UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
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incorporation or organization)
(I.R.S. Employer
Identification No.)
,
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Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol:
Name of Each Exchange on Which
Registered
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
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Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405
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files).
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or
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Number of shares outstanding at October 27, 2022:
ORCHID ISLAND CAPITAL, INC.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
1
Condensed Balance Sheets (unaudited)
1
Condensed Statements of Operations (unaudited)
2
Condensed Statements of Stockholders’ Equity (unaudited)
3
Condensed Statements of Cash Flows (unaudited)
4
Notes to Condensed Financial Statements (unaudited)
5
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
50
ITEM 4. Controls and Procedures
54
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
55
ITEM 1A. Risk Factors
55
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
55
ITEM 3. Defaults upon Senior Securities
55
ITEM 4. Mine Safety Disclosures
55
ITEM 5. Other Information
55
ITEM 6. Exhibits
56
SIGNATURES
57
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ORCHID ISLAND CAPITAL, INC.
CONDENSED BALANCE SHEETS
($ in thousands, except per share data)
(Unaudited)
September 30,
December 31,
2022
2021
ASSETS:
Mortgage-backed securities, at fair value (includes pledged assets of $
and $
, respectively)
$
$
U.S. Treasury Notes, at fair value (includes pledged assets of $
, respectively)
Cash and cash equivalents
Restricted cash
Accrued interest receivable
Derivative assets
Receivable for securities sold, pledged to counterparties
Other assets
Total Assets
$
$
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements
$
$
Dividends payable
Derivative liabilities
Accrued interest payable
Due to affiliates
Other liabilities
Total Liabilities
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $
and outstanding as of September 30, 2022 and December 31, 2021
Common Stock, $
shares issued and outstanding as of September 30, 2022 and
and outstanding as of December 31, 2021
Additional paid-in capital
Accumulated deficit
(376,133 )
(82,754 )
Total Stockholders' Equity
Total Liabilities and Stockholders' Equity
$
$
See Notes to Financial Statements
2
ORCHID ISLAND CAPITAL, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three and Nine Months Ended September 30, 2022 and 2021
($ in thousands, except per share data)
Nine Months Ended September 30,
Three Months Ended September 30,
2022
2021
2022
2021
Interest income
$
$
$
$
Interest expense
(32,196 )
(5,067 )
(21,361 )
(1,570 )
Net interest income
Realized (losses) gains on mortgage-backed securities
(132,672 )
(3,068 )
(66,143 )
Unrealized (losses) gains on mortgage-backed securities and
U.S. Treasury Notes
(692,781 )
(107,386 )
(212,221 )
(11,239 )
Gains on derivative and other hedging instruments
Net portfolio (loss) income
(278,520 )
(9,310 )
(79,295 )
Expenses:
Management fees
Allocated overhead
Incentive compensation
Directors' fees and liability insurance
Audit, legal and other professional fees
Direct REIT operating expenses
Other administrative
Total expenses
Net (loss) income
$
(293,379 )
$
(20,196 )
$
(84,513 )
$
Basic and diluted net (loss) income per share
$
(8.31
$
(0.95
$
(2.40
$
Weighted Average Shares Outstanding
Dividends declared per common share
$
$
$
$
See Notes to Financial Statements
3
ORCHID ISLAND CAPITAL, INC.
CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
For the Nine Months Ended September 30, 2022 and 2021
(in thousands)
Additional
Retained
Common Stock
Paid-in
Earnings
Shares
Par Value
Capital
(Deficit)
Total
Balances, January 1, 2021
$
$
$
(17,994 )
$
Net loss
-
(29,369 )
(29,369 )
Cash dividends declared
-
(17,226 )
(17,226
Issuance of common stock pursuant to public offerings, net
Stock based awards and amortization
Balances, March 31, 2021
$
$
$
(47,363 )
$
Net income
-
(16,865 )
(16,865 )
Cash dividends declared
-
(20,416 )
(20,416 )
Issuance of common stock pursuant to public offerings, net
Stock based awards and amortization
Balances, June 30, 2021
$
$
$
(64,228 )
$
Net income
-
Cash dividends declared
-
(26,420 )
(26,420 )
Issuance of common stock pursuant to public offerings, net
Stock based awards and amortization
-
Balances, September 30, 2021
30,664
$
$
$
(38,190 )
$
Balances, January 1, 2022
$
$
$
(82,754 )
$
Net loss
-
(148,727 )
(148,727 )
Cash dividends declared
-
(27,492 )
(27,492 )
Stock based awards and amortization
Balances, March 31, 2022
$
$
$
(231,481 )
$
Net loss
-
(60,139 )
(60,139 )
Cash dividends declared
-
(23,936 )
(23,936 )
Stock based awards and amortization
Shares repurchased and retired
(175 )
(1 )
(2,217 )
(2,218 )
Balances, June 30, 2022
$
$
$
(291,620 )
$
Net income
-
(84,513 )
(84,513 )
Cash dividends declared
-
(19,231 )
(19,231 )
Stock based awards and amortization
Shares repurchased and retired
(186 )
(2 )
(2,382 )
(2,384 )
Balances, September 30, 2022
$
$
$
(376,133 )
$
See Notes to Financial Statements
4
ORCHID ISLAND CAPITAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine Months Ended September 30, 2022 and 2021
($ in thousands)
2022
2021
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss
$
(293,379 )
$
(20,196 )
Adjustments to reconcile net loss to net cash provided by operating activities:
Stock based compensation
Realized losses on mortgage-backed securities
Unrealized losses on mortgage-backed securities and U.S. Treasury Notes
Realized and unrealized gains on derivative instruments
(261,364 )
(22,180 )
Changes in operating assets and liabilities:
Accrued interest receivable
(5,449 )
Other assets
(353 )
Accrued interest payable
(404 )
Other liabilities
(2,031 )
Due to affiliates
NET CASH PROVIDED BY OPERATING ACTIVITIES
CASH FLOWS FROM INVESTING ACTIVITIES:
From mortgage-backed securities investments:
Purchases
(622,535 )
(4,816,301 )
Sales
Principal repayments
Purchases of U.S. Treasury Notes
(37,440 )
Net proceeds from (payments on) derivative instruments
(1,228 )
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
(1,843,071 )
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements
Principal payments on repurchase agreements
(35,537,693 )
(21,376,997 )
Cash dividends
(76,527 )
(59,019 )
Proceeds from issuance of common stock, net of issuance costs
Shares repurchased and retired
(4,602 )
Shares withheld from employee stock awards for payment of taxes
(228 )
(299 )
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
(3,191,602 )
NET (DECREASE) INCREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH
(169,490 )
CASH, CASH EQUIVALENTS AND RESTRICTED CASH, beginning of the period
CASH, CASH EQUIVALENTS AND RESTRICTED CASH, end of the period
$
$
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest
$
$
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
Securities acquired settled in later period
$
$
See Notes to Financial Statements
5
ORCHID ISLAND CAPITAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
SEPTEMBER 30, 2022
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization and Business Description
Orchid Island Capital, Inc. (“Orchid” or the “Company”) was incorporated in Maryland on August 17, 2010 for the purpose of creating
and managing a leveraged investment portfolio consisting of residential mortgage-backed securities (“RMBS”). From incorporation to the
completion of Orchid’s initial public offering of its common stock on February 20, 2013, Orchid was a wholly owned subsidiary of Bimini
Capital Management, Inc. (“Bimini”). Orchid began operations on November 24, 2010 (the date of commencement of operations). From
incorporation through November 24, 2010, Orchid’s only activity was the issuance of common stock to Bimini.
On August 4, 2020, Orchid entered into an equity distribution agreement (the “August 2020 Equity Distribution Agreement”) with
four sales agents pursuant to which the Company could offer and sell, from time to time, up to an aggregate amount of $
shares of the Company’s common stock in transactions that were deemed to be “at the market” offerings and privately negotiated
transactions. The Company issued a total of
gross proceeds of
approximately $
its termination in June 2021.
On January 20, 2021, Orchid entered into an underwriting agreement (the “January 2021 Underwriting Agreement”) with J.P.
Morgan Securities LLC (“J.P. Morgan”), relating to the offer and sale of
Morgan purchased the shares of the Company’s common stock from the Company pursuant to the January 2021 Underwriting
Agreement at $
2021. The closing of the offering of
the Company of approximately $
On March 2, 2021, Orchid entered into an underwriting agreement (the “March 2021 Underwriting Agreement”) with J.P. Morgan,
relating to the offer and sale of
Company’s common stock from the Company pursuant to the March 2021 Underwriting Agreement at $
the Company granted J.P. Morgan a 30-day option to purchase up to an additional
the same terms and conditions, which J.P. Morgan exercised in full on March 3, 2021. The closing of the offering of
of the Company’s common stock occurred on March 5, 2021, with proceeds to the Company of approximately $
offering expenses.
On June 22, 2021, Orchid entered into an equity distribution agreement (the “June 2021 Equity Distribution Agreement”) with four
sales agents pursuant to which the Company could offer and sell, from time to time, up to an aggregate amount of $
shares of the Company’s common stock in transactions that were deemed to be “at the market” offerings and privately negotiated
transactions. The Company issued a total of
proceeds of approximately $
termination in October 2021.
6
On October 29, 2021, Orchid entered into an equity distribution agreement (the “October 2021 Equity Distribution Agreement”) with
four sales agents pursuant to which the Company may offer and sell, from time to time, up to an aggregate amount of $
shares of the Company’s common stock in transactions that are deemed to be “at the market” offerings and privately negotiated
transactions. Through September 30, 2022, the Company issued a total of
Distribution Agreement for aggregate gross proceeds of approximately $
after commissions and fees. No shares were issued under the October 2021 Equity Distribution Agreement during the nine months
ended September 30, 2022.
Basis of Presentation and Use of Estimates
The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted
in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.
Operating results for the nine and three month periods ended September 30, 2022 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2022.
The balance sheet at December 31, 2021 has been derived from the audited financial statements at that date but does not include all
of the information and footnotes required by GAAP for complete financial statements. For further information, refer to the financial
statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The
significant estimates affecting the accompanying financial statements are the fair values of RMBS and derivatives. Management believes
the estimates and assumptions underlying the financial statements are reasonable based on the information available as of September 30,
2022.
Common Stock Reverse Split
On August 30, 2022, the Company effected a 1-for-5 reverse stock split of its common stock and proportionately decreased the
number of authorized shares of common stock. All share, per share, deferred stock unit (“DSU”) and performance unit (“PU”)
information has been retroactively adjusted to reflect the reverse split. The shares of common stock retain a par value of $0.01 per
share.
Variable Interest Entities (“VIEs”)
The Company obtains interests in VIEs through its investments in mortgage-backed securities. The Company’s interests in these
VIEs are passive in nature and are not expected to result in the Company obtaining a controlling financial interest in these VIEs in the
future. As a result, the Company does not consolidate these VIEs and accounts for these interests in these VIEs as mortgage-backed
securities. See Note 2 for additional information regarding the Company’s investments in mortgage-backed securities. The maximum
exposure to loss for these VIEs is the carrying value of the mortgage-backed securities.
7
Cash and Cash Equivalents and Restricted Cash
Cash and cash equivalents include cash on deposit with financial institutions and highly liquid investments with original maturities of
three months or less at the time of purchase. Restricted cash includes cash pledged as collateral for repurchase agreements and other
borrowings, and interest rate swaps and other derivative instruments.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the statement of financial
position that sum to the total of the same such amounts shown in the statement of cash flows.
(in thousands)
September 30, 2022
December 31, 2021
Cash and cash equivalents
$
$
Restricted cash
Total cash, cash equivalents and restricted cash
$
$
The Company maintains cash balances at three banks and excess margin on account with two exchange clearing members. At times,
balances may exceed federally insured limits. The Company has not experienced any losses related to these balances. The Federal
Deposit Insurance Corporation insures eligible accounts up to $250,000 per depositor at each financial institution. Restricted cash
balances are uninsured, but are held in separate customer accounts that are segregated from the general funds of the counterparty. The
Company limits uninsured balances to only large, well-known banks and exchange clearing members and believes that it is not exposed to
any significant credit risk on cash and cash equivalents or restricted cash balances.
Mortgage-Backed Securities and U.S. Treasury Notes
The Company invests primarily in mortgage pass-through (“PT”) residential mortgage backed securities (“RMBS”) and collateralized
mortgage obligations (“CMOs”) issued by Freddie Mac, Fannie Mae or Ginnie Mae, interest-only (“IO”) securities and inverse interest-only
(“IIO”) securities representing interest in or obligations backed by pools of RMBS. The Company refers to RMBS and CMOs as PT
RMBS. The Company refers to IO and IIO securities as structured RMBS. The Company also invests in U.S. Treasury Notes, primarily
to satisfy collateral requirements of derivative counterparties. The Company has elected to account for its investment in RMBS and
U.S. Treasury Notes under the fair value option. Electing the fair value option requires the Company to record changes in fair value in
the statement of operations, which, in management’s view, more appropriately reflects the results of the Company’s operations for a
particular reporting period and is consistent with the underlying economics and how the portfolio is managed.
The Company records securities transactions on the trade date. Security purchases that have not settled as of the balance sheet date
are included in the portfolio balance with an offsetting liability recorded, whereas securities sold that have not settled as of the balance
sheet date are removed from the portfolio balance with an offsetting receivable recorded.
Fair value is defined as the price that would be received to sell the asset or paid to transfer the liability in an orderly transaction
between market participants at the measurement date. The fair value measurement assumes that the transaction to sell the asset or
transfer the liability either occurs in the principal market for the asset or liability, or in the absence of a principal market, occurs in the most
advantageous market for the asset or liability. Estimated fair values for RMBS are based on independent pricing sources and/or third party
broker quotes, when available. Estimated fair values for U.S. Treasury Notes are based on quoted prices for identical assets in active
markets.
8
Income on PT RMBS and U.S. Treasury Notes is based on the stated interest rate of the security. Premiums or discounts present at
the date of purchase are not amortized. Premium lost and discount accretion resulting from monthly principal repayments are reflected in
unrealized gains (losses) on RMBS in the statements of operations. For IO securities, the income is accrued based on the carrying value
and the effective yield. The difference between income accrued and the interest received on the security is characterized as a return of
investment and serves to reduce the asset’s carrying value. At each reporting date, the effective yield is adjusted prospectively for future
reporting periods based on the new estimate of prepayments and the contractual terms of the security. For IIO securities, effective yield
and income recognition calculations also take into account the index value applicable to the security. Changes in fair value of RMBS during
each reporting period are recorded in earnings and reported as unrealized gains or losses on mortgage-backed securities in the
accompanying statements of operations.
Derivative and Other Hedging Instruments
The Company uses derivative and other hedging instruments to manage interest rate risk, facilitate asset/liability strategies and
manage other exposures, and it may continue to do so in the future. The principal instruments that the Company has used to date are
Treasury Note (“T-Note”), federal funds (“Fed Funds”) and Eurodollar futures contracts, short positions in U.S. Treasury securities, interest
rate swaps, options to enter in interest rate swaps (“interest rate swaptions”) and “to-be-announced” (“TBA”) securities transactions, but the
Company may enter into other derivative and other hedging instruments in the future.
The Company accounts for TBA securities as derivative instruments. Gains and losses associated with TBA securities transactions
are reported in gain (loss) on derivative instruments in the accompanying statements of operations.
Derivative and other hedging instruments are carried at fair value, and changes in fair value are recorded in earnings for each period.
The Company’s derivative financial instruments are not designated as hedge accounting relationships, but rather are used as economic
hedges of its portfolio assets and liabilities. Gains and losses on derivatives, except those that result in cash receipts or payments, are
included in operating activities on the statement of cash flows. Cash payments and cash receipts from settlements of derivatives, including
current period net cash settlements on interest rates swaps, are classified as an investing activity on the statements of cash flows.
Holding derivatives creates exposure to credit risk related to the potential for failure on the part of counterparties and exchanges to
honor their commitments. In the event of default by a counterparty, the Company may have difficulty recovering its collateral and may not
receive payments provided for under the terms of the agreement. The Company’s derivative agreements require it to post or receive
collateral to mitigate such risk. In addition, the Company uses only registered central clearing exchanges and well-established commercial
banks as counterparties, monitors positions with individual counterparties and adjusts posted collateral as required.
Financial Instruments
The fair value of financial instruments for which it is practicable to estimate that value is disclosed either in the body of the financial
statements or in the accompanying notes. RMBS, Eurodollar, Fed Funds and T-Note futures contracts, interest rate swaps, interest rate
swaptions and TBA securities are accounted for at fair value in the balance sheets. The methods and assumptions used to estimate fair
value for these instruments are presented in Note 12 of the financial statements.
The estimated fair value of cash and cash equivalents, restricted cash, accrued interest receivable, receivable for securities sold,
other assets, due to affiliates, repurchase agreements, payable for unsettled securities purchased, accrued interest payable and other
liabilities generally approximates their carrying values as of September 30, 2022 and December 31, 2021 due to the short-term nature of
these financial instruments.
9
Repurchase Agreements
The Company finances the acquisition of the majority of its RMBS through the use of repurchase agreements under master
repurchase agreements. Repurchase agreements are accounted for as collateralized financing transactions, which are carried at their
contractual amounts, including accrued interest, as specified in the respective agreements.
Manager Compensation
The Company is externally managed by Bimini Advisors, LLC (the “Manager” or “Bimini Advisors”), a Maryland limited liability
company and wholly-owned subsidiary of Bimini. The Company’s management agreement with the Manager provides for payment to the
Manager of a management fee and reimbursement of certain operating expenses, which are accrued and expensed during the period for
which they are earned or incurred. Refer to Note 13 for the terms of the management agreement.
