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 ___________
Commission File Number
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incorporation or organization)
(I.R.S. Employer
Identification No.)
,
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(
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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
of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such
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
an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer", "smaller reporting company", and "emerging growth
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Non-accelerated filer
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Smaller reporting company
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Number of shares outstanding at October 30, 2020:
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)
5
Notes to Condensed Financial Statements
7
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, 2020
December 31, 2019
ASSETS:
Mortgage-backed securities, at fair value
Pledged to counterparties
$
$
Unpledged
Total mortgage -backed securities
Cash and cash equivalents
Restricted cash
Accrued interest receivable
Derivative assets, at fair value
Other assets
Total Assets
$
$
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements
$
$
Payable for unsettled securities purchased
Dividends payable
Derivative liabilities, at fair value
Accrued interest payable
Due to affiliates
Other liabilities
Total Liabilities
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $
and outstanding as of September 30, 2020 and December 31, 2019
Common Stock, $
shares issued and outstanding as of September 30, 2020 and
and outstanding as of December 31, 2019
Additional paid-in capital
Accumulated deficit
(34,473 )
(20,122 )
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 Nine and Three Months Ended September 30, 2020 and 2019
($ in thousands, except per share data)
Nine Months Ended September 30,
Three Months Ended September 30,
2020
2019
2020
2019
Interest income
$
$
$
$
Interest expense
(23,045 )
(63,644 )
(2,043 )
(22,321 )
Net interest income
Realized (losses) gains on mortgage-backed securities
(24,522 )
(5,135 )
(5,491 )
Unrealized gains (losses) on mortgage-backed securities
(5,292 )
(Losses) gains on derivative and other hedging instruments
(87,630 )
(61,968 )
(8,648 )
Net portfolio (loss) income
(6,605 )
(5,845 )
Expenses:
Management fees
Allocated overhead
Accrued incentive compensation
(117 )
(53 )
Directors' fees and liability insurance
Audit, legal and other professional fees
Direct REIT operating expenses
Other administrative
Total expenses
Net (loss) income
$
(14,351 )
$
$
$
(8,477 )
Basic net (loss) income per share
$
(0.22 )
$
$
$
(0.14 )
Diluted net (loss) income per share
$
(0.22 )
$
$
$
(0.14 )
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 and Three Months Ended September 30, 2020 and 2019
(in thousands)
Additional
Retained
Common Stock
Paid-in
Earnings
Shares
Par Value
Capital
(Deficit)
Total
Balances, January 1, 2019
$
$
$
(44,387 )
$
Net income
-
Cash dividends declared
-
(11,824 )
(11,824 )
Issuance of common stock pursuant to public offerings, net
Issuance of common stock pursuant to stock based
compensation plan
Amortization of stock based compensation
-
Shares repurchased and retired
(469 )
(5 )
(3,019 )
(3,024 )
Balances, March 31, 2019
$
$
$
(33,790 )
$
Net income
Cash dividends declared
(12,859 )
(12,859 )
Issuance of common stock pursuant to public offerings, net
Issuance of common stock pursuant to stock based
compensation plan
Amortization of stock based compensation
Balances, June 30, 2019
$
$
$
(30,257 )
$
Net loss
-
(8,477 )
(8,477 )
Cash dividends declared
-
(14,588 )
(14,588 )
Issuance of common stock pursuant to public offerings, net
Issuance of common stock pursuant to stock based
compensation plan
Amortization of stock based compensation
-
Balances, September 30, 2019
$
$
$
(38,734 )
$
Balances, January 1, 2020
$
$
$
(20,122 )
$
Net loss
-
(91,199 )
(91,199 )
Cash dividends declared
-
(15,670 )
(15,670 )
Issuance of common stock pursuant to public offerings, net
Issuance of common stock pursuant to stock based
compensation plan
Amortization of stock based compensation
-
Balances, March 31, 2020
$
$
$
(111,321 )
$
Net income
-
Cash dividends declared
-
(10,935 )
(10,935 )
Issuance of common stock pursuant to stock based
compensation plan
Amortization of stock based compensation
-
Shares repurchased and retired
(20 )
(68 )
(68 )
Balances, June 30, 2020
$
$
$
(62,549 )
$
Net income
-
Cash dividends declared
-
(12,920 )
(12,920 )
Issuance of common stock pursuant to public offerings, net
Issuance of common stock pursuant to stock based
compensation plan
(2 )
(2 )
Amortization of stock based compensation
-
Balances, September 30, 2020
$
$
$
(34,473 )
$
4
See Notes to Financial Statements
5
ORCHID ISLAND CAPITAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine Months Ended September 30, 2020 and 2019
($ in thousands)
2020
2019
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income
$
(14,351 )
$
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Stock based compensation
Realized and unrealized gains on mortgage-backed securities
(13,918 )
(34,120 )
Realized and unrealized losses on interest rate swaptions
Realized and unrealized losses on interest rate swaps
Realized and unrealized losses on U.S. Treasury securities
Realized losses on forward settling to-be-announced securities
Changes in operating assets and liabilities:
Accrued interest receivable
(2,146 )
Other assets
(533 )
(27 )
Accrued interest payable
(10,349 )
Other liabilities
Due from affiliates
(32 )
(57 )
NET CASH PROVIDED BY OPERATING ACTIVITIES
CASH FLOWS FROM INVESTING ACTIVITIES:
From mortgage-backed securities investments:
Purchases
(2,898,616 )
(3,096,194 )
Sales
Principal repayments
Payments from U.S. Treasury securities
(139,807 )
Proceeds on U.S. Treasury securities
Net payments on reverse repurchase agreements
Payments on net settlement of to-be-announced securities
(1,993 )
(9,846 )
Purchase of derivative financial instruments, net of margin cash received
(66,135 )
(20,032 )
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
(788,497 )
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements
Principal payments on repurchase agreements
(28,162,359 )
(33,016,040 )
Cash dividends
(40,065 )
(38,156 )
Proceeds from issuance of common stock, net of issuance costs
Common stock repurchases
(70 )
(3,024 )
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
(171,925 )
NET (DECREASE) INCREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH
(31,309 )
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
$
$
Securities sold settled in later period
6
See Notes to Financial Statements
7
ORCHID ISLAND CAPITAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
SEPTEMBER 30, 2020
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
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 2, 2017, Orchid entered into an equity distribution agreement (the “August 2017 Equity Distribution Agreement”) with
two 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 $
to its termination in July 2019.
