Orchid Island Capital (NYSE:ORC) reported a third-quarter net loss of $0.90 per share, compared with net income of $0.44 per share in the second quarter, as a late-quarter sell-off in interest-rate markets and widening mortgage spreads pressured book value.
Book value per share declined to $6.02 as of Sept. 30 from $7.22 at the end of the prior quarter. The company reported a negative total return of 12.5% for the third quarter, including declared dividends, versus a positive 6.2% total return in the second quarter. Orchid declared a $0.30-per-share dividend during the quarter, unchanged from the prior quarter.
Portfolio and liquidity metrics
Controller Jerry Sintes said Orchid’s average portfolio size was $11.1 billion during the quarter, compared with $11.4 billion in the second quarter. The company’s leverage ratio increased to 8.6 times at Sept. 30 from 7.3 times at June 30, while liquidity declined to 44% from 54%.
Three-month conditional prepayment rates, or CPR, declined to 8.4% during the third quarter from 10.9% in the prior quarter.
Chairman and Chief Executive Officer Robert Cauley said the key market development in the quarter was a substantial late-September sell-off in rates. He attributed the move to factors including inflation, capital spending tied to artificial intelligence and sovereign debt issuance, which he said raised borrowing costs and risk premiums.
Cauley said the market appeared to stabilize after quarter-end, aided in part by extremely short market positioning. He also said the Treasury market showed renewed safe-haven demand amid developments in the Middle East and Europe, as well as concerns in equity and credit markets related to AI.
Hedge adjustments amid market volatility
Orchid responded to the sell-off primarily by modifying its hedge book rather than undertaking widespread asset sales, according to Cauley. As higher rates extended the expected duration of mortgage assets, the company increased hedge coverage and lengthened the duration of its hedges.
“We, like our peers, opted to not do a lot of widespread selling,” Cauley said. “Instead, we had modest selling and let the prepayments run off and instead addressed the sell-off by adjusting our hedges.”
The company increased hedge coverage to 99% from approximately 91% entering the quarter. Cauley said Orchid shifted more of its hedging toward Treasury futures rather than swaps because swap spreads had widened.
Hunter Haas, Orchid’s CFO, CIO and director, said performance weakened in July as the 10-year Treasury yield rose by roughly 20 basis points and book value fell about 5%. The company recovered about half of that decline during August, when mortgage spreads improved modestly.
Market conditions became more difficult in September as rates and volatility rose, mortgage spreads widened and leveraged investors faced selling pressure. Haas said specified pools, particularly low-loan-balance New York geographic collateral, saw declining pay-ups relative to to-be-announced, or TBA, securities.
- Executed a 15-year/30-year coupon swap.
- Unwound a three-month into five-year payer spread swaption trade, realizing an approximately 200% return on the premium paid.
- Added short positions in seven-year, 10-year and 30-year Treasury futures.
- Replaced $1.6 billion of short-dated swaps with an equivalent amount of DV01 exposure in 10-year Treasury futures after quarter-end.
- Bought back a 1,500-contract short position in Ultra 30-year Treasury futures.
Haas said book value had increased approximately 4.5% month-to-date through Oct. 22, with the figure reflecting the dividend accrual.
Capital allocation and outlook
Since the end of the second quarter, Orchid repurchased 6.62 million shares, with approximately 1.7 million of those repurchases occurring in the fourth quarter to date, according to management. Haas said the company viewed buybacks as attractive because the shares were trading at a discount of more than 20% to estimated current book value as of Oct. 22.
Cauley said the company would weigh share repurchases against adding mortgage assets, depending on relative returns. He said Orchid had not reinvested portfolio paydowns during the third quarter but expected to begin reinvesting paydowns and could add assets as market conditions permit.
Orchid’s leverage had declined to 8.12 times by the time of the call, Haas said. Management said it was comfortable maintaining leverage near current levels while monitoring rates, mortgage spreads, liquidity and hedge exposure.
Regarding the dividend, Cauley said the portfolio’s earnings level was “very much in line” with the current $0.30 monthly payment. He said the company expected taxable income for the full year to be close to dividends paid, assuming current market conditions and portfolio composition persist.
Haas said the repricing of mortgage assets hurt third-quarter book value but improved prospective investment returns. At current leverage levels, he said management believes the portfolio can generate returns on equity in the high teens, with potentially higher returns available through new investments or selective portfolio rotation.
About Orchid Island Capital (NYSE:ORC)
Orchid Island Capital, Inc is a real estate investment trust (REIT) that invests primarily in residential mortgage-backed securities (RMBS). Its portfolio is focused mainly on agency securities, which are backed by residential mortgage loans and guaranteed by government-sponsored entities such as Fannie Mae and Freddie Mac or by Ginnie Mae.
The company seeks to generate income from its mortgage investments, primarily through the difference between the returns on its assets and the cost of financing those assets.