Earnings Per Share
Basic earnings per share (“EPS”) is calculated as net income or loss attributable to common stockholders divided by the weighted
average number of shares of common stock outstanding during the period. Diluted EPS is calculated using the treasury stock or two-class
method, as applicable, for common stock equivalents, if any. However, the common stock equivalents are not included in computing
diluted EPS if the result is anti-dilutive.
Stock-Based Compensation
The Company may grant equity-based compensation to non-employee members of its Board of Directors and to the executive officers
and employees of the Manager. Stock-based awards issued include performance units, deferred stock units and immediately vested
common stock awards. Compensation expense is measured and recognized for all stock-based payment awards made to employees and
non-employee directors based on the fair value of the Company’s common stock on the date of grant. Compensation expense is
recognized over each award’s respective service period using the graded vesting attribution method. The Company does not estimate
forfeiture rates; but rather, adjusts for forfeitures in the periods in which they occur.
Income Taxes
Orchid has elected and is organized and operated 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”). REITs are generally not subject to federal income tax on their REIT taxable
income provided that they distribute to their stockholders all of their REIT taxable income on an annual basis. A REIT must distribute at
least 90% of its REIT taxable income, determined without regard to the deductions for dividends paid and excluding net capital gain,
and meet other requirements of the Code to retain its tax status.
Orchid assesses the likelihood, based on their technical merit, that uncertain tax positions will be sustained upon examination
based on the facts, circumstances and information available at the end of each period. All of Orchid’s tax positions are categorized as
highly certain. There is no accrual for any tax, interest or penalties related to Orchid’s tax position assessment. The measurement of
uncertain tax positions is adjusted when new information is available, or when an event occurs that requires a change.
10
Recent Accounting Pronouncements
In March 2020, the FASB issued ASU 2020-04 “
Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate
Reform on Financial Reporting.
” ASU 2020-04 provides optional expedients and exceptions to GAAP requirements for modifications
on debt instruments, leases, derivatives, and other contracts, related to the expected market transition from the London Interbank
Offered Rate (“LIBOR”), and certain other floating rate benchmark indices, or collectively, IBORs, to alternative reference rates. ASU
2020-04 generally considers contract modifications related to reference rate reform to be an event that does not require contract
remeasurement at the modification date nor a reassessment of a previous accounting determination. The guidance in ASU 2020-04 is
optional and may be elected over time, through December 31, 2022, as reference rate reform activities occur. The Company does not
believe the adoption of this ASU will have a material impact on its financial statements.
In January 2021, the FASB issued ASU 2021-01 “
Reference Rate Reform (Topic 848
).” ASU 2021-01 expands the scope of ASC
848 to include all affected derivatives and give market participants the ability to apply certain aspects of the contract modification and
hedge accounting expedients to derivative contracts affected by the discounting transition. In addition, ASU 2021-01 adds
implementation guidance to permit a company to apply certain optional expedients to modifications of interest rate indexes used for
margining, discounting or contract price alignment of certain derivatives as a result of reference rate reform initiatives and extends
optional expedients to account for a derivative contract modified as a continuation of the existing contract and to continue hedge
accounting when certain critical terms of a hedging relationship change to modifications made as part of the discounting transition. The
guidance in ASU 2021-01 is effective immediately and available generally through December 31, 2022, as reference rate reform
activities occur. The Company does not believe the adoption of this ASU will have a material impact on its financial statements.
NOTE 2. MORTGAGE-BACKED SECURITIES AND U.S. TREASURY NOTES
The following table presents the Company’s RMBS portfolio as of September 30, 2022 and December 31, 2021:
(in thousands)
September 30, 2022
December 31, 2021
Pass-Through RMBS Certificates:
Fixed-rate Mortgages
$
$
Total Pass-Through Certificates
Structured RMBS Certificates:
Interest-Only Securities
Inverse Interest-Only Securities
Total Structured RMBS Certificates
Total
$
$
As of September 30, 2022 and December 31, 2021, the Company held U.S. Treasury Notes with a fair value of approximately $
million and $
The following table is a summary of the Company’s net gain (loss) from the sale of RMBS for the nine months ended September 30,
2022 and 2021.
Nine Months Ended September 30,
2022
2021
Proceeds from sales of RMBS
$
$
Carrying value of RMBS sold
(2,864,169 )
(2,601,961 )
Net (loss) gain on sales of RMBS
$
(132,672 )
$
(3,068 )
Gross gain on sales of RMBS
$
$
Gross loss on sales of RMBS
(135,377 )
(10,934 )
Net (loss) gain on sales of RMBS
$
(132,672 )
$
(3,068 )
11
NOTE 3. REPURCHASE AGREEMENTS
The Company pledges certain of its RMBS as collateral under repurchase agreements with financial institutions. Interest rates are
generally fixed based on prevailing rates corresponding to the terms of the borrowings, and interest is generally paid at the termination of a
borrowing. If the fair value of the pledged securities declines, lenders will typically require the Company to post additional collateral or pay
down borrowings to re-establish agreed upon collateral requirements, referred to as "margin calls." Similarly, if the fair value of the pledged
securities increases, lenders may release collateral back to the Company. As of September 30, 2022, the Company had met all margin call
requirements.
As of September 30, 2022 and December 31, 2021, the Company’s repurchase agreements had remaining maturities as summarized
below:
($ in thousands)
OVERNIGHT
BETWEEN 2
BETWEEN 31
GREATER
(1 DAY OR
AND
AND
THAN
LESS)
30 DAYS
90 DAYS
90 DAYS
TOTAL
(1)
September 30, 2022
Fair market value of securities pledged, including
accrued interest receivable
$
$
$
$
$
Repurchase agreement liabilities associated with
these securities
$
$
$
$
$
Net weighted average borrowing rate
-
December 31, 2021
Fair market value of securities pledged, including
accrued interest receivable
$
$
$
$
$
Repurchase agreement liabilities associated with
these securities
$
$
$
$
$
Net weighted average borrowing rate
-
1)
Includes repurchase agreements with outstanding principal balances of approximately $
rates indexed to Secured Overnight Financing Rate (“SOFR”) that reprice daily.
In addition, cash pledged to counterparties for repurchase agreements was approximately $
September 30, 2022 and December 31, 2021, respectively.
If, during the term of a repurchase agreement, a lender files for bankruptcy, the Company might experience difficulty recovering its
pledged assets, which could result in an unsecured claim against the lender for the difference between the amount loaned to the Company
plus interest due to the counterparty and the fair value of the collateral pledged to such lender, including the accrued interest receivable
and cash posted by the Company as collateral. At September 30, 2022, the Company had an aggregate amount at risk (the difference
between the amount loaned to the Company, including interest payable and securities posted by the counterparty (if any), and the fair
value of securities and cash pledged (if any), including accrued interest on such securities) with all counterparties of approximately $
million. The Company did not have an amount at risk with any individual counterparty that was greater than 10% of the Company’s equity
at September 30, 2022 and December 31, 2021.
12
NOTE 4. DERIVATIVE AND OTHER HEDGING INSTRUMENTS
The table below summarizes fair value information about the Company’s derivative and other hedging instruments assets and
liabilities as of September 30, 2022 and December 31, 2021.
(in thousands)
Derivative and Other Hedging Instruments
Balance Sheet Location
September 30, 2022
December 31, 2021
Assets
Interest rate swaps
Derivative assets, at fair value
$
$
Payer swaptions (long positions)
Derivative assets, at fair value
Interest rate caps
Derivative assets, at fair value
TBA securities
Derivative assets, at fair value
Total derivative assets, at fair value
$
$
Liabilities
Interest rate swaps
Derivative liabilities, at fair value
$
$
Payer swaptions (short positions)
Derivative liabilities, at fair value
TBA securities
Derivative liabilities, at fair value
Total derivative liabilities, at fair value
$
$
Margin Balances Posted to (from) Counterparties
Futures contracts
Restricted cash
$
$
TBA securities
Restricted cash
TBA securities
Other liabilities
(11,422 )
(856 )
Interest rate swaption contracts
Other liabilities
(27,149 )
(6,350 )
Total margin balances on derivative contracts
$
(21,179 )
$
Eurodollar, Fed Funds and T-Note futures are cash settled futures contracts on an interest rate, with gains and losses credited or
charged to the Company’s cash accounts on a daily basis. A minimum balance, or “margin”, is required to be maintained in the account on
a daily basis.
The tables below present information related to the Company’s T-Note futures positions at September 30, 2022 and
December 31, 2021.
($ in thousands)
September 30, 2022
Average
Weighted
Weighted
Contract
Average
Average
Notional
Entry
Effective
Open
Expiration Year
Amount
Rate
Rate
Equity
(1)
Treasury Note Futures Contracts (Short Positions)
(2)
December 2022 5-year T-Note futures
(Dec 2022 - Dec 2027 Hedge Period)
$
$
December 2022 10-year Ultra futures
(Dec 2022 - Dec 2032 Hedge Period)
$
$
13
($ in thousands)
December 31, 2021
Average
Weighted
Weighted
Contract
Average
Average
Notional
Entry
Effective
Open
Expiration Year
Amount
Rate
Rate
Equity
(1)
Treasury Note Futures Contracts (Short Position)
(2)
March 2022 5-year T-Note futures
(Mar 2022 - Mar 2027 Hedge Period)
$
$
March 2022 10-year Ultra futures
(Mar 2022 - Mar 2032 Hedge Period)
$
$
(3,861 )
(1)
Open equity represents the cumulative gains (losses) recorded on open futures positions from inception.
(2)
5-Year T-Note futures contracts were valued at a price of $
values of the short positions were $
futures contracts were valued at a price of $
position was $
Under its interest rate swap agreements, the Company typically pays a fixed rate and receive a floating rate based on an index
("payer swaps"). The floating rate the Company receives under its swap agreements has the effect of offsetting the repricing
characteristics of our repurchase agreements and cash flows on such liabilities. The Company is typically required to post collateral on its
interest rate swap agreements. The table below presents information related to the Company’s interest rate swap positions at September
30, 2022 and December 31, 2021.
($ in thousands)
Average
Net
Fixed
Average
Estimated
Average
Notional
Pay
Receive
Fair
Maturity
Amount
Rate
Rate
Value
(Years)
September 30, 2022
Expiration > 3 to ≤ 5 years
$
$
Expiration > 5 years
$
$
December 31, 2021
Expiration > 3 to ≤ 5 years
$
$
Expiration > 5 years
$
$
The table below presents information related to the Company’s interest rate cap positions at September 30, 2022.
($ in thousands)
Net
Strike
Estimated
Notional
Swap
Curve
Fair
Expiration
Amount
Cost
Rate
Spread
Value
February 8, 2024
$
$
2Y10Y
$
14
The table below presents information related to the Company’s interest rate swaption positions at September 30, 2022 and
31, 2021.
($ in thousands)
Option
Underlying Swap
Weighted
Average
Weighted
Average
Average
Adjustable
Average
Fair
Months to
Notional
Fixed
Rate
Term
Expiration
Cost
Value
Expiration
Amount
Rate
(LIBOR)
(Years)
September 30, 2022
Payer Swaptions - long
≤ 1 year
$
$
$
3 Month
>10 years
3 Month
$
$
$
3 Month
Payer Swaptions - short
≤ 1 year
$
(17,500 )
$
$
(958,300 )
3 Month
December 31, 2021
Payer Swaptions - long
≤ 1 year
$
$
$
3 Month
>1 year ≤ 2 years
3 Month
$
$
$
3 Month
Payer Swaptions - short
≤ 1 year
$
(16,185 )
$
(4,423 )
$
(1,331,500 )
3 Month
The following table summarizes the Company’s contracts to purchase and sell TBA securities as of September 30, 2022 and
December 31, 2021.
($ in thousands)
Notional
Net
Amount
Cost
Market
Carrying
Long (Short)
(1)
Basis
(2)
Value
(3)
Value
(4)
September 30, 2022
30-Year TBA securities:
2.0%
$
(175,000 )
$
(141,329 )
$
(141,723 )
$
(394 )
3.0%
(300,000 )
(261,047 )
(261,047 )
Total
$
(475,000 )
$
(402,376 )
$
(402,770 )
$
(394 )
December 31, 2021
30-Year TBA securities:
3.0%
$
(575,000 )
$
(595,630 )
$
(595,934 )
$
(304 )
Total
$
(575,000 )
$
(595,630 )
$
(595,934 )
$
(304 )
(1)
Notional amount represents the par value (or principal balance) of the underlying Agency RMBS.
(2)
Cost basis represents the forward price to be paid (received) for the underlying Agency RMBS.
(3)
Market value represents the current market value of the TBA securities (or of the underlying Agency RMBS) as of period-end.
(4)
Net carrying value represents the difference between the market value and the cost basis of the TBA securities as of period-end and is reported
in derivative assets (liabilities) at fair value in the balance sheets.
15
Gain (Loss) From Derivative and Other Hedging Instruments, Net
The table below presents the effect of the Company’s derivative and other hedging instruments on the statements of operations for
the nine and three months ended September 30, 2022 and 2021.
(in thousands)
Nine Months Ended September 30,
Three Months Ended September 30,
2022
2021
2022
2021
T-Note futures contracts (short position)
$
$
$
$
Eurodollar futures contracts (short positions)
(14 )
(7 )
Interest rate swaps
Payer swaptions (short positions)
(80,183 )
(35,239 )
Payer swaptions (long positions)
Interest rate caps
(499 )
Interest rate floors
TBA securities (short positions)
(2,306 )
TBA securities (long positions)
(8,559 )
Total
$
$
$
$
Credit Risk-Related Contingent Features
The use of derivatives and other hedging instruments creates exposure to credit risk relating to potential losses that could be
recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. The Company
attempts to minimize this risk by limiting its counterparties for instruments which are not centrally cleared on a registered exchange to
major financial institutions with acceptable credit ratings and monitoring positions with individual counterparties. In addition, the Company
may be required to pledge assets as collateral for its derivatives, whose amounts vary over time based on the market value, notional
amount and remaining term of the derivative contract. In the event of a default by a counterparty, the Company may not receive payments
provided for under the terms of its derivative agreements, and may have difficulty obtaining its assets pledged as collateral for its
derivatives. The cash and cash equivalents pledged as collateral for the Company derivative instruments are included in restricted cash
on its balance sheets.
It is the Company's policy not to offset assets and liabilities associated with open derivative contracts. However, Chicago Mercantile
Exchange (“CME”) and Intercontinental Exchange (“ICE”) rules characterize variation margin transfers as settlement payments, as
opposed to adjustments to collateral. As a result, derivative assets and liabilities associated with centrally cleared derivatives for which
the CME or ICE serves as the central clearing party are presented as if these derivatives had been settled as of the reporting date.
16
NOTE 5. PLEDGED ASSETS
Assets Pledged to Counterparties
The table below summarizes the Company’s assets pledged as collateral under repurchase agreements and derivative agreements
by type, including securities pledged related to securities sold but not yet settled, as of September 30, 2022 and December 31, 2021.
(in thousands)
September 30, 2022
December 31, 2021
Repurchase
Derivative
Repurchase
Derivative
Assets Pledged to Counterparties
Agreements
Agreements
Total
Agreements
Agreements
Total
PT RMBS - fair value
$
$
$
$
$
$
Structured RMBS - fair value
U.S. Treasury Notes
Accrued interest on pledged securities
Restricted cash
Total
$
$
$
$
$
$
Assets Pledged from Counterparties
The table below summarizes assets pledged to the Company from counterparties under repurchase agreements and derivative
agreements as of September 30, 2022 and December 31, 2021.
(in thousands)
September 30, 2022
December 31, 2021
Repurchase
Derivative
Repurchase
Derivative
Assets Pledged to Orchid
Agreements
Agreements
Total
Agreements
Agreements
Total
Cash
$
$
$
$
$
$
Total
$
$
$
$
$
$
$
Cash received as margin is recognized as cash and cash equivalents with a corresponding amount recognized as an increase in
repurchase agreements or other liabilities in the balance sheets.
NOTE 6. OFFSETTING ASSETS AND LIABILITIES
The Company’s derivative agreements and repurchase agreements and reverse repurchase agreements are subject to underlying
agreements with master netting or similar arrangements, which provide for the right of offset in the event of default or in the event of
bankruptcy of either party to the transactions. The Company reports its assets and liabilities subject to these arrangements on a gross
basis.
17
The following table presents information regarding those assets and liabilities subject to such arrangements as if the Company had
presented them on a net basis as of September 30, 2022 and December 31, 2021.
(in thousands)
Offsetting of Assets
Gross Amount Not
Net Amount
Offset in the Balance Sheet
of Assets
Financial
Gross Amount
Gross Amount
Presented
Instruments
Cash
of Recognized
Offset in the
in the
Received as
Received as
Net
Assets
Balance Sheet
Balance Sheet
Collateral
Collateral
Amount
September 30, 2022
Interest rate swaps
$
$
$
$
$
$
Interest rate swaptions
(27,149 )
Interest rate caps
TBA securities
305
-
305
-
(305)
-
$
$
$
$
$
(27,454 )
$
December 31, 2021
Interest rate swaps
$
$
$
$
$
$
Interest rate swaptions
(6,350 )
$
$
$
$
$
(6,350 )
$
(in thousands)
Offsetting of Liabilities
Gross Amount Not
Net Amount
Offset in the Balance Sheet
of Liabilities
Financial
Gross Amount
Gross Amount
Presented
Instruments
of Recognized
Offset in the
in the
Posted as
Cash Posted
Net
Liabilities
Balance Sheet
Balance Sheet
Collateral
as Collateral
Amount
September 30, 2022
Repurchase Agreements
$
$
$
$
(3,084,484 )
$
(49,377 )
$
Interest rate swaptions
TBA securities
(698 )
$
$
$
$
(3,084,484 )
$
(50,075 )
$
December 31, 2021
Repurchase Agreements
$
$
$
$
(6,186,842 )
$
(57,264 )
$
Interest rate swaps
(2,862 )
Interest rate swaptions
TBA securities
$
$
$
$
(6,189,704 )
$
(57,264 )
$
The amounts disclosed for collateral received by or posted to the same counterparty up to and not exceeding the net amount of the
asset or liability presented in the balance sheets. The fair value of the actual collateral received by or posted to the same counterparty
typically exceeds the amounts presented. See Note 5 for a discussion of collateral posted or received against or for repurchase obligations
and derivative and other hedging instruments.