On July 30, 2019, Orchid entered into an underwriting agreement (the “Underwriting Agreement”) with Morgan Stanley & Co. LLC,
Citigroup Global Markets Inc. and J.P. Morgan Securities LLC, as representatives of the underwriters named therein, relating to the
offer and sale of
purchased the shares pursuant to the Underwriting Agreement at a price of $
shares of common stock occurred on August 2, 2019, with net proceeds to the Company of approximately $
of underwriting discounts and commissions and other estimated offering expenses.
On January 23, 2020, Orchid entered into an equity distribution agreement (the “January 2020 Equity Distribution Agreement”) with
three sales agents pursuant to which the Company could offer and sell, from time to time, up to an aggregate amount of $
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 August 2020.
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 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, 2020, the Company issued a total of
Agreement for aggregate gross proceeds of
approximately $
commissions and fees.
COVID-19 Impact
Beginning in mid-March 2020, the global pandemic associated with the novel coronavirus COVID-19 (“COVID-19”) and related
economic conditions began to impact our financial position and results of operations. As a result of the economic, health and market
turmoil brought about by COVID-19, the Agency RMBS market experienced severe dislocations. This resulted in falling prices of our
8
assets and increased margin calls from our repurchase agreement lenders. Further, as interest rates declined, we faced additional
margin calls related to our various hedge positions. In order to maintain sufficient cash and liquidity, reduce risk and satisfy margin
calls, we were forced to sell assets at levels significantly below their carrying values and closed several hedge positions. The Agency
RMBS market largely stabilized after the Federal Reserve announced on March 23, 2020 that it would purchase Agency RMBS and
U.S. Treasuries in the amounts needed to support smooth market functioning. As of September 30, 2020, we had timely satisfied all
margin calls. The following summarizes the impact COVID-19 has had on our financial position and results of operations through
September 30, 2020.
●
We sold approximately $
$
approximately $
associated with COVID-19.
●
We terminated interest rate swap positions with an aggregate notional value of $
million in mark to market losses on the positions through the date of the respective terminations. Approximately $
these losses occurred during the three months ended March 31, 2020.
●
Our RMBS portfolio had a fair market value of approximately $
December 31, 2019. The September 30, 2020 balance represents an increase from the $
and the $
●
Our outstanding balances under our repurchase agreement borrowings as of September 30, 2020 were approximately $
compared to $
●
Our stockholders’ equity was $
$
In response to the Shelter in Place order issued in Florida in March 2020, our Manager (as defined below) invoked its Disaster
Recovery Plan and its employees are working remotely. Prior planning resulted in the successful implementation of this plan and key
operational team members maintain daily communication.
Although the Company cannot estimate the length or gravity of the impact of the COVID-19 outbreak at this time, if the pandemic
continues, it may continue to have adverse effects on the Company’s results of future operations, financial position, and liquidity in
fiscal year 2020 and beyond.
In addition, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which has provided
billions of dollars of relief to individuals, businesses, state and local governments, and the health care system suffering the impact of
the pandemic, including mortgage loan forbearance and modification programs to qualifying borrowers who may have difficulty making
their loan payments. The Company has evaluated the provisions of the CARES Act and has determined that it will not have a material
effect on the Company’s business, results of operations and financial condition. The Federal Housing Financing Agency (the “FHFA”)
has instructed the GSEs on how they will handle servicer advances for loans that back Agency RMBS that enter into forbearance,
which should limit prepayments during the forbearance period that could have resulted otherwise. There can be no assurance as to
how, in the long term, these and other actions by the U.S. government will affect the efficiency, liquidity and stability of the financial and
mortgage markets. To the extent the financial or mortgage markets do not respond favorably to any of these actions, or such actions do
not function as intended, our business, results of operations and financial condition may continue to be materially adversely affected.
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.
9
Operating results for the nine and three month period ended September 30, 2020 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2020.
The balance sheet at December 31, 2019 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, 2019.
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,
2020; however, uncertainty over the ultimate impact that COVID-19 will have on the global economy generally, and on Orchid’s business in
particular, makes any estimates and assumptions as of September 30, 2020 inherently less certain than they would be absent the current
and potential impacts of COVID-19.
Variable Interest Entities (“VIEs”)
We obtain interests in VIEs through our investments in mortgage-backed securities. Our interests in these VIEs are passive in
nature and are not expected to result in us obtaining a controlling financial interest in these VIEs in the future. As a result, we do not
consolidate these VIEs and we account for our interest in these VIEs as mortgage-backed securities. See Note 2 for additional
information regarding our investments in mortgage-backed securities. Our maximum exposure to loss for these VIEs is the carrying
value of the mortgage-backed securities.
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, 2020
December 31, 2019
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
The Company invests primarily in mortgage pass-through (“PT”) residential mortgage backed certificates issued by Freddie Mac,
10
Fannie Mae or Ginnie Mae (“RMBS”), collateralized mortgage obligations (“CMOs”), interest-only (“IO”) securities and inverse interest-only
(“IIO”) securities representing interest in or obligations backed by pools of RMBS. We refer to RMBS and CMOs as PT RMBS. We refer
to IO and IIO securities as structured RMBS. The Company has elected to account for its investment in RMBS 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 our operations for a particular reporting period and is consistent with the
underlying economics and how the portfolio is managed.
