Orchid Island Capital, Inc. (the “Company”) reported its financial results for the quarter ended September 30, 2024. The Company declared a dividend of $0.12 per share on April 10, 2024, which will be paid on May 30, 2024. As of September 30, 2024, the Company had a net carrying value of $78.1 million in TBA securities, with a market value of $100.4 million. The Company’s notional balance for the interest-only securities portfolio was $88.8 million, and the notional balance for the inverse interest-only securities portfolio was $23.4 million. The Company’s cost basis for the TBA securities was $20 million, and the market value was $100.4 million. The Company had a net income of $99.4 million for the quarter, and a net income of $148.8 million for the nine months ended September 30, 2024. The Company’s book value per share was $0.36 as of September 30, 2024, and $0.48 as of December 31, 2023.
Overview of the Company’s Financial Performance
Orchid Island Capital (ORC) is a specialty finance company that invests in residential mortgage-backed securities (RMBS) issued and guaranteed by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. The company’s investment strategy focuses on traditional pass-through RMBS as well as structured RMBS like interest-only and inverse interest-only securities.
For the nine months ended September 30, 2024, ORC reported net income of $32.1 million, or $0.53 per share, compared to a net loss of $66.4 million, or $1.58 per share, for the same period in 2023. This significant improvement was driven by a $96.4 million increase in net portfolio income, which offset a $2.1 million decrease in operating expenses.
On a GAAP basis, ORC generated $169.6 million in interest income and incurred $172.4 million in interest expense during the first nine months of 2024, resulting in $2.8 million of net interest expense. This represents an improvement from the $21.6 million of net interest expense recorded in the prior year period. The company’s economic net interest income, which adjusts for the impact of hedging activities, was $86.1 million for the nine months ended September 30, 2024, up from $45.6 million in the comparable 2023 period.
Revenue and Profit Trends
ORC’s interest income increased by $41.6 million year-over-year, driven by a 106 basis point (bps) rise in the yield on its average RMBS portfolio and a $223.7 million increase in average RMBS holdings. The higher yields were primarily due to rising interest rates, as the 5-year and 10-year U.S. Treasury rates increased by 33 bps and 33 bps, respectively, over the same period.
While interest expense also increased by $22.8 million due to a 47 bps rise in the average cost of funds and a $217.2 million increase in average borrowings, ORC was able to more than offset this through its hedging activities. On an economic basis, which includes the impact of hedges, the company’s interest expense increased by only $1.0 million year-over-year, allowing it to generate a significant improvement in economic net interest income.
ORC recorded $47.4 million in net gains on its RMBS and derivative contracts during the first nine months of 2024, compared to $30.3 million in net losses in the prior year period. This $77.7 million swing was driven by unrealized gains on the company’s RMBS portfolio as interest rates declined, as well as gains on its interest rate hedges.
Strengths and Weaknesses
One of ORC’s key strengths is its diversified RMBS portfolio, which is split between traditional pass-through securities (99.7% of the portfolio) and structured products like interest-only and inverse interest-only securities (0.3% of the portfolio). This mix allows the company to generate income from both the net interest margin on its leveraged pass-through holdings as well as the interest income from its unleveraged structured RMBS.
Additionally, ORC’s active management of its asset allocation between pass-through and structured RMBS, as well as its use of hedging strategies, have helped to stabilize its earnings and book value in different interest rate environments. The company’s ability to generate positive economic net interest income despite rising rates demonstrates the effectiveness of its risk management approach.
However, ORC’s reliance on short-term repurchase agreement financing exposes it to potential liquidity and refinancing risks, especially in periods of market stress. While the company has maintained access to its repurchase facilities on favorable terms thus far, a prolonged disruption in the repo market could negatively impact its operations.
Another potential weakness is the company’s external management structure, which requires it to pay significant fees to its manager, Bimini Advisors, LLC. These fees, which totaled $9.4 million for the first nine months of 2024, represent a meaningful drag on ORC’s profitability and could limit its ability to return capital to shareholders.
Outlook and Conclusion
Looking ahead, ORC’s financial performance will likely continue to be influenced by trends in interest rates, mortgage prepayment speeds, and the overall health of the housing and mortgage markets. The company’s ability to actively manage its asset allocation and hedging strategies will be crucial in navigating these dynamics.
Given the recent volatility in interest rates, ORC’s focus on book value stability through its balanced investment approach and risk management practices should serve it well. However, the company’s reliance on short-term funding and external management structure remain potential areas of concern that warrant close monitoring by investors.
Overall, ORC’s strong performance in the first nine months of 2024, marked by a return to profitability and improved net interest income, suggests the company is well-positioned to continue delivering attractive risk-adjusted returns to shareholders over the long term. By maintaining its disciplined investment strategy and prudent risk management, the company appears poised to navigate the challenges and opportunities that lie ahead in the evolving mortgage REIT landscape.