18
NOTE 7. CAPITAL STOCK
Reverse Stock Split
On August 30, 2022, the Company effected a 1-for-5 reverse stock split of its common stock and proportionately decreased the
number of authorized shares of common stock. All share, per share, deferred stock unit (“DSU”) and performance unit information has
been retroactively adjusted to reflect the reverse split. The shares of common stock retain a par value of $0.01 per share.
Common Stock Issuances
The Company did not complete any public offerings of its common stock during the nine months ended September 30, 2022. During
the year ended December 31, 2021, the Company completed the following public offerings of shares of its common stock.
($ in thousands, except per share amounts)
Weighted
Average
Price
Received
Net
Type of Offering
Period
Per Share
(1)
Shares
Proceeds
(2)
At the Market Offering Program
(3)
First Quarter
$
$
Follow-on Offerings
First Quarter
At the Market Offering Program
(3)
Second Quarter
At the Market Offering Program
(3)
Third Quarter
At the Market Offering Program
(3)
Fourth Quarter
$
(1)
Weighted average price received per share is after deducting the underwriters’ discount, if applicable, and other offering costs.
(2)
Net proceeds are net of the underwriters’ discount, if applicable, and other offering costs.
(3)
The Company has entered into ten equity distribution agreements, nine of which have either been terminated because all shares were sold or
were replaced with a subsequent agreement.
Stock Repurchase Program
On July 29, 2015, the Company’s Board of Directors authorized the repurchase of up to
common stock. On February 8, 2018, the Board of Directors approved an increase in the stock repurchase program for up to an
additional
share authorization, the increased authorization brought the total authorization to
Company’s then outstanding share count.
On December 9, 2021, the Board of Directors approved an increase in the number of shares of the Company’s common stock
available in the stock repurchase program for up to an additional
stock repurchase program to
common stock.
On October 12, 2022, the Board of Directors approved an increase in the number of shares of the Company’s common stock
available in the stock repurchase program for up to an additional
stock repurchase program to
common stock.
19
As part of the stock repurchase program, shares may be purchased in open market transactions, block purchases, through
privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”). Open market repurchases will be made in accordance with Exchange Act
Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of open market stock repurchases. The timing,
manner, price and amount of any repurchases will be determined by the Company in its discretion and will be 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. The stock repurchase program has no termination date.
From the inception of the stock repurchase program through September 30, 2022, the Company repurchased a total of
shares at an aggregate cost of approximately $
per share. During the nine months ended September 30, 2022, the Company repurchased a total of
cost of approximately $
repurchased during the year ended December 31, 2021. Subsequent to September 30, 2022, and through October 27, 2022, the
Company repurchased a total of
fees, for a weighted average price of $
27, 2022 was
Cash Dividends
The table below presents the cash dividends declared on the Company’s common stock.
(in thousands, except per share amounts)
Year
Per Share
Amount
Total
2013
$
$
2014
2015
2016
2017
2018
2019
2020
2021
2022 - YTD
(1)
Totals
$
$
(1)
On
, the Company declared a dividend of $
. The effect of this dividend is
included in the table above but is not reflected in the Company’s financial statements as of September 30, 2022.
20
NOTE 8. STOCK INCENTIVE PLAN
In 2021, the Company’s Board of Directors adopted, and the stockholders approved, the Orchid Island Capital, Inc. 2021 Equity
Incentive Plan (the “2021 Incentive Plan”) to replace the Orchid Island Capital, Inc. 2012 Equity Incentive Plan (the “2012 Incentive Plan”
and together with the 2021 Incentive Plan, the “Incentive Plans”). The 2021 Incentive Plan provides for the award of stock options, stock
appreciation rights, stock award, performance units, other equity-based awards (and dividend equivalents with respect to awards of
performance units and other equity-based awards) and incentive awards. The 2021 Incentive Plan is administered by the Compensation
Committee of the Company’s Board of Directors except that the Company’s full Board of Directors will administer awards made to directors
who are not employees of the Company or its affiliates. The 2021 Incentive Plan provides for awards of up to an aggregate of
% of the
issued and outstanding shares of the Company’s common stock (on a fully diluted basis) at the time of the awards, subject to a maximum
aggregate
replaces the 2012 Incentive Plan, and no further grants will be made under the 2012 Incentive Plan. However, any outstanding awards
under the 2012 Incentive Plan will continue in accordance with the terms of the 2012 Incentive Plan and any award agreement executed in
connection with such outstanding awards.
Performance Units
The Company has issued, and may in the future issue additional, performance units under the Incentive Plans to certain executive
officers and employees of its Manager. “Performance Units” vest after the end of a defined performance period, based on satisfaction of
the performance conditions set forth in the performance unit agreement. When earned, each Performance Unit will be settled by the
issuance of one share of the Company’s common stock, at which time the Performance Unit will be cancelled. The Performance Units
contain dividend equivalent rights, which entitle the Participants to receive distributions declared by the Company on common stock, but do
not include the right to vote the underlying shares of common stock. Performance Units are subject to forfeiture should the participant no
longer serve as an executive officer or employee of the Company or the Manager. Compensation expense for the Performance Units,
included in incentive compensation on the statements of operations, is recognized over the remaining vesting period once it becomes
probable that the performance conditions will be achieved.
The following table presents information related to Performance Units outstanding during the nine months ended September 30, 2022
and 2021.
($ in thousands, except per share data)
Nine Months Ended September 30,
2022
2021
Weighted
Weighted
Average
Average
Grant Date
Grant Date
Shares
Fair Value
Shares
Fair Value
Unvested, beginning of period
$
$
Granted
Forfeited
(8,464 )
Vested and issued
(7,594 )
(911 )
Unvested, end of period
$
$
Compensation expense during period
$
$
Unrecognized compensation expense, end of period
$
$
Intrinsic value, end of period
$
$
Weighted-average remaining vesting term (in years)
21
The number of shares of common stock issuable upon the vesting of the remaining outstanding Performance Units was reduced as a
result of the book value impairment event that occurred pursuant to the terms of the long term equity incentive compensation plans (the
“Plans”) established under the Company’s 2012 Equity Incentive Plan and 2021 Equity Incentive Plan. The book value impairment event
occurred when the Company's book value per share declined by more than 15% during the quarter ended March 31, 2022 and the
Company’s book value per share decline from January 1, 2022 to June 30, 2022 was more than 10%. The Plans provide that if such a
book value impairment event occurs, then the number of outstanding Performance Units that are outstanding as of the last day of such two
quarter period shall be reduced by 15%.
Stock Awards
The Company has issued, and may in the future issue additional, immediately vested common stock under the Incentive Plans to
certain executive officers and employees of its Manager.
The following table presents information related to fully vested common stock
issued during the nine months ended September 30, 2022 and 2021. All of the fully vested shares of common stock issued during the nine
months ended September 30, 2022 and 2021, and the related compensation expense, were granted with respect to service performed
during the fiscal years ended December 31, 2021 and 2020, respectively.
($ in thousands, except per share data)
Nine Months Ended September 30,
2022
2021
Fully vested shares granted
Weighted average grant date price per share
$
$
Compensation expense related to fully vested shares of common stock awards
$
$
Deferred Stock Units
Non-employee directors receive a portion of their compensation in the form of DSU awards pursuant to the Incentive Plans. Each
DSU represents a right to receive one share of the Company’s common stock. Beginning in 2022, each non-employee director can elect to
receive all of his or her compensation in the form of DSUs. The DSUs are immediately vested and are settled at a future date based on the
election of the individual participant. Compensation expense for the DSUs is included in directors’ fees and liability insurance in the
statements of operations. The DSUs contain dividend equivalent rights, which entitle the participant to receive distributions declared by the
Company on common stock. These dividend equivalent rights are settled in cash or additional DSUs at the participant’s election. The
DSUs do not include the right to vote the underlying shares of common stock.
The following table presents information related to the DSUs outstanding during the nine months ended September 30, 2022 and
2021.
($ in thousands, except per share data)
Nine Months Ended September 30,
2022
2021
Weighted
Weighted
Average
Average
Grant Date
Grant Date
Shares
Fair Value
Shares
Fair Value
Outstanding, beginning of period
$
$
Granted and vested
Outstanding, end of period
$
$
Compensation expense during period
$
$
Intrinsic value, end of period
$
$
22
NOTE 9. COMMITMENTS AND CONTINGENCIES
From time to time, the Company may become involved in various claims and legal actions arising in the ordinary course of
business. Management is not aware of any reported or unreported contingencies at September 30, 2022.
NOTE 10. INCOME TAXES
The Company will generally not be subject to U.S. federal income tax on its REIT taxable income to the extent that it distributes its
REIT taxable income to its stockholders and satisfies the ongoing REIT requirements, including meeting certain asset, income and
stock ownership tests. A REIT must generally distribute at least 90% of its REIT taxable income, determined without regard to the
deductions for dividends paid and excluding net capital gain, to its stockholders, annually to maintain REIT status. An amount equal to
the sum of which 85% of its REIT ordinary income and 95% of its REIT capital gain net income, plus certain undistributed income from
prior taxable years, must be distributed within the taxable year, in order to avoid the imposition of an excise tax. The remaining
balance may be distributed up to the end of the following taxable year, provided the REIT elects to treat such amount as a prior year
distribution and meets certain other requirements.
NOTE 11. EARNINGS PER SHARE (EPS)
The Company had dividend eligible Performance Units and Deferred Stock Units that were outstanding during the nine and three
months ended September 30, 2022 and 2021. The basic and diluted per share computations include these unvested Performance Units
and Deferred Stock Units if there is income available to common stock, as they have dividend participation rights. The unvested
Performance Units and Deferred Stock Units have no contractual obligation to share in losses. Because there is no such obligation, the
unvested Performance Units and Deferred Stock Units are not included in the basic and diluted EPS computations when no income is
available to common stock even though they are considered participating securities.
The table below reconciles the numerator and denominator of EPS for the nine and three months ended September 30, 2022 and
2021.
(in thousands, except per share information)
Nine Months Ended September 30,
Three Months Ended September 30,
2022
2021
2022
2021
Basic and diluted EPS per common share:
Numerator for basic and diluted EPS per share of common stock:
Net (loss) income - Basic and diluted
$
(293,380 )
$
(20,196 )
$
(84,514 )
$
Weighted average shares of common stock:
Shares of common stock outstanding at the balance sheet date
Unvested dividend eligible share based compensation
outstanding at the balance sheet date
-
-
-
53
Effect of weighting
(9,603 )
(5,000 )
Weighted average shares-basic and diluted
Net (loss) income per common share:
Basic and diluted
$
(8.31 )
$
(0.95 )
$
(2.40 )
$
Anti-dilutive incentive shares not included in calculation
23
NOTE 12. FAIR VALUE
The framework for using fair value to measure assets and liabilities defines fair value as the price that would be received to sell an
asset or paid to transfer a liability (an exit price). A fair value measure should reflect the assumptions that market participants would use in
pricing the asset or liability, including the assumptions about the risk inherent in a particular valuation technique, the effect of a restriction
on the sale or use of an asset and the risk of non-performance. Required disclosures include stratification of balance sheet amounts
measured at fair value based on inputs the Company uses to derive fair value measurements. These stratifications are:
●
Level 1 valuations, where the valuation is based on quoted market prices for identical assets or liabilities traded in active markets
(which include exchanges and over-the-counter markets with sufficient volume),
●
Level 2 valuations, where the valuation is based on quoted market prices for similar instruments traded in active markets, quoted
prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all
significant assumptions are observable in the market, and
●
Level 3 valuations, where the valuation is generated from model-based techniques that use significant assumptions not
observable in the market, but observable based on Company-specific data. These unobservable assumptions reflect the
Company’s own estimates for assumptions that market participants would use in pricing the asset or liability. Valuation
techniques typically include option pricing models, discounted cash flow models and similar techniques, but may also include the
use of market prices of assets or liabilities that are not directly comparable to the subject asset or liability.
The Company's RMBS and TBA securities are Level 2 valuations, and such valuations currently are determined by the Company
based on independent pricing sources and/or third party broker quotes. Because the price estimates may vary, the Company must make
certain judgments and assumptions about the appropriate price to use to calculate the fair values. The Company and the independent
pricing sources use various valuation techniques to determine the price of the Company’s securities. These techniques include observing
the most recent market for like or identical assets (including security coupon, maturity, yield, and prepayment speeds), spread pricing
techniques to determine market credit spreads (option adjusted spread, zero volatility spread, spread to the U.S. Treasury curve or spread
to a benchmark such as a TBA), and model driven approaches (the discounted cash flow method, Black Scholes and SABR models which
rely upon observable market rates such as the term structure of interest rates and volatility). The appropriate spread pricing method used
is based on market convention. The pricing source determines the spread of recently observed trade activity or observable markets for
assets similar to those being priced. The spread is then adjusted based on variances in certain characteristics between the market
observation and the asset being priced. Those characteristics include: type of asset, the expected life of the asset, the stability and
predictability of the expected future cash flows of the asset, whether the coupon of the asset is fixed or adjustable, the guarantor of the
security if applicable, the coupon, the maturity, the issuer, size of the underlying loans, year in which the underlying loans were originated,
loan to value ratio, state in which the underlying loans reside, credit score of the underlying borrowers and other variables if appropriate.
The fair value of the security is determined by using the adjusted spread.
The Company’s U.S. Treasury Notes are based on quoted prices for identical instruments in active markets and are classified as
Level 1 assets.
The Company’s futures contracts are Level 1 valuations, as they are exchange-traded instruments and quoted market prices are
readily available. Futures contracts are settled daily. The Company’s interest rate swaps and interest rate swaptions are Level 2
valuations. The fair value of interest rate swaps is determined using a discounted cash flow approach using forward market interest rates
and discount rates, which are observable inputs. The fair value of interest rate swaptions is determined using an option pricing model.
RMBS (based on the fair value option), derivatives and TBA securities were recorded at fair value on a recurring basis during the nine
and three months ended September 30, 2022 and 2021. When determining fair value measurements, the Company considers the principal
or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the
asset. When possible, the Company looks to active and observable markets to price identical assets. When identical assets are not traded
in active markets, the Company looks to market observable data for similar assets.
24
The following table presents financial assets (liabilities) measured at fair value on a recurring basis as of September 30, 2022 and
December 31, 2021. Derivative contracts are reported as a net position by contract type, and not based on master netting arrangements.
(in thousands)
Quoted Prices
in Active
Significant
Markets for
Other
Significant
Identical
Observable
Unobservable
Assets
Inputs
Inputs
(Level 1)
(Level 2)
(Level 3)
September 30, 2022
Mortgage-backed securities
$
$
$
U.S. Treasury Notes
Interest rate swaps
Interest rate swaptions
Interest rate caps
TBA securities
(394 )
December 31, 2021
Mortgage-backed securities
$
$
$
U.S. Treasury Notes
Interest rate swaps
Interest rate swaptions
TBA securities
(304 )
During the nine and three months ended September 30, 2022 and 2021, there were no transfers of financial assets or liabilities
between levels 1, 2 or 3.
NOTE 13. RELATED PARTY TRANSACTIONS
Management Agreement
The Company is externally managed and advised by Bimini Advisors, LLC (the “Manager”) pursuant to the terms of a
management agreement. The management agreement has been renewed through
year extension options thereafter and is subject to certain termination rights. Under the terms of the management agreement, the
Manager is responsible for administering the business activities and day-to-day operations of the Company. The Manager receives a
monthly management fee in the amount of:
●
One-twelfth of 1.5% of the first $250 million of the Company’s month-end equity, as defined in the management agreement,
●
One-twelfth of 1.25% of the Company’s month-end equity that is greater than $250 million and less than or equal to $500
million, and
●
One-twelfth of 1.00% of the Company’s month-end equity that is greater than $500 million.
On April 1, 2022, pursuant to the third amendment to the management agreement entered into on November 16, 2021, the
Manager began providing certain repurchase agreement trading, clearing and administrative services to the Company that had been
previously provided by AVM, L.P. under an agreement terminated on March 31, 2022. In consideration for such services, the Company
will pay the following fees to the Manager:
25
●
A daily fee equal to the outstanding principal balance of repurchase agreement funding in place as of the end of such day
multiplied by 1.5 basis points for the amount of aggregate outstanding principal balance less than or equal to $5 billion, and
multiplied by 1.0 basis point for any amount of aggregate outstanding principal balance in excess of $5 billion, and
●
A fee for the clearing and operational services provided by personnel of the Manager equal to $10,000 per month.
The Company is obligated to reimburse the Manager for any direct expenses incurred on its behalf and to pay the Manager the
Company’s pro rata portion of certain overhead costs set forth in the management agreement. Should the Company terminate the
management agreement without cause, it will pay the Manager a termination fee equal to three times the average annual management
fee, as defined in the management agreement, before or on the last day of the term of the agreement.