The Company records RMBS transactions on the trade date. Security purchases that have not settled as of the balance sheet date
are included in the RMBS balance with an offsetting liability recorded, whereas securities sold that have not settled as of the balance sheet
date are removed from the RMBS 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.
Income on PT RMBS securities 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”), 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 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 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.
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 addition, the Company may be required to post collateral based on any declines in the market value of the
derivatives. 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. To mitigate this risk, the Company uses only well-established commercial banks
and exchanges as counterparties.
11
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, 2020 and December 31, 2019 due to the short-term nature of
these financial instruments.
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.
Reverse Repurchase Agreements and Obligations to Return Securities Borrowed under Reverse Repurchase Agreements
The Company borrows securities to cover short sales of U.S. Treasury securities through reverse repurchase transactions under our
master repurchase agreements. We account for these as securities borrowing transactions and recognize an obligation to return the
borrowed securities at fair value on the balance sheet based on the value of the underlying borrowed securities as of the reporting date.
The securities received as collateral in connection with our reverse repurchase agreements mitigate our credit risk exposure to
counterparties. Our reverse repurchase agreements typically have maturities of 30 days or less.
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 or subscribed 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.
Income Taxes
Orchid has qualified and elected 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 at least 90% of their REIT taxable income on an annual basis. In addition, a REIT must meet other
provisions 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
12
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.
Recent Accounting Pronouncements
On January 1, 2020, we adopted Accounting Standards Update (“ASU”) 2016-13,
Financial Instruments – Credit Losses (Topic
326): Measurement of Credit Losses on Financial Instruments.
ASU 2016-13 requires credit losses on most financial assets measured
at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current
expected credit loss model). The Company’s adoption of this ASU did not have a material effect on its financial statements as its
financial assets were already measured at fair value through earnings.
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 consolidated financial statements.
NOTE 2. MORTGAGE-BACKED SECURITIES
The following table presents the Company’s RMBS portfolio as of September 30, 2020 and December 31, 2019:
(in thousands)
September 30, 2020
December 31, 2019
Pass-Through RMBS Certificates:
Adjustable-rate Mortgages
$
$
Fixed-rate Mortgages
Fixed-rate CMOs
Total Pass-Through Certificates
Structured RMBS Certificates:
Interest-Only Securities
Inverse Interest-Only Securities
Total Structured RMBS Certificates
Total
$
$
NOTE 3. REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS
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, 2020, the Company had met all margin call
requirements.
As of September 30, 2020 and December 31, 2019, the Company’s repurchase agreements had remaining maturities as summarized
13
below:
($ in thousands)
OVERNIGHT
BETWEEN 2
BETWEEN 31
GREATER
(1 DAY OR
AND
AND
THAN
LESS)
30 DAYS
90 DAYS
90 DAYS
TOTAL
September 30, 2020
Fair market value of securities pledged, including
accrued interest receivable
$
$
$
$
$
Repurchase agreement liabilities associated with
these securities
$
$
$
$
$
Net weighted average borrowing rate
December 31, 2019
Fair market value of securities pledged, including
accrued interest receivable
$
$
$
$
$
Repurchase agreement liabilities associated with
these securities
$
$
$
$
$
Net weighted average borrowing rate
In addition, cash pledged to counterparties for repurchase agreements was approximately
$24.8
$65.9
September 30, 2020 and December 31, 2019, 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, 2020, 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
$170.4
million. The Company did not have an amount at risk with any individual counterparty greater than 10% of the Company’s equity at
September 30, 2020 and December 31, 2019.
NOTE 4. DERIVATIVE AND OTHER HEDGING INSTRUMENTS
Derivative and Other Hedging Instruments Assets (Liabilities), at Fair Value
The table below summarizes fair value information about our derivative and other hedging instruments assets and liabilities as of
September 30, 2020 and December 31, 2019.
(in thousands)
Derivative Instruments and Related Accounts
Balance Sheet Location
September 30, 2020
December 31, 2019
Assets
Payer swaptions - long
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
Derivative liabilities, at fair value
TBA securities
Derivative liabilities, at fair value
Total derivative liabilities, at fair value
$
$
Margin Balances Posted to (from) Counterparties
14
Futures contracts
Restricted cash
$
$
TBA securities
Restricted cash
Interest rate swaption contracts
Other liabilities
(1,037 )
Interest rate swap contracts
Restricted cash
Total margin balances on derivative contracts
$
$
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 Eurodollar and T-Note futures positions at September 30,
2020 and December 31, 2019.
($ in thousands)
September 30, 2020
Average
Weighted
Weighted
Contract
Average
Average
Notional
Entry
Effective
Open
Expiration Year
Amount
Rate
Rate
Equity
(1)
Eurodollar Futures Contracts (Short Positions)
2020
$
$
(375 )
2021
(415 )
Total / Weighted Average
$
$
(790 )
Treasury Note Futures Contracts (Short Position)
(2)
December 2020 5-year T-Note futures
(Dec 2020 - Dec 2025 Hedge Period)
$
$
(22 )
($ in thousands)
December 31, 2019
Average
Weighted
Weighted
Contract
Average
Average
Notional
Entry
Effective
Open
Expiration Year
Amount
Rate
Rate
Equity
(1)
Eurodollar Futures Contracts (Short Positions)
2020
$
$
(6,505 )
Total / Weighted Average
$
$
(6,505 )
Treasury Note Futures Contracts (Short Position)
(2)
March 2020 5 year T-Note futures
(Mar 2020 - Mar 2025 Hedge Period)
$
$
(1)
Open equity represents the cumulative gains (losses) recorded on open futures positions from inception.
