) on
Eurodollar futures              4,096              (40 )       4,136           (2,272 )            (14 )       (2,258 )

During the nine months ended September 30, 2013 and 2012, the Company received proceeds of $237.4 million and $91.0 million, respectively, from the sales of MBS. We do not expect to sell assets on a frequent basis, but may from time to time sell existing assets to acquire new assets, which our management believes might have higher risk-adjusted returns or to manage our balance sheet as part of our asset/liability management strategy.

In May and again in June of 2013, the Federal Reserve hinted to the markets that . . .

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