Total expenses recorded for the management fee and allocated overhead incurred were approximately $
million for the nine and three months ended September 30, 2022, respectively, and $
months ended September 30, 2021, respectively. At September 30, 2022 and December 31, 2021, the net amount due to affiliates was
approximately $
Other Relationships with Bimini
Robert Cauley, the Company’s Chief Executive Officer and Chairman of the Board of Directors, also serves as Chief Executive
Officer and Chairman of the Board of Directors of Bimini and owns shares of common stock of Bimini. George H. Haas, IV, the
Company’s Chief Financial Officer, Chief Investment Officer, Secretary and a member of the Board of Directors, also serves as the
Chief Financial Officer, Chief Investment Officer and Treasurer of Bimini and owns shares of common stock of Bimini. In addition, as of
September 30, 2022, Bimini owned
%, of the Company’s common stock.
26
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, our actual results may
differ materially from those anticipated in such forward-looking statements.
Common Stock Reverse Split
On August 30, 2022, the Company effected a 1-for-5 reverse stock split of its common stock and proportionately decreased the
number of authorized shares of common stock. All share and per share information has been retroactively adjusted to reflect the
reverse split.
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”.
27
Capital Raising Activities
On August 4, 2020, we entered into an equity distribution agreement (the “August 2020 Equity Distribution Agreement”) with four
sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $150,000,000 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 5,538,730 shares under the August 2020 Equity Distribution Agreement for aggregate gross proceeds of approximately $150.0
million, and net proceeds of approximately $147.4 million, after commissions and fees, prior to its termination in June 2021.
On January 20, 2021, we entered into an underwriting agreement (the “January 2021 Underwriting Agreement”) with J.P. Morgan
Securities LLC (“J.P. Morgan”), relating to the offer and sale of 1,520,000 shares of our common stock. J.P. Morgan purchased the
shares of our common stock from the Company pursuant to the January 2021 Underwriting Agreement at $26.00 per share. In addition,
we granted J.P. Morgan a 30-day option to purchase up to an additional 228,000 shares of our common stock on the same terms and
conditions, which J.P. Morgan exercised in full on January 21, 2021. The closing of the offering of 1,748,000 shares of our common
stock occurred on January 25, 2021, with proceeds to us of approximately $45.2 million, net of offering expenses.
On March 2, 2021, we entered into an underwriting agreement (the “March 2021 Underwriting Agreement”) with J.P. Morgan,
relating to the offer and sale of 1,600,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from
the Company pursuant to the March 2021 Underwriting Agreement at $27.25 per share. In addition, we granted J.P. Morgan a 30-day
option to purchase up to an additional 240,000 shares of our common stock on the same terms and conditions, which J.P. Morgan
exercised in full on March 3, 2021. The closing of the offering of 1,840,000 shares of our common stock occurred on March 5, 2021,
with proceeds to us of approximately $50.0 million, net of offering expenses.
On June 22, 2021, we entered into an equity distribution agreement (the “June 2021 Equity Distribution Agreement”) with four
sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $250,000,000 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 9,881,467 shares under the June 2021 Equity Distribution Agreement for aggregate gross proceeds of approximately $250.0 million,
and net proceeds of approximately $246.2 million, after commissions and fees, prior to its termination in October 2021.
On October 29, 2021, we entered into an equity distribution agreement (the “October 2021 Equity Distribution Agreement”) with
four sales agents pursuant to which we may offer and sell, from time to time, up to an aggregate amount of $250,000,000 of shares of
our common stock in transactions that are deemed to be “at the market” offerings and privately negotiated transactions. Through
September 30, 2022, we issued a total of 3,167,140 shares under the October 2021 Equity Distribution Agreement for aggregate gross
proceeds of approximately $78.3 million, and net proceeds of approximately $77.0 million, after commissions and fees.
Stock Repurchase Agreement
On July 29, 2015, the Company’s Board of Directors authorized the repurchase of up to 400,000 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 904,564 shares of the Company’s common stock. Coupled with the 156,751 shares remaining from the original 400,000
share authorization, the increased authorization brought the total authorization to 1,061,316 shares, representing 10% of the
Company’s then outstanding share count.
28
On December 9, 2021, the Board of Directors approved an increase in the number of shares of the Company’s common stock
available in the stock repurchase program for up to an additional 3,372,399 shares, bringing the remaining authorization under the
stock repurchase program to 3,539,861 shares, representing approximately 10% of the Company’s then outstanding shares of
common stock.
On October 12, 2022, the Board of Directors approved an increase in the number of shares of the Company’s common stock
available in the stock repurchase program for up to an additional 4,300,000 shares, bringing the remaining authorization under the
stock repurchase program to 6,183,601 shares, representing approximately 18% of the Company’s then outstanding shares of
common stock. This stock repurchase program has no termination date.
From the inception of the stock repurchase program through September 30, 2022, the Company repurchased a total of 1,487,362
shares at an aggregate cost of approximately $44.8 million, including commissions and fees, for a weighted average price of $30.12
per share. During the nine months ended September 30, 2022, the Company repurchased a total of 350,260 shares of its common
stock at an aggregate cost of approximately $4.4 million, including commissions and fees, for a weighted average price of $12.68 per
share. Subsequent to September 30, 2022, and through October 27, 2022, the Company repurchased a total of 1,644,044 shares at an
aggregate cost of approximately $14.2 million, including commissions and fees, for a weighted average price of $8.64 per share.
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 Federal Reserve (the “Fed”), the Federal
Housing Financing Agency (the “FHFA”), Federal Housing Administration (the “FHA”), 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
●
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
●
increases in our cost of funds resulting from increases in the Fed Funds rate that are controlled by the Fed which have
occurred, and are likely to continue to occur, in 2022; 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 nine and three months ended September 30, 2022, as compared to
the Company’s results of operations for the nine and three months ended September 30, 2021.
29
Net (Loss) Income Summary
Net loss for the nine months ended September 30, 2022 was $293.4 million, or $8.31 per share. Net loss for the nine months ended
September 30, 2021 was $20.2 million, or $0.95 per share. Net loss for the three months ended September 30, 2022 was $84.5 million, or
$2.40 per share. Net income for the three months ended September 30, 2021 was $26.0 million, or $1.00 per share. The components of
net (loss) income for the nine and three months ended September 30, 2022 and 2021, 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,
2022
2021
Change
2022
2021
Change
Interest income
$
112,735
$
90,279
$
22,456
$
35,610
$
34,169
$
1,441
Interest expense
(32,196)
(5,067)
(27,129)
(21,361)
(1,570)
(19,791)
Net interest income
80,539
85,212
(4,673)
14,249
32,599
(18,350)
Losses on RMBS and derivative contracts
(359,059)
(94,522)
(264,537)
(93,544)
(2,887)
(90,657)
Net portfolio (loss) income
(278,520)
(9,310)
(269,210)
(79,295)
29,712
(109,007)
Expenses
(14,859)
(10,886)
(3,973)
(5,218)
(3,674)
(1,544)
Net (loss) income
$
(293,379)
$
(20,196)
$
(273,183)
$
(84,513)
$
26,038
$
(110,551)
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.
In addition, we have not designated our derivative financial instruments used for hedging purposes as hedges for accounting
purposes, 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.
Described below are the Company’s results of operations for the nine months ended September 30, 2022 and 2021, and for each
quarter in 2022 to date and 2021.
30
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
September 30, 2022
$
(84,513)
$
(93,544)
$
9,031
$
(2.40)
$
(2.66)
$
0.26
June 30, 2022
(60,139)
(82,283)
22,144
(1.70)
(2.32)
0.62
March 31, 2022
(148,727)
(183,232)
34,505
(4.20)
(5.18)
0.98
December 31, 2021
(44,564)
(82,597)
38,033
(1.33)
(2.46)
1.13
September 30, 2021
26,038
(2,887)
28,925
1.01
(0.11)
1.12
June 30, 2021
(16,865)
(40,844)
23,979
(0.85)
(2.05)
1.20
March 31, 2021
(29,369)
(50,791)
21,422
(1.72)
(2.98)
1.26
Nine Months Ended
September 30, 2022
$
(293,379)
$
(359,059)
$
65,680
$
(8.31)
$
(10.16)
$
1.85
September 30, 2021
(20,196)
(94,522)
74,326
(0.96)
(4.49)
3.53
(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 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.
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.
31
The Company from time to time invests in TBAs, which are forward contracts for the purchase or sale of Agency RMBS at a
predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date. The specific Agency RMBS to be
delivered into the contract are not known until shortly before the settlement date. We may choose, prior to settlement, to move the
settlement of these securities out to a later date by entering into a dollar roll transaction. The Agency RMBS purchased or sold for a
forward settlement date are typically priced at a discount to equivalent securities settling in the current month. Consequently, forward
purchases of Agency RMBS and dollar roll transactions represent a form of off-balance sheet financing. These TBAs are accounted for as
derivatives and marked to market through the income statement. Gains or losses on TBAs are included with gains or losses on other
derivative contracts and are not included in interest income for purposes of the discussions below.
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 2022 to date and 2021.
Gains (Losses) on Derivative Instruments
(in thousands)
Funding Hedges
Recognized in
Attributed to
Attributed to
Income
U.S. Treasury and TBA
Current
Future
Statement
Securities Gain (Loss)
Period
Periods
(GAAP)
(Short Positions)
(Long Positions)
(Non-GAAP)
(Non-GAAP)
Three Months Ended
September 30, 2022
$
184,819
$
10,642
$
106
$
5,043
$
169,028
June 30, 2022
103,758
1,013
1,067
1,996
99,682
March 31, 2022
177,816
2,539
27
(1,287)
176,537
December 31, 2021
10,945
2,568
-
(7,949)
16,326
September 30, 2021
5,375
(2,306)
-
(1,248)
8,929
June 30, 2021
(34,915)
(5,963)
-
(5,104)
(23,848)
March 31, 2021
45,472
9,133
(8,559)
(4,044)
48,942
Nine Months Ended
September 30, 2022
$
466,393
$
14,194
$
1,200
$
5,752
$
445,247
September 30, 2021
15,932
864
(8,559)
(10,396)
34,023
32
Economic Interest Expense and Economic Net Interest Income
(in thousands)
Interest Expense on Borrowings
Gains
(Losses) on
Derivative
Instruments
Net Interest Income
GAAP
Attributed
Economic
GAAP
Economic
Interest
Interest
to Current
Interest
Net Interest
Net Interest
Income
Expense
Period
(1)
Expense
(2)
Income
Income
(3)
Three Months Ended
September 30, 2022
$
35,610
$
21,361
$
5,043
$
16,318
$
14,249
$
19,292
June 30, 2022
35,268
8,180
1,996
6,184
27,088
$
29,084
March 31, 2022
41,857
2,655
(1,287)
3,942
39,202
37,915
December 31, 2021
44,421
2,023
(7,949)
9,972
42,398
34,449
September 30, 2021
34,169
1,570
(1,248)
2,818
32,599
31,351
June 30, 2021
29,254
1,556
(5,104)
6,660
27,698
22,594
March 31, 2021
26,856
1,941
(4,044)
5,985
24,915
20,871
Nine Months Ended
September 30, 2022
$
112,735
$
32,196
$
5,752
$
26,444
$
80,539
$
86,291
September 30, 2021
90,279
5,067
(10,396)
15,463
85,212
74,816
(1)
Reflects the effect of derivative instrument hedges for only the period presented.
(2)
Calculated by adding the effect of derivative instrument hedges attributed to the period presented to GAAP interest expense.
(3)
Calculated by adding the effect of derivative instrument hedges attributed to the period presented to GAAP net interest income.
Net Interest Income
During the nine months ended September 30, 2022, we generated $80.5 million of net interest income, consisting of $112.7 million of
interest income from RMBS assets offset by $32.2 million of interest expense on borrowings. For the comparable period ended
September 30, 2021, we generated $85.2 million of net interest income, consisting of $90.3 million of interest income from RMBS assets
offset by $5.1 million of interest expense on borrowings. The $22.5 million increase in interest income was due to a 73 basis point ("bps")
increase in the yield on average RMBS, which was partially offset by a $98.8 million decrease in average RMBS. The $27.1 million
increase in interest expense was due to a 85 bps increase in the average cost of funds, partially offset by a $63.0 million decrease in
average outstanding borrowings.
On an economic basis, our interest expense on borrowings for the nine months ended September 30, 2022 and 2021 was $26.4
million and $15.5 million, respectively, resulting in $86.3 million and $74.8 million of economic net interest income, respectively.
During the three months ended September 30, 2022, we generated $14.2 million of net interest income, consisting of $35.6 million of
interest income from RMBS assets offset by $21.4 million of interest expense on borrowings. For the three months ended September 30,
2021, we generated $32.6 million of net interest income, consisting of $34.2 million of interest income from RMBS assets offset by $1.6
million of interest expense on borrowings. The $1.4 million increase in interest income was due to a 133 bps increase in the yield on
average RMBS, partially offset by a $1,565.3 million decrease in average RMBS. The $19.8 million increase in interest expense was due
to a 235 bps increase in the average cost of funds, partially offset by a $1,417.9 million decrease in average outstanding borrowings.
On an economic basis, our interest expense on borrowings for the three months ended September 30, 2022 and 2021 was $16.3
million and $2.8 million, respectively, resulting in $19.3 million and $31.4 million of economic net interest income, respectively.
33
The tables below provide information on our portfolio average balances, interest income, yield on assets, average borrowings, interest
expense, cost of funds, net interest income and net interest spread for the nine months ended September 30, 2022 and 2021 and each
quarter of 2022 to date and 2021 on both a GAAP and economic basis.
($ in thousands)
Average
Yield on
Interest Expense
Average Cost of Funds
RMBS
Interest
Average
Average
GAAP
Economic
GAAP
Economic
Held
(1)
Income
RMBS
Borrowings
(1)
Basis
Basis
(2)
Basis
Basis
(3)
Three Months Ended
September 30, 2022
$
3,571,037
$
35,610
3.99%
$
3,446,420
$
21,361
$
16,318
2.48%
1.89%
June 30, 2022
4,260,727
35,268
3.31%
4,111,544
8,180
6,184
0.80%
0.60%
March 31, 2022
5,545,844
41,857
3.02%
5,354,107
2,655
3,942
0.20%
0.29%
December 31, 2021
6,056,259
44,421
2.93%
5,728,988
2,023
9,972
0.14%
0.70%
September 30, 2021
5,136,331
34,169
2.66%
4,864,287
1,570
2,818
0.13%
0.23%
June 30, 2021
4,504,887
29,254
2.60%
4,348,192
1,556
6,660
0.14%
0.61%
March 31, 2021
4,032,716
26,856
2.66%
3,888,633
1,941
5,985
0.20%
0.62%
Nine Months Ended
September 30, 2022
$
4,459,203
$
112,735
3.37%
$
4,304,024
$
32,196
$
26,444
1.00%
0.82%
September 30, 2021
4,557,978
90,279
2.64%
4,367,037
5,067
15,463
0.15%
0.47%
($ in thousands)
Net Interest Income
Net Interest Spread
GAAP
Economic
GAAP
Economic
Basis
Basis
(2)
Basis
Basis
(4)
Three Months Ended
September 30, 2022
$
14,249
$
19,292
1.51%
2.10%
June 30, 2022
27,088
29,084
2.51%
2.71%
March 31, 2022
39,202
37,915
2.82%
2.73%
December 31, 2021
42,398
34,449
2.79%
2.23%
September 30, 2021
32,599
31,351
2.53%
2.43%
June 30, 2021
27,698
22,594
2.46%
1.99%
March 31, 2021
24,915
20,871
2.46%
2.04%
Nine Months Ended
September 30, 2022
$
80,539
$
86,291
2.37%
2.55%
September 30, 2021
85,212
74,816
2.49%
2.17%
(1)
Portfolio yields and costs of borrowings presented in the tables above and the tables on pages 34 and 35 are calculated based on the
average balances of the underlying investment portfolio/borrowings balances and are annualized for the periods presented. Average
balances for quarterly periods are calculated using two data points, the beginning and ending balances.
(2)
Economic interest expense and economic net interest income
presented in the table above and the tables on page 35 includes the effect
of our derivative instrument hedges for only the periods presented.
(3) Represents interest cost of our borrowings and the effect of derivative instrument hedges attributed to the period divided by average
RMBS.
(4) Economic net interest spread is calculated by subtracting average economic cost of funds from realized yield on average RMBS.
Interest Income and Average Asset Yield
Our interest income for the nine months ended September 30, 2022 and 2021 was $112.7 million and $90.3 million, respectively. We
had average RMBS holdings of $4,459.2 million and $4,558.0 million for the nine months ended September 30, 2022 and 2021,
respectively. The yield on our portfolio was 3.37% and 2.64% for the nine months ended September 30, 2022 and 2021, respectively. For
the nine months ended September 30, 2022, as compared to the nine months ended September 30, 2021, there was a $22.5 million
increase in interest income due to the 73 bps increase in the yield on average RMBS, partially offset by the $98.8 million decrease in
average RMBS.
34
Our interest income for the three months ended September 30, 2022 and 2021 was $35.6 million and $34.2 million, respectively. We
had average RMBS holdings of $3,571.0 million and $5,136.3 million for the three months ended September 30, 2022 and 2021,
respectively. The yield on our portfolio was 3.99% and 2.66% for the three months ended September 30, 2022 and 2021, respectively. For
the three months ended September 30, 2022, as compared to the three months ended September 30, 2021, there was a $1.4 million
increase in interest income due to
the 133 bps increase in the yield on average RMBS, partially offset by the $1,565.3 million decrease in
average RMBS.