(2)
T-Note futures contracts were valued at a price of $
the short positions were $
Under our interest rate swap agreements, we typically pay a fixed rate and receive a floating rate based on the LIBOR ("payer
swaps"). The floating rate we receive under our swap agreements has the effect of offsetting the repricing characteristics of our repurchase
agreements and cash flows on such liabilities. We are typically required to post collateral on our interest rate swap agreements. The table
below presents information related to the Company’s interest rate swap positions at September 30, 2020 and December 31, 2019.
($ in thousands)
Average
Net
Fixed
Average
Estimated
Average
Notional
Pay
Receive
Fair
Maturity
Amount
Rate
Rate
Value
(Years)
September 30, 2020
15
Expiration > 3 to ≤ 5 years
$
$
(23,817 )
Expiration > 5 years
(2,819 )
$
$
(26,636 )
December 31, 2019
Expiration > 1 to ≤ 3 years
$
$
(3,680 )
Expiration > 3 to ≤ 5 years
(16,466 )
$
$
(20,146 )
The table below presents information related to the Company’s interest rate swaption positions at September 30, 2020.
open swaption positions at December 31, 2019.
($ in thousands)
Option
Underlying Swap
Weighted
Average
Weighted
Average
Average
Adjustabl
e
Average
Fair
Months to
Notional
Fixed
Rate
Term
Expiration
Cost
Value
Expiration
Amount
Rate
(LIBOR)
(Years)
September 30, 2020
Payer Swaptions - long
≤ 1 year
$
$
$
>1 year ≤ 2 years
$
$
$
Payer Swaptions - short
≤ 1 year
$
(4,660 )
$
(6,221 )
$
The following table summarizes our contracts to purchase and sell TBA securities as of September 30, 2020 and December 31,
2019
.
($ in thousands)
Notional
Net
Amount
Cost
Market
Carrying
Long (Short)
(1)
Basis
(2)
Value
(3)
Value
(4)
September 30, 2020
15-Year TBA securities:
2.0%
$
$
$
$
30-Year TBA securities:
2.5%
(438 )
Total
$
$
$
$
(247 )
December 31, 2019
30-Year TBA securities:
4.5%
$
(300,000 )
$
(315,426 )
$
(315,938 )
$
(512 )
Total
$
(300,000 )
$
(315,426 )
$
(315,938 )
$
(512 )
(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 our balance sheets.
Gain (Loss) From Derivative and Other Hedging Instruments, Net
The table below presents the effect of the Company’s derivative financial instruments on the statements of operations
for the nine and three months ended September 30, 2020 and 2019.
16
(in thousands)
Nine Months Ended September 30,
Three Months Ended September 30,
2020
2019
2020
2019
Eurodollar futures contracts (short positions)
$
(8,324 )
$
(14,423 )
$
(6 )
$
(94 )
T-Note futures contracts (short position)
(4,837 )
(6,311 )
(113 )
(1,112 )
Fed Funds futures contracts (short positions)
-
313
-
313
Interest rate swaps
(67,713 )
(36,322 )
(9,918 )
Payer swaptions - short
(1,561 )
(672 )
Payer swaptions - long
(3,287 )
(1,379 )
(316 )
Net TBA securities
(1,813 )
(3,846 )
U.S. Treasury securities - short position
(95 )
Total
$
(87,630 )
$
(61,968 )
$
$
(8,648 )
Credit Risk-Related Contingent Features
The use of derivatives 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. We minimize this risk by
limiting our 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, we may be
required to pledge assets as collateral for our 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, we may not
receive payments provided for under the terms of our derivative agreements, and may have difficulty obtaining our assets
pledged as collateral for our derivatives. The cash and cash equivalents pledged as collateral for our derivative instruments
are included in restricted cash on our balance sheets.
It is the Company's policy not to offset assets and liabilities
associated with open derivative contracts. However, the Chicago Mercantile Exchange (“CME”) 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 serves as the central clearing party are presented
as if these derivatives had been settled as of the reporting date.
NOTE 5. PLEDGED ASSETS
Assets Pledged to Counterparties
The table below summarizes our assets pledged as collateral under our repurchase agreements and derivative agreements by type,
including securities pledged related to securities sold but not yet settled, as of September 30, 2020 and December 31, 2019.
(in thousands)
September 30, 2020
December 31, 2019
Repurchase
Derivative
Repurchase
Derivative
Assets Pledged to Counterparties
Agreements
Agreements
Total
Agreements
Agreements
Total
PT RMBS - fair value
$
$
$
$
$
$
Structured RMBS - fair value
Accrued interest on pledged securities
Restricted cash
Total
$
$
$
$
$
$
Assets Pledged from Counterparties
The table below summarizes our assets pledged to us from counterparties under our repurchase agreements, reverse repurchase
agreements and derivative agreements as of September 30, 2020 and December 31, 2019.
17
(in thousands)
Reverse
Repurchase
Repurchase
Derivative
Assets Pledged to Orchid
Agreements
Agreements
Agreements
Total
September 30, 2020
Cash
$
$
$
$
U.S. Treasury securities - fair value
Total
$
$
$
$
December 31, 2019
Cash
$
$
$
$
Total
$
$
$
$
RMBS and U.S. Treasury securities received as margin under our repurchase agreements are not recorded in the balance sheets
because the counterparty retains ownership of the security. U.S. Treasury securities received from counterparties as collateral under our
reverse repurchase agreements are recognized as obligations to return securities borrowed under reverse repurchase agreements in the
balance sheet. 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.
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, 2020 and December 31, 2019.
(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, 2020
Interest rate swaptions
$
$
$
$
$
(1,037 )
$
TBA securities
$
$
$
$
$
(1,037 )
$
(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, 2020
Repurchase Agreements
$
$
$
$
(3,256,536 )
$
(24,767 )
$
Interest rate swaps
(20,819 )
18
Interest rate swaptions
TBA securities
(438 )
$
$
$
$
(3,256,536 )
$
(46,024 )
$
December 31, 2019
Repurchase Agreements
$
$
$
$
(3,382,255 )
$
(65,851 )
$
Interest rate swaps
(17,450 )
TBA securities
(246 )
$
$
$
$
(3,382,255 )
$
(83,547 )
$
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 instruments.
NOTE 7. CAPITAL STOCK
Common Stock Issuances
During the nine months ended September 30, 2020 and the year ended December 31, 2019, 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)
2020
At the Market Offering Program
(3)
First Quarter
$
$
At the Market Offering Program
(3)
Third Quarter
Total
$
2019
At the Market Offering Program
(3)
First Quarter
$
$
At the Market Offering Program
(3)
Second Quarter
At the Market Offering Program
(3)
Third Quarter
Follow-on Offering
Third Quarter
$
(1)
Weighted average price received per share is before 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 eight equity distribution agreements, seven of which have either been terminated because all shares were sold
or were replaced with a subsequent agreement.
Stock Repurchase Program
On
, 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 5,306,579 shares, representing 10% of the
Company’s then outstanding share count. 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
19
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.
From the inception of the stock repurchase program through September 30, 2020, the Company repurchased a total of
shares at an aggregate cost of approximately $
share. During the nine months ended September 30, 2020, the Company repurchased a total of
approximately $
ended September 30, 2019, the Company repurchased a total of
including commissions and fees, for a weighted average price of $
program as of September 30, 2020 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 - YTD
(1)
Totals
$
$
(1)
On October 14, 2020, the Company declared a dividend of $
included in the table above, but is not reflected in the Company’s financial statements as of September 30, 2020.
NOTE 8. STOCK INCENTIVE PLAN
In October 2012, the Company’s Board of Directors adopted and Bimini, then the Company’s sole stockholder,
approved, the Orchid Island Capital, Inc. 2012 Equity Incentive Plan (the “Incentive Plan”) to recruit and retain employees,
directors and other service providers, including employees of the Manager and other affiliates. The 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 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 Incentive Plan provides for awards of up to an aggregate of
10
% of the issued and outstanding shares of our
common stock (on a fully diluted basis) at the time of the awards, subject to a maximum aggregate
4,000,000
Company’s common stock that may be issued under the Incentive Plan.
Performance Units
The Company has issued, and may in the future issue additional, performance units under the Incentive Plan to certain
executive officers and employees of its Manager. “Performance Units” vest after the end of a defined performance period,
20
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. Compensation expense for the Performance Units 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, 2020 and 2019.
($ in thousands, except per share data)
Nine Months Ended September 30,
2020
2019
Weighted
Weighted
Average
Average
Grant Date
Grant Date
Shares
Fair Value
Shares
Fair Value
Unvested, beginning of period
$
$
Forfeited
(1,607 )
Vested and issued
(10,583 )
(20,498 )
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)
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 Company's Long Term Incentive
Compensation Plans (the "Plans"). 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, 2020 and the Company's book value per share decline from
January 1, 2020 to June 30, 2020 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%.
Deferred Stock Units
Non-employee directors began to receive a portion of their compensation in the form of deferred stock unit awards
(“DSUs”) pursuant to the Incentive Plan beginning with the awards for the second quarter of 2018. Each DSU represents a
right to receive one share of the Company’s common stock. The DSUs are immediately vested and are settled at a future
date based on the election of the individual participant. 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,
2020 and 2019.
($ in thousands, except per share data)
Nine Months Ended September 30,
2020
2019
Weighted
Weighted
21
Average
Average
Grant Date
Grant Date
Shares
Fair Value
Shares
Fair Value
Outstanding, beginning of period
$
$
Granted and vested
Issued
Outstanding, end of period
$
$
Compensation expense during period
$
$
Intrinsic value, end of period
$
$
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, 2020.
NOTE 10. INCOME TAXES
The Company will generally not be subject to 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 to its stockholders, of which 85% generally
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, 2020 and 2019. 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, 2020 and
2019.
(in thousands, except per share information)
Nine Months Ended September
30,
Three Months Ended September
30,
2020
2019
2020
2019
Basic and diluted EPS per common share:
Numerator for basic and diluted EPS per share of common stock:
Net (loss) income - Basic and diluted
$
(14,351
$
$
$
(8,477
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
Effect of weighting
(3,282 )
(9,078 )
(2,081 )
(2,639 )
Weighted average shares-basic and diluted
Net (loss) income per common share:
Basic and diluted
$
(0.22 )
$
$
$
(0.14 )
22
Anti-dilutive incentive shares not included in calculation.
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, interest rate swaps, interest rate swaptions, U.S. Treasury securities and TBA securities are valued using
Level 2 valuations, and such valuations currently are determined by the Company based on independent pricing sources and/or third party
broker quotes, when available. 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, spread pricing techniques (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.
RMBS (based on the fair value option), interest rate swaps, interest rate swaptions, U.S. Treasury securities and TBA securities were
recorded at fair value on a recurring basis during the nine and three months ended September 30, 2020 and 2019. 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.
The following table presents financial assets (liabilities) measured at fair value on a recurring basis as of September 30, 2020 and
December 31, 2019.
(in thousands)
23
Quoted Prices
in Active
Significant
Markets for
Other
Significant
Identical
Observable
Unobservable
Assets
Inputs
Inputs
(Level 1)
(Level 2)
(Level 3)
September 30, 2020
Mortgage-backed securities
$
$
$
Interest rate swaps
(26,636 )
Interest rate swaptions
TBA securities
(246 )
December 31, 2019
Mortgage-backed securities
$
$
$
Interest rate swaps
(20,146 )
TBA securities
(512 )
During the nine and three months ended September 30, 2020 and 2019, 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
February 20, 2021
automatic
one-year
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.