The table below presents the average portfolio size, income and yields of our respective sub-portfolios, consisting of structured RMBS
and PT RMBS, for the nine months ended September 30, 2022 and 2021, and for each quarter of 2022 to date and 2021.
($ in thousands)
Average RMBS Held
Interest Income
Realized Yield on Average RMBS
PT
Structured
PT
Structured
PT
Structured
RMBS
RMBS
Total
RMBS
RMBS
Total
RMBS
RMBS
Total
Three Months Ended
September 30, 2022
$
3,458,277
$
112,760
$
3,571,037
$
32,297
$
3,313
$
35,610
3.74%
11.75%
3.99%
June 30, 2022
4,069,334
191,393
4,260,727
31,894
3,374
35,268
3.14%
7.05%
3.31%
March 31, 2022
5,335,353
210,491
5,545,844
40,066
1,791
41,857
3.00%
3.40%
3.02%
December 31, 2021
5,878,376
177,883
6,056,259
42,673
1,748
44,421
2.90%
3.93%
2.93%
September 30, 2021
5,016,550
119,781
5,136,331
33,111
1,058
34,169
2.64%
3.53%
2.66%
June 30, 2021
4,436,135
68,752
4,504,887
29,286
(32)
29,254
2.64%
(0.18)%
2.60%
March 31, 2021
3,997,965
34,751
4,032,716
26,869
(13)
26,856
2.69%
(0.15)%
2.66%
Nine Months Ended
September 30, 2022
$
4,287,655
$
171,548
$
4,459,203
$
104,257
$
8,478
$
112,735
3.24%
6.59%
3.37%
September 30, 2021
4,483,550
74,428
4,557,978
89,266
1,013
90,279
2.65%
1.81%
2.64%
Interest Expense and the Cost of Funds
We had average outstanding borrowings of $4,304.0 million and $4,367.0 million and total interest expense of $32.2 million and $5.1
million for the nine months ended September 30, 2022 and 2021, respectively. Our average cost of funds was 1.00% for the nine months
ended September 30, 2022, compared to 0.15% for the comparable period in 2021. The $27.1 million increase in interest expense was
due to the 85 bps increase in the average cost of funds, partially offset by the $63.0 million decrease in average outstanding borrowings
during the nine months ended September 30, 2022, as compared to the nine months ended September 30, 2021.
Our economic interest expense was $26.4 million and $15.5 million for the nine months ended September 30, 2022 and 2021,
respectively. There was a 35 bps increase in the average economic cost of funds to 0.82% for the nine months ended September 30,
2022, from 0.47% for the nine months ended September 30, 2021.
We had average outstanding borrowings of $3,446.4 million and $4,864.3 million and total interest expense of $21.4 million and $1.6
million for the three months ended September 30, 2022 and 2021, respectively. Our average cost of funds was 2.48% and 0.13% for three
months ended September 30, 2022 and 2021, respectively. There was a 235 bps increase in the average cost of funds and a $1,417.9
million decrease in average outstanding borrowings during the three months ended September 30, 2022, compared to the three months
ended September 30, 2021.
Our economic interest expense was $16.3 million and $2.8 million for the three months ended September 30, 2022 and 2021,
respectively. There was a 166 bps increase in the average economic cost of funds to 1.89% for the three months ended September 30,
2022 from 0.23% for the three months ended September 30, 2021.
35
Since all of our repurchase agreements are short-term, changes in market rates directly affect our interest expense. Our average cost
of funds calculated on a GAAP basis was 29 bps above the average one-month LIBOR and 81 bps below the average six-month LIBOR
for the quarter ended September 30, 2022. Our average economic cost of funds was 30 bps below the average one-month LIBOR and
140 bps below the average six-month LIBOR for the quarter ended September 30, 2022. The average term to maturity of the outstanding
repurchase agreements was 29 days at September 30, 2022 and 27 days at December 31, 2021.
The tables below present the average balance of borrowings outstanding, interest expense and average cost of funds, and average
one-month and six-month LIBOR rates for the nine months ended September 30, 2022 and 2021, and for each quarter in 2022 to date and
2021 on both a GAAP and economic basis.
($ in thousands)
Average
Interest Expense
Average Cost of Funds
Balance of
GAAP
Economic
GAAP
Economic
Borrowings
Basis
Basis
Basis
Basis
Three Months Ended
September 30, 2022
$
3,446,420
$
21,361
$
16,318
2.48%
1.89%
June 30, 2022
4,111,544
8,180
6,184
0.80%
0.60%
March 31, 2022
5,354,107
2,655
3,942
0.20%
0.29%
December 31, 2021
5,728,988
2,023
9,972
0.14%
0.70%
September 30, 2021
4,864,287
1,570
2,818
0.13%
0.23%
June 30, 2021
4,348,192
1,556
6,660
0.14%
0.61%
March 31, 2021
3,888,633
1,941
5,985
0.20%
0.62%
Nine Months Ended
September 30, 2022
$
4,304,024
$
32,196
$
26,444
1.00%
0.82%
September 30, 2021
4,367,037
5,067
15,463
0.15%
0.47%
Average GAAP Cost of Funds
Average Economic Cost of Funds
Relative to Average
Relative to Average
Average LIBOR
One-Month
Six-Month
One-Month
Six-Month
One-Month
Six-Month
LIBOR
LIBOR
LIBOR
LIBOR
Three Months Ended
September 30, 2022
2.19%
3.29%
0.29%
(0.81)%
(0.30)%
(1.40)%
June 30, 2022
0.93%
1.90%
(0.13)%
(1.10)%
(0.33)%
(1.30)%
March 31, 2022
0.25%
0.76%
(0.05)%
(0.56)%
0.04%
(0.47)%
December 31, 2021
0.09%
0.23%
0.05%
(0.09)%
0.61%
0.47%
September 30, 2021
0.09%
0.16%
0.04%
(0.03)%
0.14%
0.07%
June 30, 2021
0.10%
0.18%
0.04%
(0.04)%
0.51%
0.43%
March 31, 2021
0.13%
0.23%
0.07%
(0.03)%
0.49%
0.39%
Nine Months Ended
September 30, 2022
1.12%
1.98%
(0.12)%
(0.98)%
(0.30)%
(1.16)%
September 30, 2021
0.10%
0.19%
0.05%
(0.04)%
0.37%
0.28%
36
Gains or Losses
The table below presents our gains or losses for the nine and three months ended September 30, 2022 and 2021.
(in thousands)
Nine Months Ended September 30,
Three Months Ended September 30,
2022
2021
Change
2022
2021
Change
Realized (losses) gains on sales of RMBS
$
(132,672)
$
(3,068)
$
(129,604)
$
(66,143)
$
2,977
$
(69,120)
Unrealized losses on RMBS
(692,781)
(107,386)
(585,395)
(212,221)
(11,239)
(200,982)
Total losses on RMBS
(825,453)
(110,454)
(714,999)
(278,364)
(8,262)
(270,102)
Gains on interest rate futures
207,681
852
206,829
84,713
574
84,139
Gains on interest rate swaps
172,069
12,446
159,623
65,966
3,000
62,966
(Losses) gains on payer swaptions (short positions)
(80,183)
3,507
(83,690)
(35,239)
2,295
(37,534)
Gains on payer swaptions (long positions)
150,445
5,477
144,968
59,131
1,767
57,364
Gains (losses) on interest rate caps
988
-
988
(499)
-
(499)
Gains (losses) on interest rate floors
-
1,345
(1,345)
-
45
(45)
Gains (losses) on TBA securities (short positions)
14,194
864
13,330
10,642
(2,306)
12,948
Gains (losses) on TBA securities (long positions)
1,200
(8,559)
9,759
106
-
106
Total gains from derivative instruments
466,394
15,932
450,462
184,820
5,375
179,445
We invest in RMBS with the intent to earn net income from the realized yield on those assets over their related funding and hedging
costs, and not for the purpose of making short term gains from sales. However, we have sold, and may continue to sell, existing assets to
acquire new assets, which our management believes might have higher risk-adjusted returns in light of current or anticipated interest rates,
federal government programs or general economic conditions or to manage our balance sheet as part of our asset/liability management
strategy. During the nine months ended September 30, 2022 and 2021, we received proceeds of $2,731.5 million and $2,598.9 million,
respectively, from the sales of RMBS. During the three months ended September 30, 2022 and 2021, we received proceeds of $796.9
million and $918.0 million, respectively, from the sales of RMBS.
Realized and unrealized gains and losses on RMBS are driven in part by changes in yields and interest rates, the spreads that
Agency RMBS trade relative to comparable duration U.S. Treasuries or swaps, as well as varying levels of demand for RMBS, which affect
the pricing of the securities in our portfolio. The unrealized gains and losses on RMBS may also include the premium lost as a result of
prepayments on the underlying mortgages, decreasing unrealized gains or increasing unrealized losses as speeds or premiums increase.
To the extent RMBS are carried at a discount to par, unrealized gains or losses on RMBS would also include discount accreted as a result
of prepayments on the underlying mortgages, increasing unrealized gains or decreasing unrealized losses as speeds on discounts
increase. Gains and losses on interest rate futures contracts are affected by changes in implied forward rates during the reporting period.
The table below presents historical interest rate data for each quarter end during 2022 to date and 2021.
5 Year
10 Year
15 Year
30 Year
Three
U.S. Treasury
U.S. Treasury
Fixed-Rate
Fixed-Rate
Month
Rate
(1)
Rate
(1)
Mortgage Rate
(2)
Mortgage Rate
(2)
LIBOR
(3)
September 30, 2022
4.04%
3.80%
5.35%
6.11%
3.45%
June 30, 2022
3.00%
2.97%
4.65%
5.52%
1.97%
March 31, 2022
2.42%
2.33%
3.39%
4.17%
0.84%
December 31, 2021
1.26%
1.51%
2.35%
3.10%
0.21%
September 30, 2021
1.00%
1.53%
2.18%
2.90%
0.12%
June 30, 2021
0.87%
1.44%
2.27%
2.98%
0.13%
March 31, 2021
0.94%
1.75%
2.39%
3.08%
0.19%
(1)
Historical 5 and 10 Year U.S. Treasury Rates are obtained from quoted end of day prices on the Chicago Board Options Exchange.
(2)
Historical 30 Year and 15 Year Fixed Rate Mortgage Rates are obtained from Freddie Mac’s Primary Mortgage Market Survey.
(3)
Historical LIBOR is obtained from the Intercontinental Exchange Benchmark Administration Ltd.
37
Expenses
For the nine and three months ended September 30, 2022, the Company’s total operating expenses were approximately $14.9 million
and $5.2 million, respectively, compared to approximately $10.9 million and $3.7 million, respectively, for the nine and three months ended
September 30, 2021. The table below presents a breakdown of operating expenses for the nine and three months ended September 30,
2022 and 2021.
(in thousands)
Nine Months Ended September 30,
Three Months Ended September 30,
2022
2021
Change
2022
2021
Change
Management fees
$
7,881
$
5,569
$
2,312
$
2,616
$
2,156
$
460
Overhead allocation
1,482
1,189
293
522
390
132
Accrued incentive compensation
763
884
(121)
212
259
(47)
Directors fees and liability insurance
929
874
55
308
279
29
Audit, legal and other professional fees
899
832
67
293
212
81
Direct REIT operating expenses
2,281
1,024
1,257
1,064
309
755
Other administrative
624
514
110
203
69
134
Total expenses
$
14,859
$
10,886
$
3,973
$
5,218
$
3,674
$
1,544
Direct REIT operating expenses were higher in both the nine and three month periods ended September 30, 2022, as compared to
the same periods in 2021 primarily due to increased commissions and fees related to the Company’s interest rate derivative positions.
We are externally managed and advised by Bimini Advisors, LLC (the “Manager”) pursuant to the terms of a management
agreement. The management agreement has been renewed through February 20, 2023 and provides for automatic one-year extension
options thereafter and is subject to certain termination rights. Under the terms of the management agreement, the Manager is
responsible for administering the business activities and day-to-day operations of the Company. The Manager receives a monthly
management fee in the amount of:
●
One-twelfth of 1.5% of the first $250 million of the Company’s month end equity, as defined in the management agreement,
●
One-twelfth of 1.25% of the Company’s month end equity that is greater than $250 million and less than or equal to $500
million, and
●
One-twelfth of 1.00% of the Company’s month end equity that is greater than $500 million.
Should the Company terminate the management agreement without cause, it will pay the Manager a termination fee equal to three
times the average annual management fee, as defined in the management agreement, before or on the last day of the term of the
agreement.
The Company is obligated to reimburse the Manager for any direct expenses incurred on its behalf and to pay the Manager the
Company’s pro rata portion of certain overhead costs set forth in the management agreement.
On April 1, 2022, pursuant to the third amendment to the management agreement entered into on November 16, 2021, the
Manager began providing certain repurchase agreement trading, clearing and administrative services to the Company that had been
previously provided by AVM, L.P. under an agreement terminated on March 31, 2022. In consideration for such services, the Company
will pay the following fees to the Manager:
●
A daily fee equal to the outstanding principal balance of repurchase agreement funding in place as of the end of such day
multiplied by 1.5 basis points for the amount of aggregate outstanding principal balance less than or equal to $5 billion, and
multiplied by 1.0 basis point for any amount of aggregate outstanding principal balance in excess of $5 billion, and
●
A fee for the clearing and operational services provided by personnel of the Manager equal to $10,000 per month.
38
The following table summarizes the management fee and overhead allocation expenses for the nine months ended September 30,
2022 and 2021, and for each quarter in 2022 to date and 2021.
($ in thousands)
Average
Average
Advisory Services
Orchid
Orchid
Management
Overhead
Three Months Ended
MBS
Equity
Fee
Allocation
Total
September 30, 2022
$
3,571,037
$
839,935
$
2,616
$
522
$
3,138
June 30, 2022
4,260,727
866,539
2,631
519
3,150
March 31, 2022
5,545,844
853,576
2,634
441
3,075
December 31, 2021
6,056,259
806,382
2,587
443
3,030
September 30, 2021
5,136,331
672,384
2,156
390
2,546
June 30, 2021
4,504,887
542,679
1,792
395
2,187
March 31, 2021
4,032,716
456,687
1,621
404
2,025
Nine Months Ended
September 30, 2022
$
4,459,203
$
853,350
$
7,881
$
1,482
$
9,363
September 30, 2021
4,557,978
557,250
5,569
1,189
6,758
Financial Condition:
Mortgage-Backed Securities
As of September 30, 2022, our RMBS portfolio consisted of $3,201.2 million of Agency RMBS at fair value and had a weighted
average coupon on assets of 3.31%. During the nine months ended September 30, 2022, we received principal repayments of $376.2
million compared to $413.0 million for the nine months ended September 30, 2021. The average three month prepayment speeds for the
quarters ended September 30, 2022 and 2021 were 6.5% and 12.4%, respectively.
The following table presents the 3-month constant prepayment rate (“CPR”) experienced on our structured and PT RMBS sub-
portfolios, on an annualized basis, for the quarterly periods presented. CPR is a method of expressing the prepayment rate for a mortgage
pool that assumes that a constant fraction of the remaining principal is prepaid each month or year. Specifically, the CPR in the chart
below represents the three month prepayment rate of the securities in the respective asset category.
Structured
PT RMBS
RMBS
Total
Three Months Ended
Portfolio (%)
Portfolio (%)
Portfolio (%)
September 30, 2022
6.1
10.4
6.5
June 30, 2022
8.3
13.7
9.4
March 31, 2022
8.1
19.5
10.7
December 31, 2021
9.0
24.6
11.4
September 30, 2021
9.8
25.1
12.4
June 30, 2021
10.9
29.9
12.9
March 31, 2021
9.9
40.3
12.0
39
The following tables summarize certain characteristics of the Company’s PT RMBS and structured RMBS as of September 30, 2022
and December 31, 2021:
($ in thousands)
Weighted
Percentage
Average
of
Weighted
Maturity
Fair
Entire
Average
in
Longest
Asset Category
Value
Portfolio
Coupon
Months
Maturity
September 30, 2022
Fixed Rate RMBS
$
3,150,403
98.4%
3.30%
341
1-Aug-52
Interest-Only Securities
50,274
1.6%
3.72%
278
25-Nov-51
Inverse Interest-Only Securities
537
0.0%
1.51%
289
15-Jun-42
Total Mortgage Assets
$
3,201,214
100.0%
3.31%
336
1-Aug-52
December 31, 2021
Fixed Rate RMBS
$
6,298,189
96.7%
2.93%
342
1-Dec-51
Interest-Only Securities
210,382
3.2%
3.40%
263
25-Jan-52
Inverse Interest-Only Securities
2,524
0.1%
3.75%
300
15-Jun-42
Total Mortgage Assets
$
6,511,095
100.0%
3.03%
325
25-Jan-52
($ in thousands)
September 30, 2022
December 31, 2021
Percentage of
Percentage of
Agency
Fair Value
Entire Portfolio
Fair Value
Entire Portfolio
Fannie Mae
$
2,231,699
69.7%
$
4,719,349
72.5%
Freddie Mac
969,515
30.3%
1,791,746
27.5%
Total Portfolio
$
3,201,214
100.0%
$
6,511,095
100.0%
September 30, 2022
December 31, 2021
Weighted Average Pass-through Purchase Price
$
107.06
$
107.19
Weighted Average Structured Purchase Price
$
18.08
$
15.21
Weighted Average Pass-through Current Price
$
89.44
$
105.31
Weighted Average Structured Current Price
$
17.32
$
14.08
Effective Duration
(1)
5.800
3.390
(1)
Effective duration is the approximate percentage change in price for a 100 bps change in rates. An effective duration of 5.800 indicates that an
interest rate increase of 1.0% would be expected to cause a 5.800% decrease in the value of the RMBS in the Company’s investment portfolio
at September 30, 2022. An effective duration of 3.390 indicates that an interest rate increase of 1.0% would be expected to cause a 3.390%
decrease in the value of the RMBS in the Company’s investment portfolio at December 31, 2021. These figures include the structured securities
in the portfolio, but do not include the effect of the Company’s funding cost hedges. Effective duration quotes for individual investments are
obtained from The Yield Book, Inc.