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 costs incurred were approximately
$5.0
$1.6
for the nine and three months ended September 30, 2020, respectively, and
$5.1
$1.8
three months ended September 30, 2019, respectively. At September 30, 2020 and December 31, 2019, the net amount
due to affiliates was approximately
$0.6
$0.6
Other Relationships with Bimini
24
Robert Cauley, our Chief Executive Officer and Chairman of our 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, our Chief Financial
Officer, Chief Investment Officer, Secretary and a member of our 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, 2020, Bimini
owned
2,595,357
3.8%
, of the Company’s common stock.
25
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with the financial
statements and notes to those statements included in Item 1 of this Form 10-Q. The discussion may contain certain forward-looking
statements that involve risks and uncertainties. Forward-looking statements are those that are not historical in nature. As a result of
many factors, such as those set forth under “Risk Factors” in our most recent Annual Report on Form 10-K and our quarterly reports on
Form 10-Q, our actual results may differ materially from those anticipated in such forward-looking statements.
Overview
We are a specialty finance company that invests in residential mortgage-backed securities (“RMBS”) which are issued and
guaranteed by a federally chartered corporation or agency (“Agency RMBS”). Our investment strategy focuses on, and our portfolio
consists of, two categories of Agency RMBS: (i) traditional pass-through Agency RMBS, such as mortgage pass-through certificates
issued by Fannie Mae, Freddie Mac or Ginnie Mae (the “GSEs”) and collateralized mortgage obligations (“CMOs”) issued by the GSEs
(“PT RMBS”) and (ii) structured Agency RMBS, such as interest-only securities (“IOs”), inverse interest-only securities (“IIOs”) and
principal only securities (“POs”), among other types of structured Agency RMBS. We were formed by Bimini in August 2010,
commenced operations on November 24, 2010 and completed our initial public offering (“IPO”) on February 20, 2013. We are
externally managed by Bimini Advisors, an investment adviser registered with the Securities and Exchange Commission (the “SEC”).
Our business objective is to provide attractive risk-adjusted total returns over the long term through a combination of capital
appreciation and the payment of regular monthly distributions. We intend to achieve this objective by investing in and strategically
allocating capital between the two categories of Agency RMBS described above. We seek to generate income from (i) the net interest
margin on our leveraged PT RMBS portfolio and the leveraged portion of our structured Agency RMBS portfolio, and (ii) the interest
income we generate from the unleveraged portion of our structured Agency RMBS portfolio. We intend to fund our PT RMBS and
certain of our structured Agency RMBS through short-term borrowings structured as repurchase agreements. PT RMBS and structured
Agency RMBS typically exhibit materially different sensitivities to movements in interest rates. Declines in the value of one portfolio
may be offset by appreciation in the other. The percentage of capital that we allocate to our two Agency RMBS asset categories will
vary and will be actively managed in an effort to maintain the level of income generated by the combined portfolios, the stability of that
income stream and the stability of the value of the combined portfolios. We believe that this strategy will enhance our liquidity,
earnings, book value stability and asset selection opportunities in various interest rate environments.
We operate so as to qualify to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as
amended (the “Code”). We generally will not be subject to U.S. federal income tax to the extent that we currently distribute all of our
REIT taxable income (as defined in the Code) to our stockholders and maintain our REIT qualification.
The Company’s common stock trades on the New York Stock Exchange under the symbol “ORC”.
Impact of the COVID-19 Pandemic
Beginning in March 2020, the global pandemic associated with the novel coronavirus COVID-19 (“COVID-19”) and related
economic conditions began to impact our financial position and results of operations. As a result of the economic, health and market
turmoil brought about by COVID-19, the Agency RMBS market experienced severe dislocations. This resulted in falling prices of our
assets and increased margin calls from our repurchase agreement lenders. Further, as interest rates declined, we faced additional
margin calls related to our various hedge positions. In order to maintain sufficient cash and liquidity, reduce risk and satisfy margin
calls, we were forced to sell assets at levels significantly below their carrying values and closed several of our hedge positions. The
Agency RMBS market largely stabilized after the Federal Reserve (the “Fed”) announced on March 23, 2020 that it would purchase
Agency RMBS and U.S. Treasuries in the amounts needed to support smooth market functioning. As of September 30, 2020, we had
26
timely satisfied all margin calls. The following summarizes the impact COVID-19 has had on our financial position and results of
operations through September 30, 2020.
●
We sold approximately $2.7 billion of RMBS during the nine months ended September 30, 2020, realizing losses of approximately
$24.5 million. Approximately $1.1 billion of these sales were executed on March 19th and March 20th and resulted in losses of
approximately $31.4 million. The losses sustained on these two days were a direct result of the adverse RMBS market conditions
associated with COVID-19.
●
We terminated interest rate swap positions with an aggregate notional value of $1.2 billion and incurred approximately $54.5
million in mark to market losses on the positions through the date of the respective terminations. Approximately $45.0 million of
these losses occurred during the three months ended March 31, 2020.
●
Our RMBS portfolio had a fair market value of approximately $3.5 billion as of September 30, 2020, compared to $3.6 billion as of
December 31, 2019. The September 30, 2020 balance represents an increase from the $3.3 billion balance as of June 30, 2020
and the $2.9 billion balance as of March 31, 2020.
●
Our outstanding balances under our repurchase agreement borrowings as of September 30, 2020 were approximately $3.3 billion,
compared to $3.4 billion as of December 31, 2019, $3.2 billion as of June 30, 2020, and $2.8 billion as of March 31, 2020.
●
Our stockholders’ equity was $376.7 million as of September 30, 2020, compared to $395.5 million as of December 31, 2019,
$346.0 million as of June 30, 2020 and $308.1 million as of March 31, 2020.
Largely as a result of actions taken by the Fed in late March, Agency RMBS valuations have increased and the market for these
assets has stabilized.
Bimini Advisors, LLC (our “Manager”) has invoked its Disaster Recovery Plan and its employees are working remotely. Prior
planning resulted in the successful implementation of this plan and key operational team members maintain daily communication. We
do not anticipate incurring additional material costs, nor have we identified any operational or internal control issues related to this
remote working plan.
Capital Raising Activities
On August 2, 2017, we entered into an equity distribution agreement (the “August 2017 Equity Distribution Agreement”) with two
sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our
common stock in transactions that were deemed to be “at the market” offerings and privately negotiated transactions. We issued a total
of 15,123,178 shares under the August 2017 Equity Distribution Agreement for aggregate gross proceeds of $125.0 million, and net
proceeds of approximately $123.1 million, net of commissions and fees, prior to its termination in July 2019.
On July 30, 2019, we entered into an underwriting agreement (the “Underwriting Agreement”) with Morgan Stanley & Co. LLC,
Citigroup Global Markets Inc. and J.P. Morgan Securities LLC, as representatives of the underwriters named therein, relating to the
offer and sale of 7,000,000 shares of our common stock at a price to the public of $6.55 per share. The underwriters purchased the
shares pursuant to the Underwriting Agreement at a price of $6.3535 per share. The closing of the offering of 7,000,000 shares of
common stock occurred on August 2, 2019, with net proceeds to us of approximately $44.2 million after deduction of underwriting
discounts and commissions and other estimated offering expenses.
On January 23, 2020, we entered into an equity distribution agreement (the “January 2020 Equity Distribution Agreement”) with
three sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $200,000,000 of shares
of our common stock in transactions that were deemed to be “at the market” offerings and privately negotiated transactions. We issued
a total of 3,170,727 shares under the January 2020 Equity Distribution Agreement for aggregate gross proceeds of $19.8 million, and
net proceeds of approximately $19.4 million, net of commissions and fees, prior to its termination in August 2020.
27
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 may 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 are deemed to be “at the market” offerings and privately negotiated transactions. Through
September 30, 2020, we issued a total of 3,073,326 shares under the August 2020 Equity Distribution Agreement for aggregate gross
proceeds of approximately $15.8 million, and net proceeds of approximately $15.6 million, net of commissions and fees.
Stock Repurchase Agreement
On July 29, 2015, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of our common stock.
The timing, manner, price and amount of any repurchases is determined by the Company in its discretion and is subject to economic
and market conditions, stock price, applicable legal requirements and other factors. The authorization does not obligate the Company
to acquire any particular amount of common stock and the program may be suspended or discontinued at the Company’s discretion
without prior notice. On February 8, 2018, the Board of Directors approved an increase in the stock repurchase program for up to an
additional 4,522,822 shares of the Company’s common stock. Coupled with the 783,757 shares remaining from the original 2,000,000
share authorization, the increased authorization brought the total authorization to 5,306,579 shares, representing 10% of the
Company’s then outstanding share count. This stock repurchase program has no termination date.
From the inception of the stock repurchase program through September 30, 2020, the Company repurchased a total of 5,685,511
shares at an aggregate cost of approximately $40.4 million, including commissions and fees, for a weighted average price of $7.10 per
share. During the nine months ended September 30, 2020, the Company repurchased 19,891 shares of its common at an aggregate
cost of approximately $0.1 million, including commissions and fees, for a weighted average price of $3.42 per share. The remaining
authorization under the repurchase program as of September 30, 2020 was 837,311 shares.
Factors that Affect our Results of Operations and Financial Condition
A variety of industry and economic factors may impact our results of operations and financial condition. These factors include:
●
interest rate trends;
●
the difference between Agency RMBS yields and our funding and hedging costs;
●
competition for, and supply of, investments in Agency RMBS;
●
actions taken by the U.S. government, including the presidential administration, the Fed, the Federal Housing Financing
Agency (the “FHFA”), the Federal Open Market Committee (the “FOMC”) and the U.S. Treasury;
●
prepayment rates on mortgages underlying our Agency RMBS and credit trends insofar as they affect prepayment rates; and
●
other market developments.
In addition, a variety of factors relating to our business may also impact our results of operations and financial condition. These
factors include:
●
our degree of leverage;
●
our access to funding and borrowing capacity;
●
our borrowing costs;
●
our hedging activities;
●
the market value of our investments; and
●
the requirements to qualify as a REIT and the requirements to qualify for a registration exemption under the Investment
Company Act.
Results of Operations
28
Described below are the Company’s results of operations for the nine and three months ended September 30, 2020, as compared to
the Company’s results of operations for the nine and three months ended September 30, 2019.
Net (Loss) Income Summary
Net loss for the nine months ended September 30, 2020 was $14.4 million, or $0.22 per share. Net income for the nine months
ended September 30, 2019 was $5.7 million, or $0.10 per share. Net income for the three months ended September 30, 2020 was $28.1
million, or $0.42 per share. Net loss for the three months ended September 30, 2019 was $8.5 million, or $0.14 per share. The
components of net (loss) income for the nine and three months ended September 30, 2020 and 2019, 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,
2020
2019
Change
2020
2019
Change
Interest income
$
90,152
$
104,795
$
(14,643)
$
27,223
$
35,907
$
(8,684)
Interest expense
(23,045)
(63,644)
40,599
(2,043)
(22,321)
20,278
Net interest income
67,107
41,151
25,956
25,180
13,586
11,594
(Losses) gains on RMBS and derivative contracts
(73,712)
(27,848)
(45,864)
5,745
(19,431)
25,176
Net portfolio (loss) income
(6,605)
13,303
(19,908)
30,925
(5,845)
36,770
Expenses
(7,746)
(7,650)
(96)
(2,849)
(2,632)
(217)
Net (loss) income
$
(14,351)
$
5,653
$
(20,004)
$
28,076
$
(8,477)
$
36,553
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 in hedge accounting relationships, but rather
hold them for economic hedging purposes. Changes in fair value of these instruments are presented in a separate line item
in the Company’s statements of operations and are not included in interest expense. As such, for financial reporting
purposes, interest expense and cost of funds are not impacted by the fluctuation in value of the derivative instruments.