The following table presents a summary of portfolio assets acquired during the nine months ended September 30, 2022 and 2021,
including securities purchased during the period that settled after the end of the period, if any.
($ in thousands)
2022
2021
Total Cost
Average
Price
Weighted
Average
Yield
Total Cost
Average
Price
Weighted
Average
Yield
Pass-through RMBS
$
622,535
$
100.66
4.24%
$
4,871,121
$
106.96
1.56%
Structured RMBS
-
-
-
125,728
13.04
3.80%
40
Borrowings
As of September 30, 2022, we had established borrowing facilities in the repurchase agreement market with a number of commercial
banks and other financial institutions and had borrowings in place with 20 of these counterparties. None of these lenders are affiliated with
the Company. These borrowings are secured by the Company’s RMBS and cash, and bear interest at prevailing market rates. We believe
our established repurchase agreement borrowing facilities provide borrowing capacity in excess of our needs.
As of September 30, 2022, we had obligations outstanding under the repurchase agreements of approximately $3,133.9 million with a
net weighted average borrowing cost of 3.00%. The remaining maturity of our outstanding repurchase agreement obligations ranged from
3 to 122 days, with a weighted average remaining maturity of 29 days. Securing the repurchase agreement obligations as of September
30, 2022 are RMBS with an estimated fair value, including accrued interest, of approximately $3,206.4 million and a weighted average
maturity of 345 months, and cash pledged to counterparties of approximately $49.4 million. Through October 27, 2022, we have been able
to maintain our repurchase facilities with comparable terms to those that existed at September 30, 2022, with maturities through January
30, 2023.
The table below presents information about our period end, maximum and average balances of borrowings for each quarter in
2022 to date and 2021.
($ in thousands)
Difference Between Ending
Ending
Maximum
Average
Borrowings and
Balance of
Balance of
Balance of
Average Borrowings
Three Months Ended
Borrowings
Borrowings
Borrowings
Amount
Percent
September 30, 2022
$
3,133,861
$
4,047,606
$
3,446,420
$
(312,559)
(9.07)%
June 30, 2022
3,758,980
4,464,544
4,111,544
(352,564)
(8.57)%
March 31, 2022
4,464,109
6,244,106
5,354,107
(889,998)
(16.62)%
(1)
December 31, 2021
6,244,106
6,419,689
5,728,988
515,118
8.99%
September 30, 2021
5,213,869
5,214,254
4,864,287
349,582
7.19%
June 30, 2021
4,514,704
4,517,953
4,348,192
166,512
3.83%
March 31, 2021
4,181,680
4,204,935
3,888,633
293,047
7.54%
(1)
The lower ending balance relative to the average balance during the quarter ended March 31, 2022 reflects the disposal of RMBS pledged as
collateral. During the quarter ended March 31, 2022, the Company’s investment in RMBS decreased $510.4 million.
Liquidity and Capital Resources
Liquidity is our ability to turn non-cash assets into cash, purchase additional investments, repay principal and interest on borrowings,
fund overhead, fulfill margin calls and pay dividends. We have both internal and external sources of liquidity. However, our material
unused sources of liquidity include cash balances, unencumbered assets and our ability to sell encumbered assets to raise cash. Our
balance sheet also generates liquidity on an on-going basis through payments of principal and interest we receive on our RMBS portfolio.
Management believes that we currently have sufficient liquidity and capital resources available for (a) the acquisition of additional
investments consistent with the size and nature of our existing RMBS portfolio, (b) the repayments on borrowings and (c) the payment of
dividends to the extent required for our continued qualification as a REIT. We may also generate liquidity from time to time by selling our
equity or debt securities in public offerings or private placements.
41
Internal Sources of Liquidity
Our internal sources of liquidity include our cash balances, unencumbered assets and our ability to liquidate our encumbered security
holdings. Our balance sheet also generates liquidity on an on-going basis through payments of principal and interest we receive on our
RMBS portfolio. Because our PT RMBS portfolio consists entirely of government and agency securities, we do not anticipate having
difficulty converting our assets to cash should our liquidity needs ever exceed our immediately available sources of cash. Our structured
RMBS portfolio also consists entirely of governmental agency securities, although they typically do not trade with comparable bid / ask
spreads as PT RMBS. However, we anticipate that we would be able to liquidate such securities readily, even in distressed markets,
although we would likely do so at prices below where such securities could be sold in a more stable market. To enhance our liquidity even
further, we may pledge a portion of our structured RMBS as part of a repurchase agreement funding, but retain the cash in lieu of acquiring
additional assets. In this way we can, at a modest cost, retain higher levels of cash on hand and decrease the likelihood we will have to
sell assets in a distressed market in order to raise cash.
Our strategy for hedging our funding costs typically involves taking short positions in interest rate futures, treasury futures, interest rate
swaps, interest rate swaptions or other instruments. When the market causes these short positions to decline in value we are required to
meet margin calls with cash. This can reduce our liquidity position to the extent other securities in our portfolio move in price in such a way
that we do not receive enough cash via margin calls to offset the derivative related margin calls. If this were to occur in sufficient
magnitude, the loss of liquidity might force us to reduce the size of the levered portfolio, pledge additional structured securities to raise
funds or risk operating the portfolio with less liquidity.
External Sources of Liquidity
Our primary external sources of liquidity are our ability to (i) borrow under master repurchase agreements, (ii) use the TBA security
market and (iii) sell our equity or debt securities in public offerings or private placements. Our borrowing capacity will vary over time as the
market value of our interest earning assets varies. Our master repurchase agreements have no stated expiration, but can be terminated at
any time at our option or at the option of the counterparty. However, once a definitive repurchase agreement under a master repurchase
agreement has been entered into, it generally may not be terminated by either party. A negotiated termination can occur, but may involve
a fee to be paid by the party seeking to terminate the repurchase agreement transaction.
Under our repurchase agreement funding arrangements, we are required to post margin at the initiation of the borrowing. The margin
posted represents the haircut, which is a percentage of the market value of the collateral pledged. To the extent the market value of the
asset collateralizing the financing transaction declines, the market value of our posted margin will be insufficient and we will be required to
post additional collateral. Conversely, if the market value of the asset pledged increases in value, we would be over collateralized and we
would be entitled to have excess margin returned to us by the counterparty. Our lenders typically value our pledged securities daily to
ensure the adequacy of our margin and make margin calls as needed, as do we. Typically, but not always, the parties agree to a minimum
threshold amount for margin calls so as to avoid the need for nuisance margin calls on a daily basis.
Our master repurchase agreements
do not specify the haircut; rather haircuts are determined on an individual repurchase transaction basis. Throughout the nine months
ended September 30, 2022, haircuts on our pledged collateral remained stable and as of September 30, 2022, our weighted average
haircut was approximately 4.6% of the value of our collateral.
TBAs represent a form of off-balance sheet financing and are accounted for as derivative instruments. (See Note 4 to our Financial
Statements in this Form 10-Q for additional details on our TBAs). Under certain market conditions, it may be uneconomical for us to roll our
TBAs into future months and we may need to take or make physical delivery of the underlying securities. If we were required to take
physical delivery to settle a long TBA, we would have to fund our total purchase commitment with cash or other financing sources and our
liquidity position could be negatively impacted.
42
Our TBAs are also subject to margin requirements governed by the Mortgage-Backed Securities Division ("MBSD") of the FICC and
by our Master Securities Forward Transaction Agreements (“MSFTAs”), which may establish margin levels in excess of the MBSD. Such
provisions require that we establish an initial margin based on the notional value of the TBA, which is subject to increase if the estimated
fair value of our TBAs or the estimated fair value of our pledged collateral declines. The MBSD has the sole discretion to determine the
value of our TBAs and of the pledged collateral securing such contracts. In the event of a margin call, we must generally provide additional
collateral on the same business day.
Settlement of our TBA obligations by taking delivery of the underlying securities as well as satisfying margin requirements could
negatively impact our liquidity position. However, since we do not use TBA dollar roll transactions as our primary source of financing, we
believe that we will have adequate sources of liquidity to meet such obligations.
We invest a portion of our capital in structured Agency RMBS. We generally do not apply leverage to this portion of our portfolio. The
leverage inherent in structured securities replaces the leverage obtained by acquiring PT securities and funding them in the repurchase
market. This structured RMBS strategy has been a core element of the Company’s overall investment strategy since inception. However,
we have and may continue to pledge a portion of our structured RMBS in order to raise our cash levels, but generally will not pledge these
securities in order to acquire additional assets.
In future periods, we expect to continue to finance our activities in a manner that is consistent with our current operations through
repurchase agreements. As of September 30, 2022, we had cash and cash equivalents of $214.2 million. We generated cash flows of
$496.2 million from principal and interest payments on our RMBS and had average repurchase agreements outstanding of $4,304.0 million
during the nine months ended September 30, 2022.
As described more fully below, we may also access liquidity by selling our equity or debt securities in public offerings or private
placements.
Stockholders’ Equity
On August 4, 2020, we entered into the August 2020 Equity Distribution Agreement with four sales agents pursuant to which we
could offer and sell, from time to time, up to an aggregate amount of $150,000,000 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 5,538,730 shares under the
August 2020 Equity Distribution Agreement for aggregate gross proceeds of approximately $150.0 million, and net proceeds of
approximately $147.4 million, after commissions and fees, prior to its termination in June 2021.
On January 20, 2021, we entered into the January 2021 Underwriting Agreement with J.P. Morgan Securities LLC (“J.P. Morgan”),
relating to the offer and sale of 1,520,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from
the Company pursuant to the January 2021 Underwriting Agreement at $26.00 per share. In addition, we granted J.P. Morgan a 30-day
option to purchase up to an additional 228,000 shares of our common stock on the same terms and conditions, which J.P. Morgan
exercised in full on January 21, 2021. The closing of the offering of 1,748,000 shares of our common stock occurred on January 25,
2021, with proceeds to us of approximately $45.2 million, net of offering expenses.
On March 2, 2021, we entered into the March 2021 Underwriting Agreement with J.P. Morgan, relating to the offer and sale of
1,600,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from the Company pursuant to the
March 2021 Underwriting Agreement at $27.25 per share. In addition, we granted J.P. Morgan a 30-day option to purchase up to an
additional 240,000 shares of our common stock on the same terms and conditions, which J.P. Morgan exercised in full on March 3,
2021. The closing of the offering of 1,840,000 shares of our common stock occurred on March 5, 2021, with proceeds to us of
approximately $50.0 million, net of offering expenses payable.
43
On June 22, 2021, we entered into the June 2021 Equity Distribution Agreement with four sales agents pursuant to which we may
could offer and sell, from time to time, up to an aggregate amount of $250,000,000 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 9,881,467 shares under the
June 2021 Equity Distribution Agreement for aggregate gross proceeds of approximately $250.0 million, and net proceeds of
approximately $246.2 million, after commissions and fees, prior to its termination in October 2021.
On October 29, 2021, we entered into the October 2021 Equity Distribution Agreement with four sales agents pursuant to which
we may offer and sell, from time to time, up to an aggregate amount of $250,000,000 of shares of our common stock in transactions
that are deemed to be “at the market” offerings and privately negotiated transactions. Through September 30, 2022, we issued a total
of 3,167,140 shares under the October 2021 Equity Distribution Agreement for aggregate gross proceeds of approximately $78.3
million, and net proceeds of approximately $77.0 million, after commissions and fees.
Outlook
Economic Summary
The evolution of economic and market developments pivoted in the third quarter of 2022. Trends in place since late 2021 have
changed in the third quarter. The outlook for the domestic economy of the United States, particularly with respect to inflation, the level of
interest rates and expectations for monetary policy from the Fed changed during the quarter. As the second quarter of 2022 ended, the
market expected that the monetary tightening policies implemented by the Fed to control inflation would soon succeed, and that by early in
2023 the Fed would likely start to unwind their rate increases in order to avert an economic slowdown resulting from these policies. The
catalyst for the changes that occurred during the third quarter of 2022 was clear evidence that not only was inflation persisting, but that it
was becoming more broad based and entrenched. As the Fed and the various members of the FOMC became aware of this, their public
comments consistently sought to dispel the notion that they would be easing monetary policy in early 2023 as the futures markets were
pricing. As the quarter unfolded and the inflation data continued to reflect this trend, the market grew to accept that the Fed would have to
raise the Fed Funds target further into restrictive territory. The inflation data for September of 2022, released in early October of 2022, was
again very strong and broad based. The market now expects the terminal rate to approach 5% and the Fed to raise the Fed Funds rate by
at least 125 basis points during the fourth quarter of 2022 alone. The incoming economic data – other than inflationary data – has
generally been very strong as well, implying the Fed rate increases have yet to have an impact on the economy other than the most rate
sensitive sectors.
Contributing to the change in economic and interest rate trends were developments abroad, particularly in Europe and the United
Kingdom. While inflation has proven to be more robust and challenging to control in the U.S., it has been even more so in Europe and
most of the world outside of China, which is grappling with persistent COVID-19 cases that have forced the government to intermittently
lock down various population centers. The war in Ukraine has contributed significantly to food and energy price pressures globally, more
so than in the U.S. The result is essentially all central banks across the globe – outside of China and Japan – are raising rates. Like the
Fed, the central banks’ efforts have yet to slow inflation and more rate hikes are very likely. Food and energy inflation poses additional
pressure on governments who are eager to ease the burden of elevated prices for essentials like food and energy, but are constrained
because their efforts themselves might increase inflationary pressures and run counter to central bank actions that are attempting to
constrain economic activity and demand.
A further complicating factor has been the U.S. dollar. As the Fed is forced to continue to raise rates in the U.S., the dollar has
appreciated against all other currencies. This in turn forces other central banks to raise rates to protect their own currencies, often above
and beyond what their domestic economic circumstances might warrant.
Risk sentiment is at extremely depressed levels and all asset classes across the financial markets have generated negative year-to-
date returns for 2022, outside of energy and certain food commodities. Economic growth is expected to continue to slow over the balance
of the year, both in the U.S. and globally, and likely contract in 2023.
44
Interest Rates
As the market incorporated inflation data and the Fed’s response through the second quarter of 2022, interest rates began to rise
materially. On August 1, 2022, the 10-year U.S. Treasury Note closed with a yield of 2.5759%, shortly before the FOMC began to temper
market expectations that the Fed would pivot away from their tightening and begin to lower the Fed Funds rate in early 2023. The yield on
the 10-year U.S. Treasury Note closed just above 3.83% on September 30, 2022, and surpassed 4% in October of 2022. This increase
was much less than the increase in short-term rates. Interest rates on U.S. Treasury Note maturities inside one year increased by well
over 100 basis points and by more than 160 basis points for maturities of three months or less – in each case by the end of the third
quarter of 2022. In the case of U.S. Treasury Note maturities of three or fewer months, such increases are over 230 basis points as of
October 26, 2022. As of September 30, 2022, market pricing implied the terminal rate for the current cycle would be approximately 4.53%,
which would be reached late in the first quarter of 2023. As of October 26, 2022, pricing is for a terminal rate of approximately 4.85%
sometime late in the second quarter of 2023 and with the Fed Funds rate still approximately 4.40% in early 2024.
The Fed has repeatedly acknowledged their efforts to bring inflation under control and taking the Fed Funds rate above neutral may
cause the economy to enter a recession. They deem these steps as necessary to prevent inflation from remaining higher than the Fed’s
target rate of inflation. However, as it appears the Fed will have to increase the Fed Funds rate considerably higher than was believed to
be the case even a few months ago, and central banks across the globe are doing likewise, financial conditions have begun to deteriorate
and liquidity in many financial markets has declined. If such trends persist and evidence appears that certain financial markets are not
operating smoothly, or financial conditions are prohibiting economic activity from operating smoothly, central banks may face a dilemma of
continuing to increase the Fed Funds rate or implementing accommodations to permit the smooth operation of financial markets and the
economy – assuming this were to occur before inflation could be brought under control. The outcome in such a scenario cannot be
predicted with any confidence.
The Agency RMBS Market
Returns for the Agency RMBS market for the third quarter of 2022 were (5.4)% and these returns were 1.7% lower than comparable
duration LIBOR swaps. The largest RMBS investors have generally been selling or decreasing their exposure to the sector. Agency
RMBS spreads relative to benchmark interest rates increased to levels observed in March of 2020 by the end of the third quarter of 2022
and have exceeded those levels in October of 2022. The largest investors of Agency RMBS, the Fed via quantitative easing (which is now
quantitative tightening as the Fed allows their holdings of Agency RMBS to run-off), large domestic banks (which due to quantitative
tightening by the Fed are experiencing declines in reserves/deposits) and large money managers (which have experienced significant
outflows as investors leave fixed income investments), are collectively causing demand for Agency RMBS to decline materially and driving
the spread widening. As the U.S. dollar has strengthened against most other currencies across the globe, there is the chance certain
central banks – namely the Bank of Japan – may be forced to intervene in the currency markets to support their local currency, in this case
the Yen. They would do so by selling U.S. dollar-denominated assets and buying Yen. The only U.S. dollar-denominated assets they own
are U.S. Treasuries and Agency RMBS, and selling these would represent another source of downward pressure on Agency RMBS. The
relative performance across the Agency RMBS universe was skewed in favor of higher coupon, 30-year securities that are currently in
production by originators. Lower coupon securities, especially those held in large amounts by the Fed, and which may eventually be sold
by the Fed, have performed the worst. These results are consistent with the relative duration of the securities, as higher coupons have
shorter durations, or less sensitivity to movements in interest rates.
As both the domestic and the global economies appear to be slowing, the more credit sensitive sectors of the fixed income markets
have come under pressure and are likely to weaken further if the economies do indeed contract. Actions by the Fed as described above
may prevent the sector from performing well in the near term but, if the economy does contract and enter a recession, the sector could do
well on a relative performance basis owing to the lack of credit exposure of Agency RMBS. This is consistent with the sector’s history of
performance in a counter-cyclical manner – doing well when the economy is soft and relatively poorly when the economy is strong.
45
Recent Legislative and Regulatory Developments
In response to the deterioration in the markets for U.S. Treasuries, Agency RMBS and other mortgage and fixed income markets
resulting from the impacts of the COVID-19 pandemic, the Fed implemented a program of quantitative easing. Through November of 2021,
the Fed was committed to purchasing $80 billion of U.S. Treasuries and $40 billion of Agency RMBS each month. In November of 2021, it
began tapering its net asset purchases each month and ended net asset purchases entirely by early March of 2022. On May 4, 2022, the
FOMC announced a plan for reducing the Fed’s balance sheet. In June of 2022, in accordance with this plan, the Fed began reducing its
balance sheet by a maximum of $30 billion of U.S. Treasuries and $17.5 billion of Agency RMBS each month. On September 21, 2022,
the FOMC announced the Fed’s decision to continue reducing the balance sheet by a maximum of $60 billion of U.S Treasuries and $35
billion of Agency RMBS per month.
On January 29, 2021, the CDC issued guidance extending eviction moratoriums for covered persons put in place by the CARES Act
through March 31, 2021. The FHFA subsequently extended the foreclosure moratorium for loans backed by Fannie Mae and Freddie Mac
and the eviction moratorium for real estate owned by Fannie Mae and Freddie Mac until July 31, 2021 and September 30, 2021,
respectively. The U.S. Housing and Urban Development Department subsequently extended the FHA foreclosure and eviction moratoria to
July 31, 2021, and September 30, 2021, respectively. Despite the expirations of these foreclosure moratoria, a final rule adopted by the
CFPB on June 28, 2021, effectively prohibited servicers from initiating a foreclosure before January 1, 2022, in most instances.
Foreclosure activity has risen since the end of the moratorium, with foreclosure starts in the third quarter of 2022 up 167% from the
comparable period in 2021, but still remaining slightly below pre-pandemic levels.
In January 2019, the Trump administration made statements of its plans to work with Congress to overhaul Fannie Mae and Freddie
Mac and expectations to announce a framework for the development of a policy for comprehensive housing finance reform soon. On
September 30, 2019, the FHFA announced that Fannie Mae and Freddie Mac were allowed to increase their capital buffers to $25 billion
and $20 billion, respectively, from the prior limit of $3 billion each. This step could ultimately lead to Fannie Mae and Freddie Mac being
privatized and represents the first concrete step on the road to GSE reform. On June 30, 2020, the FHFA released a proposed rule on a
new regulatory framework for the GSEs which seeks to implement both a risk-based capital framework and minimum leverage capital
requirements. The final rule on the new capital framework for the GSEs was published in the federal register in December 2020. On
January 14, 2021, the U.S. Treasury and the FHFA executed letter agreements allowing the GSEs to continue to retain capital up to their
regulatory minimums, including buffers, as prescribed in the December rule. These letter agreements provide, in part, (i) there will be no
exit from conservatorship until all material litigation is settled and the GSE has common equity Tier 1 capital of at least 3% of its assets, (ii)
the GSEs will comply with the FHFA’s regulatory capital framework, (iii) higher-risk single-family mortgage acquisitions will be restricted to
current levels, and (iv) the U.S. Treasury and the FHFA will establish a timeline and process for future GSE reform. However, no definitive
proposals or legislation have been released or enacted with respect to ending the conservatorship, unwinding the GSEs, or materially
reducing the roles of the GSEs in the U.S. mortgage market. On September 14, 2021, the U.S. Treasury and the FHFA suspended certain
policy provisions in the January agreement, including limits on loans acquired for cash consideration, multifamily loans, loans with higher
risk characteristics and second homes and investment properties. On February 25, 2022, the FHFA published a final rule, effective as of
April 26, 2022, amending the GSE capital framework established in December 2020 by, among other things, replacing the fixed leverage
buffer equal to 1.5% of a GSE’s adjusted total assets with a dynamic leverage buffer equal to 50% of a GSE’s stability capital buffer,
reducing the risk weight floor from 10% to 5%, and removing the requirement that the GSEs must apply an overall effectiveness
adjustment to their credit risk transfer exposures. On June 14, 2022, the GSEs announced that they will each charge a 50 bps fee for
commingled securities issued on or after July 1, 2022 to cover the additional capital required for such securities under the GSE capital
framework. Industry groups have expressed concern that this poses a risk to the fungibility of the Uniform Mortgage-Backed Security
(“UMBS”), which could negatively impact liquidity and pricing in the market for TBA securities.
46
In 2017, policymakers announced that LIBOR will be replaced by December 31, 2021. The directive was spurred by the fact that
banks are uncomfortable contributing to the LIBOR panel given the shortage of underlying transactions on which to base levels and the
liability associated with submitting an unfounded level. However, the ICE Benchmark Administration, in its capacity as administrator of
USD LIBOR, has announced that it intends to extend publication of USD LIBOR (other than one-week and two-month tenors) by 18
months to June 2023. Notwithstanding this extension, a joint statement by key regulatory authorities calls on banks to cease entering into
new contracts that use USD LIBOR as a reference rate by no later than December 31, 2021.
On December 7, 2021, the CFPB released a final rule that amends Regulation Z, which implemented the Truth in Lending Act, aimed
at addressing cessation of LIBOR for both closed-end (e.g., home mortgage) and open-end (e.g., home equity line of credit) products. The
rule, which mostly became effective in April of 2022, establishes requirements for the selection of replacement indices for existing LIBOR-
linked consumer loans. Although the rule does not mandate the use of SOFR as the alternative rate, it identifies SOFR as a comparable
rate for closed-end products and states that for open-end products, the CFPB has determined that ARRC’s recommended spread-adjusted
indices based on SOFR for consumer products to replace the one-month, three-month, or six-month USD LIBOR index “have historical
fluctuations that are substantially similar to those of the LIBOR indices that they are intended to replace.” The CFPB reserved judgment,
however, on a SOFR-based spread-adjusted replacement index to replace the one-year USD LIBOR until it obtained additional
information.
On March 15, 2022, the Adjustable Interest Rate (LIBOR) Act (the “LIBOR Act”) was signed into law as part of the Consolidated
Appropriations Act, 2022 (H.R. 2471). The LIBOR Act provides for a statutory replacement benchmark rate for contracts that use LIBOR
as a benchmark and do not contain any fallback mechanism independent of LIBOR. Pursuant to the LIBOR Act, SOFR becomes the new
benchmark rate by operation of law for any such contract. The LIBOR Act establishes a safe harbor from litigation for claims arising out of
or related to the use of SOFR as the recommended benchmark replacement. The LIBOR Act makes clear that it should not be construed
to disfavor the use of any benchmark on a prospective basis.
On July 28, 2022, the Fed published a proposed rule to implement the LIBOR Act. Since the GSEs have generally been using 30-day
average SOFR in their newly issued multifamily loans and other structured products, the Fed proposed that the benchmark replacement
for Agency RMBS be the 30-day average SOFR plus the applicable tenor spread adjustment specified in the LIBOR Act. Comments for
the proposed rule closed August 29, 2022, and any final rule will go into effect 30 days after publication in the Federal Register.
The LIBOR Act also attempts to forestall challenges that it is impairing contracts. It provides that the discontinuance of LIBOR and the
automatic statutory transition to a replacement rate neither impairs or affects the rights of a party to receive payment under such contracts,
nor allows a party to discharge their performance obligations or to declare a breach of contract. It amends the Trust Indenture Act of 1939
to state that the “the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture
security shall not be deemed to be impaired or affected” by application of the LIBOR Act to any indenture security.
Effective January 1, 2021, Fannie Mae, in alignment with Freddie Mac, extended the timeframe for its delinquent loan buyout policy
for Single-Family Uniform Mortgage-Backed Securities (UMBS) and Mortgage-Backed Securities (MBS) from four consecutively missed
monthly payments to twenty-four consecutively missed monthly payments (i.e., 24 months past due). This new timeframe applied to
outstanding single-family pools and newly issued single-family pools and was first reflected when January 2021 factors were released on
the fourth business day in February 2021.
For Agency RMBS investors, when a delinquent loan is bought out of a pool of mortgage loans, the removal of the loan from the pool
is the same as a total prepayment of the loan. The respective GSEs anticipated, however, that delinquent loans will be repurchased in
most cases before the 24-month deadline under one of the following exceptions listed below.
• a loan that is paid in full, or where the related lien is released and/or the note debt is satisfied or forgiven;
• a loan repurchased by a seller/servicer under applicable selling and servicing requirements;
• a loan entering a permanent modification, which generally requires it to be removed from the MBS (during any modification trial
period, the loan will remain in the MBS until the trial period ends);
47
• a loan subject to a short sale or deed-in-lieu of foreclosure; or
• a loan referred to foreclosure.
Because of these exceptions, the GSEs believe based on prevailing assumptions and market conditions this change will have only a
marginal impact on prepayment speeds, in aggregate. Cohort level impacts may vary. For example, more than half of loans referred to
foreclosure are historically referred within six months of delinquency. The degree to which speeds are affected depends on delinquency
levels, borrower response, and referral to foreclosure timelines.
The scope and nature of the actions the U.S. government or the Fed will ultimately undertake are unknown and will continue to evolve
Effect on Us
Regulatory developments, movements in interest rates and prepayment rates affect us in many ways, including the following:
Effects on our Assets
A change in or elimination of the guarantee structure of Agency RMBS may increase our costs (if, for example, guarantee fees
increase) or require us to change our investment strategy altogether. For example, the elimination of the guarantee structure of Agency
RMBS may cause us to change our investment strategy to focus on non-Agency RMBS, which in turn would require us to significantly
increase our monitoring of the credit risks of our investments in addition to interest rate and prepayment risks.
Lower long-term interest rates can affect the value of our Agency RMBS in a number of ways. If prepayment rates are relatively low
(due, in part, to the refinancing problems described above), lower long-term interest rates can increase the value of higher-coupon Agency
RMBS. This is because investors typically place a premium on assets with yields that are higher than market yields. Although lower long-
term interest rates may increase asset values in our portfolio, we may not be able to invest new funds in similarly-yielding assets.
If prepayment levels increase, the value of our Agency RMBS affected by such prepayments may decline. This is because a principal
prepayment accelerates the effective term of an Agency RMBS, which would shorten the period during which an investor would receive
above-market returns (assuming the yield on the prepaid asset is higher than market yields). Also, prepayment proceeds may not be able
to be reinvested in similar-yielding assets. Agency RMBS backed by mortgages with high interest rates are more susceptible to
prepayment risk because holders of those mortgages are most likely to refinance to a lower rate. IOs and IIOs, however, may be the types
of Agency RMBS most sensitive to increased prepayment rates. Because the holder of an IO or IIO receives no principal payments, the
values of IOs and IIOs are entirely dependent on the existence of a principal balance on the underlying mortgages. If the principal balance
is eliminated due to prepayment, IOs and IIOs essentially become worthless. Although increased prepayment rates can negatively affect
the value of our IOs and IIOs, they have the opposite effect on POs. Because POs act like zero-coupon bonds, meaning they are
purchased at a discount to their par value and have an effective interest rate based on the discount and the term of the underlying loan, an
increase in prepayment rates would reduce the effective term of our POs and accelerate the yields earned on those assets, which would
increase our net income.
Higher long-term rates can also affect the value of our Agency RMBS. As long-term rates rise, rates available to borrowers also rise.
This tends to cause prepayment activity to slow and extend the expected average life of mortgage cash flows. As the expected average
life of the mortgage cash flows increases, coupled with higher discount rates, the value of Agency RMBS declines. Some of the
instruments the Company uses to hedge our Agency RMBS assets, such as interest rate futures, swaps and swaptions, are stable
average life instruments. This means that to the extent we use such instruments to hedge our Agency RMBS assets, our hedges may not
adequately protect us from price declines, and therefore may negatively impact our book value. It is for this reason we use interest only
securities in our portfolio. As interest rates rise, the expected average life of these securities increases, causing generally positive price
movements as the number and size of the cash flows increase the longer the underlying mortgages remain outstanding. This makes
interest only securities desirable hedge instruments for pass-through Agency RMBS.
48
As described above, the Agency RMBS market began to experience severe dislocations in mid-March 2020 as a result of the
economic, health and market turmoil brought about by COVID-19. On March 23, 2020, the Fed announced that it would purchase Agency
RMBS and U.S. Treasuries in the amounts needed to support smooth market functioning, which largely stabilized the Agency RMBS
market, but ended these purchases in March 2022 and announced plans to reduce its balance sheet. The Fed’s planned reduction of its
balance sheet could negatively impact our investment portfolio. Further, the moratoriums on foreclosures and evictions described above
will likely delay potential defaults on loans that would otherwise be bought out of Agency RMBS pools as described above. Depending on
the ultimate resolution of the foreclosure or evictions, when and if it occurs, these loans may be removed from the pool into which they
were securitized. If this were to occur, it would have the effect of delaying a prepayment on the Company’s securities until such time. To
the extent the Company’s Agency RMBS assets were acquired at a premium to par, this will tend to increase the realized yield on the
asset in question. To the extent they were acquired at a discount, this will tend to decrease the realized yield on the asset in question.
Because we base our investment decisions on risk management principles rather than anticipated movements in interest rates, in a
volatile interest rate environment we may allocate more capital to structured Agency RMBS with shorter durations. We believe these
securities have a lower sensitivity to changes in long-term interest rates than other asset classes. We may attempt to mitigate our
exposure to changes in long-term interest rates by investing in IOs and IIOs, which typically have different sensitivities to changes in long-
term interest rates than PT RMBS, particularly PT RMBS backed by fixed-rate mortgages.
Effects on our borrowing costs
We leverage our PT RMBS portfolio and a portion of our structured Agency RMBS with principal balances through the use of short-
term repurchase agreement transactions. The interest rates on our debt are determined by the short term interest rate markets. Increases
in the Fed Funds rate, SOFR or LIBOR typically increase our borrowing costs, which could affect our interest rate spread if there is no
corresponding increase in the interest we earn on our assets. This would be most prevalent with respect to our Agency RMBS backed by
fixed rate mortgage loans because the interest rate on a fixed-rate mortgage loan does not change even though market rates may change.
In order to protect our net interest margin against increases in short-term interest rates, we may enter into interest rate swaps, which
economically convert our floating-rate repurchase agreement debt to fixed-rate debt, or utilize other hedging instruments such as
Eurodollar, Fed Funds and T-Note futures contracts or interest rate swaptions.
Summary
In a continuation of the extremely turbulent and volatile market conditions that have existed since the onset of the COVID-19
pandemic, during the third quarter of 2022 the state of the markets and the outlook changed materially. The perception of inflation on the
part of the Fed has shaped the rates markets, currency markets and the outlook for the economy since the spring of 2021. This is when
inflation first began to accelerate in the U.S. During the third quarter the Fed’s outlook, or more accurately, the market’s perception of how
the Fed saw inflation, changed significantly. Through early August of 2022 the markets perceived that, while inflation was not transitory,
the Fed would be able to dampen demand by raising rates and cause inflation to decrease back towards the Fed’s long-term target of 2%.
Further, the market anticipated this would happen by early in 2023 and that the Fed would then start to loosen monetary policy shortly
thereafter. The Fed, through repeated public comments by various Fed officials and ultimately by the Chairman at the Fed’s annual central
banker symposium in Jackson Hole, Wyoming in late August, stressed that this was not going to be the case. Incoming economic data
over the period was persistently strong, indicating the rate increases to date had yet to slow demand. More importantly, incoming inflation
data showed no evidence of slowing at all and was in fact becoming more widespread, possibly even well entrenched. This reinforced the
notion the Fed will have to take rates higher and for longer.
49
The result of these developments were significant and widespread. Germane to Orchid Island and levered Agency RMBS investors
were increases in market interest rates and a widening in the spreads that Agency RMBS securities trade relative to comparable duration
U.S. Treasuries or swaps. The yield on the 10-year U.S. Treasury closed just above 3.83% on September 30, 2022, and surpassed 4% in
October of 2022. This increase was much less than short-term rates increased. Interest rates on maturities inside one year increased by
well over 100 basis points and by more than 160 basis points for maturities of three months or less – in each case by the end of the
quarter. Yields of maturities of three or fewer months have increased by over 230 basis points since the end of the second quarter of 2022
through October 26, 2022. As of September 30, 2022, market pricing implied the terminal rate for the current cycle would be approximately
4.53% - achieved late in the first quarter of 2023. As of October 26, 2022, the market is pricing in a terminal rate of approximately 4.85%
sometime late in the second quarter of 2023 and with the Fed Funds rate still approximately 4.40% in early 2024.
Agency RMBS spreads relative to benchmark interest rates increased to levels observed in March of 2020 by the end of the third
quarter of 2022 and have exceeded those levels in October of 2022. Returns for the Agency RMBS market for the third quarter of 2022
were (5.40)% and these returns were 1.7% lower than comparable duration LIBOR swaps. The relative performance across the Agency
RMBS universe is skewed in favor of higher coupon, 30-year securities that are currently in production by originators. Lower coupon
securities, especially those held in large amounts by the Fed, and which may eventually be sold by the Fed, have performed the worst.
These results are consistent with the relative duration of the securities, as higher coupons have shorter durations, or less sensitivity to
movements in interest rates. Actions by the Fed may prevent the sector from performing well in the near term but, if the economy does
contract and enter a recession, the sector could do well on a relative performance basis owing to the lack of credit exposure of Agency
RMBS. This is consistent with the sector’s history of performance in a counter-cyclical manner – doing well when the economy is soft and
relatively poorly when the economy is strong.
Critical Accounting Estimates
Our condensed financial statements are prepared in accordance with GAAP. GAAP requires our management to make some complex
and subjective decisions and assessments. Our most critical accounting estimates involve decisions and assessments which could
significantly affect reported assets, liabilities, revenues and expenses. There have been no changes to our critical accounting estimates as
discussed in our annual report on Form 10-K for the year ended December 31, 2021.
Capital Expenditures
At September 30, 2022, we had no material commitments for capital expenditures.
Dividends
In addition to other requirements that must be satisfied to continue to qualify as a REIT, we must pay annual dividends to our
stockholders of at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding any
net capital gains. REIT taxable income (loss) is computed in accordance with the Code, and can be greater than or less than our financial
statement net income (loss) computed in accordance with GAAP. These book to tax differences primarily relate to the recognition of
interest income on RMBS, unrealized gains and losses on RMBS, and the amortization of losses on derivative instruments that are treated
as funding hedges for tax purposes.
50
We intend to pay regular monthly dividends to our stockholders and have declared the following dividends since the completion of our
IPO.
(in thousands, except per share amounts)
Year
Per Share
Amount
Total
2013
$
6.975
$
4,662
2014
10.800
22,643
2015
9.600
38,748
2016
8.400
41,388
2017
8.400
70,717
2018
5.350
55,814
2019
4.800
54,421
2020
3.950
53,570
2021
3.900
97,601
2022 - YTD
(1)
2.155
76,024
Totals
$
64.330
$
515,588
(1)
On October 12, 2022, the Company declared a dividend of $0.16 per share to be paid on November 28, 2022. The effect of this dividend is
included in the table above, but is not reflected in the Company’s financial statements as of September 30, 2022.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in market factors such as interest rates, foreign currency exchange rates,
commodity prices and equity prices. The primary market risks that we are exposed to are interest rate risk, prepayment risk, spread risk,
liquidity risk, extension risk and counterparty credit risk.
Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international
economic and political considerations and other factors beyond our control.
Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income
earned on interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities, by affecting the
spread between our interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates can also affect the rate of
prepayments of our securities and the value of the RMBS that constitute our investment portfolio, which affects our net income, ability to
realize gains from the sale of these assets and ability to borrow, and the amount that we can borrow against these securities.
We may utilize a variety of financial instruments in order to limit the effects of changes in interest rates on our operations. The principal
instruments that we use are futures contracts, interest rate swaps and swaptions. These instruments are intended to serve as an economic
hedge against future interest rate increases on our repurchase agreement borrowings. Hedging techniques are partly based on assumed
levels of prepayments of our Agency RMBS. If prepayments are slower or faster than assumed, the life of the Agency RMBS will be
longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such
transactions. Hedging strategies involving the use of derivative securities are highly complex and may produce volatile returns. Hedging
techniques are also limited by the rules relating to REIT qualification. In order to preserve our REIT status, we may be forced to terminate
a hedging transaction at a time when the transaction is most needed.
51
Our profitability and the value of our investment portfolio (including derivatives used for hedging purposes) may be adversely affected
during any period as a result of changing interest rates, including changes in the forward yield curve.
Our portfolio of PT RMBS is typically comprised of adjustable-rate RMBS (“ARMs”), fixed-rate RMBS and hybrid adjustable-rate
RMBS. We generally seek to acquire low duration assets that offer high levels of protection from mortgage prepayments provided that they
are reasonably priced by the market. Although the duration of an individual asset can change as a result of changes in interest rates, we
strive to maintain a hedged PT RMBS portfolio with an effective duration of less than 2.0. The stated contractual final maturity of the
mortgage loans underlying our portfolio of PT RMBS generally ranges up to 30 years. However, the effect of prepayments of the
underlying mortgage loans tends to shorten the resulting cash flows from our investments substantially. Prepayments occur for various
reasons, including refinancing of underlying mortgages and loan payoffs in connection with home sales, and borrowers paying more than
their scheduled loan payments, which accelerates the amortization of the loans.
The duration of our IO and IIO portfolios will vary greatly depending on the structural features of the securities. While prepayment
activity will always affect the cash flows associated with the securities, the interest only nature of IOs may cause their durations to become
extremely negative when prepayments are high, and less negative when prepayments are low. Prepayments affect the durations of IIOs
similarly, but the floating rate nature of the coupon of IIOs (which is inversely related to the level of one month LIBOR) causes their price
movements, and model duration, to be affected by changes in both prepayments and one month LIBOR, both current and anticipated
levels. As a result, the duration of IIO securities will also vary greatly.
Prepayments on the loans underlying our RMBS can alter the timing of the cash flows from the underlying loans to us. As a result, we
gauge the interest rate sensitivity of our assets by measuring their effective duration. While modified duration measures the price sensitivity
of a bond to movements in interest rates, effective duration captures both the movement in interest rates and the fact that cash flows to a
mortgage related security are altered when interest rates move. Accordingly, when the contract interest rate on a mortgage loan is
substantially above prevailing interest rates in the market, the effective duration of securities collateralized by such loans can be quite low
because of expected prepayments.
We face the risk that the market value of our PT RMBS assets will increase or decrease at different rates than that of our structured
RMBS or liabilities, including our hedging instruments. Accordingly, we assess our interest rate risk by estimating the duration of our assets
and the duration of our liabilities. We generally calculate duration using various third party models. However, empirical results and various
third party models may produce different duration numbers for the same securities.
The following sensitivity analysis shows the estimated impact on the fair value of our interest rate-sensitive investments and hedge
positions as of September 30, 2022 and December 31, 2021, assuming rates instantaneously fall 200 bps, fall 100 bps, fall 50 bps, rise 50
bps, rise 100 bps and rise 200 bps, adjusted to reflect the impact of convexity, which is the measure of the sensitivity of our hedge
positions and Agency RMBS’ effective duration to movements in interest rates. We have a negatively convex asset profile and a linear to
slightly positively convex hedge portfolio (short positions). It is not uncommon for us to have losses in both directions.
All changes in value in the table below are measured as percentage changes from the investment portfolio value and net asset value
at the base interest rate scenario. The base interest rate scenario assumes interest rates and prepayment projections as of September 30,
2022 and December 31, 2021.
Actual results could differ materially from estimates, especially in the current market environment. To the extent that these estimates
or other assumptions do not hold true, which is likely in a period of high price volatility, actual results will likely differ materially from
projections and could be larger or smaller than the estimates in the table below. Moreover, if different models were employed in the
analysis, materially different projections could result. Lastly, while the table below reflects the estimated impact of interest rate increases
and decreases on a static portfolio, we may from time to time sell any of our agency securities as a part of the overall management of our
investment portfolio.
52
Interest Rate Sensitivity
(1)
Portfolio
Market
Book
Change in Interest Rate
Value
(2)(3)
Value
(2)(4)
As of September 30, 2022
-200 Basis Points
0.23%
1.87%
-100 Basis Points
0.54%
4.32%
-50 Basis Points
0.38%
3.04%
+50 Basis Points
(0.47)%
(3.73)%
+100 Basis Points
(1.00)%
(8.01)%
+200 Basis Points
(2.18)%
(17.46)%
As of December 31, 2021
-200 Basis Points
(2.01)%
(17.00)%
-100 Basis Points
(0.33)%
(2.76)%
-50 Basis Points
0.19%
1.59%
+50 Basis Points
(0.48)%
(4.04)%
+100 Basis Points
(1.64)%
(13.91)%
+200 Basis Points
(4.79)%
(40.64)%
(1) Interest rate sensitivity is derived from models that are dependent on inputs and assumptions provided by third parties as well as by our Manager,
and assumes there are no changes in mortgage spreads and assumes a static portfolio. Actual results could differ materially from these estimates.
(2) Includes the effect of derivatives and other securities used for hedging purposes.
(3) Estimated dollar change in investment portfolio value expressed as a percent of the total fair value of our investment portfolio as of such date.
(4) Estimated dollar change in portfolio value expressed as a percent of stockholders' equity as of such date.
In addition to changes in interest rates, other factors impact the fair value of our interest rate-sensitive investments, such as the shape
of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, in the event of changes
in actual interest rates, the change in the fair value of our assets would likely differ from that shown above and such difference might be
material and adverse to our stockholders.
Prepayment Risk
Because residential borrowers have the option to prepay their mortgage loans at par at any time, we face the risk that we will
experience a return of principal on our investments faster than anticipated. Various factors affect the rate at which mortgage prepayments
occur, including changes in the level of and directional trends in housing prices, interest rates, general economic conditions, loan age and
size, loan-to-value ratio, the location of the property and social and demographic conditions. Additionally, changes to government
sponsored entity underwriting practices or other governmental programs could also significantly impact prepayment rates or expectations.
Generally, prepayments on Agency RMBS increase during periods of falling mortgage interest rates and decrease during periods of rising
mortgage interest rates. However, this may not always be the case. We may reinvest principal repayments at a yield that is lower or
higher than the yield on the repaid investment, thus affecting our net interest income by altering the average yield on our assets.
Spread Risk
When the market spread widens between the yield on our Agency RMBS and benchmark interest rates, our net book value could
decline if the value of our Agency RMBS falls by more than the offsetting fair value increases on our hedging instruments tied to the
underlying benchmark interest rates. We refer to this as "spread risk" or "basis risk." The spread risk associated with our mortgage assets
and the resulting fluctuations in fair value of these securities can occur independent of changes in benchmark interest rates and may relate
to other factors impacting the mortgage and fixed income markets, such as actual or anticipated monetary policy actions by the Fed,
market liquidity, or changes in required rates of return on different assets. Consequently, while we use futures contracts and interest rate
swaps and swaptions to attempt to protect against moves in interest rates, such instruments typically will not protect our net book value
against spread risk.
53
Liquidity Risk
The primary liquidity risk for us arises from financing long-term assets with shorter-term borrowings through repurchase agreements.
Our assets that are pledged to secure repurchase agreements are Agency RMBS and cash. As of September 30, 2022, we had
unrestricted cash and cash equivalents of $214.2 million and unpledged securities of approximately $5.4 million (not including unsettled
securities purchases or securities pledged to us) available to meet margin calls on our repurchase agreements and derivative contracts,
and for other corporate purposes. However, should the value of our Agency RMBS pledged as collateral or the value of our derivative
instruments suddenly decrease, margin calls relating to our repurchase and derivative agreements could increase, causing an adverse
change in our liquidity position. Further, there is no assurance that we will always be able to renew (or roll) our repurchase agreements. In
addition, our counterparties have the option to increase our haircuts (margin requirements) on the assets we pledge against repurchase
agreements, thereby reducing the amount that can be borrowed against an asset even if they agree to renew or roll the repurchase
agreement. Significantly higher haircuts can reduce our ability to leverage our portfolio or even force us to sell assets, especially if
correlated with asset price declines or faster prepayment rates on our assets.
Extension Risk
The projected weighted average life and the duration (or interest rate sensitivity) of our investments is based on our Manager's
assumptions regarding the rate at which the borrowers will prepay the underlying mortgage loans. In general, we use futures contracts and
interest rate swaps and swaptions to help manage our funding cost on our investments in the event that interest rates rise. These hedging
instruments allow us to reduce our funding exposure on the notional amount of the instrument for a specified period of time.
However, if prepayment rates decrease in a rising interest rate environment, the average life or duration of our fixed-rate assets or the
fixed-rate portion of the ARMs or other assets generally extends. This could have a negative impact on our results from operations, as our
hedging instrument expirations are fixed and will, therefore, cover a smaller percentage of our funding exposure on our mortgage assets to
the extent that their average lives increase due to slower prepayments. This situation may also cause the market value of our Agency
RMBS and CMOs collateralized by fixed rate mortgages or hybrid ARMs to decline by more than otherwise would be the case while most
of our hedging instruments would not receive any incremental offsetting gains. In extreme situations, we may be forced to sell assets to
maintain adequate liquidity, which could cause us to incur realized losses.
Counterparty Credit Risk
We are exposed to counterparty credit risk relating to potential losses that could be recognized in the event that the counterparties to
our repurchase agreements and derivative contracts fail to perform their obligations under such agreements. The amount of assets we
pledge as collateral in accordance with our agreements varies over time based on the market value and notional amount of such assets as
well as the value of our derivative contracts. In the event of a default by a counterparty, we may not receive payments provided for under
the terms of our agreements and may have difficulty obtaining our assets pledged as collateral under such agreements. Our credit risk
related to certain derivative transactions is largely mitigated through daily adjustments to collateral pledged based on changes in market
value and we limit our counterparties to registered central clearing exchanges and major financial institutions with acceptable credit ratings,
monitoring positions with individual counterparties and adjusting collateral posted as required. However, there is no guarantee our efforts
to manage counterparty credit risk will be successful and we could suffer significant losses if unsuccessful.
54
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report (the “evaluation date”), we carried out an evaluation, under the supervision and with
the participation of our management, including our Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”), of the
effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Exchange Act.
Based on this evaluation, the CEO and CFO concluded our disclosure controls and procedures, as designed and implemented, were
effective as of the evaluation date (1) in ensuring that information regarding the Company is accumulated and communicated to our
management, including our CEO and CFO, by our employees, as appropriate to allow timely decisions regarding required disclosure and
(2) in providing reasonable assurance that information we must disclose in our periodic reports under the Exchange Act is recorded,
processed, summarized and reported within the time periods prescribed by the SEC’s rules and forms.
Changes in Internal Control over Financial Reporting
There were no significant changes in the Company’s internal control over financial reporting that occurred during the Company’s most
recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial
reporting.
55
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not party to any material pending legal proceedings as described in Item 103 of Regulation S-K.
ITEM 1A. RISK FACTORS
A description of certain factors that may affect our future results and risk factors is set forth in our Annual Report on Form 10-K for
the year ended December 31, 2021. As of September 30, 2022, there have been no material changes in our risk factors from those set
forth in our Annual Report on Form 10-K for the year ended December 31, 2021.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The Company did not have any unregistered sales of its equity securities during the three months ended September 30, 2022.
The table below presents the Company’s share repurchase activity for the three months ended September 30, 2022.
Shares Purchased
Maximum Number
Total Number
Weighted-Average
as Part of Publicly
of Shares That May Yet
of Shares
Price Paid
Announced
Be Repurchased Under
Repurchased
(1)
Per Share
Programs
the Authorization
(2)
July 1, 2022 - July 31, 2022
-
$
-
-
3,364,601
August 1, 2022 - August 31, 2022
-
-
-
3,364,601
September 1, 2022 - September 30, 2022
186,249
12.73
175,000
3,189,601
Totals / Weighted Average
186,249
$
12.73
175,000
3,189,601
(1)
Includes 452 shares of the Company’s common stock acquired by the Company in connection with the satisfaction of tax withholding obligations on
vested employment related awards under equity incentive plans and cash paid for 10,796.6 fractional shares as a result of the Company’s 1-for-5
reverse stock split effected on August 30, 2022. These repurchases do not reduce the number of shares available under the stock repurchase
program authorization.
(2)
On October 12, 2022, the Board of Directors approved an increase in the number of shares of the Company’s common stock available in the stock
repurchase program for up to an additional 4,300,000 shares. The effect of this increase in not reflected in the table.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.
ITEM 5. OTHER INFORMATION
None.
56
ITEM 6. EXHIBITS
Exhibit No.
3.1
3.2
3.3
3.4
4.1
31.1
31.2
32.1
32.2
Exhibit 101.INS XBRL
Inline XBRL Instance Document – the instance document does not appear in the
Interactive Data File because its XBRL tags are embedded within the Inline XBRL
document.***
Exhibit 101.SCH XBRL
Taxonomy Extension Schema Document ***
Exhibit 101.CAL XBRL
Taxonomy Extension Calculation Linkbase Document***
Exhibit 101.DEF XBRL
Additional Taxonomy Extension Definition Linkbase Document Created***
Exhibit 101.LAB XBRL
Taxonomy Extension Label Linkbase Document ***
Exhibit 101.PRE XBRL
Taxonomy Extension Presentation Linkbase Document ***
Exhibit 104
Cover Page Interactive Data File (embedded within the Inline XBRL document)
* Filed herewith.
** Furnished herewith.
*** Submitted electronically herewith.
† Management contract or compensatory plan.
57
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Orchid Island Capital, Inc
.
Registrant
Date: October 28, 2022
By:
/s/ Robert E. Cauley
Robert E. Cauley
Chief Executive Officer, President and Chairman of the Board
(Principal Executive Officer)
Date: October 28, 2022
By:
/s/ George H. Haas, IV
George H. Haas, IV
Secretary, Chief Financial Officer, Chief Investment Officer and
Director (Principal Financial and Accounting Officer)