Presenting net earnings excluding realized and unrealized gains and losses allows management to: (i) isolate the net
interest income and other expenses of the Company over time, free of all fair value adjustments and (ii) assess the
effectiveness of our funding and hedging strategies on our capital allocation decisions and our asset allocation performance.
Our funding and hedging strategies, capital allocation and asset selection are integral to our risk management strategy, and
therefore critical to the management of our portfolio. We believe that the presentation of our net earnings excluding realized
and unrealized gains is useful to investors because it provides a means of comparing our results of operations to those of
our peers who have not elected the same accounting treatment. Our presentation of net earnings excluding realized and
unrealized gains and losses may not be comparable to similarly-titled measures of other companies, who may use different
calculations. As a result, net earnings excluding realized and unrealized gains and losses should not be considered as a
substitute for our GAAP net income (loss) as a measure of our financial performance or any measure of our liquidity under
GAAP. The table below presents a reconciliation of our net income (loss) determined in accordance with GAAP and net
earnings excluding realized and unrealized gains and losses.
29
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, 2020
$
28,076
$
5,745
$
22,331
$
0.42
$
0.09
$
0.33
June 30, 2020
48,772
28,749
20,023
0.74
0.43
0.31
March 31, 2020
(91,199)
(108,206)
17,007
(1.41)
(1.68)
0.27
December 31, 2019
18,612
3,840
14,772
0.29
0.06
0.23
September 30, 2019
(8,477)
(19,431)
10,954
(0.14)
(0.32)
0.18
June 30, 2019
3,533
(7,670)
11,203
0.07
(0.15)
0.22
March 31, 2019
10,597
(747)
11,344
0.22
(0.02)
0.24
Nine Months Ended
September 30, 2020
$
(14,351)
$
(73,712)
$
59,361
$
(0.22)
$
(1.12)
$
0.90
September 30, 2019
5,653
(27,848)
33,501
0.10
(0.52)
0.62
(1)
Includes realized and unrealized gains (losses) on RMBS and derivative financial instruments, including net interest income or expense on
interest rate swaps
.
Economic Interest Expense and Economic Net Interest Income
We use derivative and other hedging instruments, specifically Eurodollar, Fed Funds and Treasury Note (“T-Note”)
futures contracts, short positions in U.S. Treasury securities, interest rate swaps and swaptions, to hedge a portion of the
interest rate risk on repurchase agreements in a rising rate environment.
We have not elected to designate our derivative holdings for hedge accounting treatment. Changes in fair value of these
instruments are presented in a separate line item in our statements of operations and not included in interest expense. As
such, for financial reporting purposes, interest expense and cost of funds are not impacted by the fluctuation in value of the
derivative instruments.
For the purpose of computing economic net interest income and ratios relating to cost of funds measures, GAAP
interest expense has been adjusted to reflect the realized and unrealized gains or losses on certain derivative instruments
the Company uses, specifically Eurodollar, Fed Funds and U.S. Treasury futures, and interest rate swaps and swaptions,
that pertain to each period presented. We believe that adjusting our interest expense for the periods presented by the gains
or losses on these derivative instruments would not accurately reflect our economic interest expense for these periods. The
reason is that these derivative instruments may cover periods that extend into the future, not just the current period. Any
realized or unrealized gains or losses on the instruments reflect the change in market value of the instrument caused by
changes in underlying interest rates applicable to the term covered by the instrument, not just the current period. For each
period presented, we have combined the effects of the derivative financial instruments in place for the respective period with
the actual interest expense incurred on borrowings to reflect total economic interest expense for the applicable period.
Interest expense, including the effect of derivative instruments for the period, is referred to as economic interest expense.
Net interest income, when calculated to include the effect of derivative instruments for the period, is referred to as economic
net interest income. This presentation includes gains or losses on all contracts in effect during the reporting period, covering
the current period as well as periods in the future.
We believe that economic interest expense and economic net interest income provide meaningful information to
consider, in addition to the respective amounts prepared in accordance with GAAP. The non-GAAP measures help
30
management to evaluate its financial position and performance without the effects of certain transactions and GAAP
adjustments that are not necessarily indicative of our current investment portfolio or operations. The unrealized gains or
losses on derivative instruments presented in our statements of operations are not necessarily representative of the total
interest rate expense that we will ultimately realize. This is because as interest rates move up or down in the future, the
gains or losses we ultimately realize, and which will affect our total interest rate expense in future periods, may differ from
the unrealized gains or losses recognized as of the reporting date.
Our presentation of the economic value of our hedging strategy has important limitations. First, other market
participants may calculate economic interest expense and economic net interest income differently than the way we
calculate them. Second, while we believe that the calculation of the economic value of our hedging strategy described
above helps to present our financial position and performance, it may be of limited usefulness as an analytical tool.
Therefore, the economic value of our investment strategy should not be viewed in isolation and is not a substitute for
interest expense and net interest income computed in accordance with GAAP.
The tables below present a reconciliation of the adjustments to interest expense shown for each period relative to our
derivative instruments, and the income statement line item, gains (losses) on derivative instruments, calculated in
accordance with GAAP for each quarter of 2020 to date and 2019.
Gains (Losses) on Derivative Instruments
(in thousands)
U.S. Treasury
Funding Hedges
Recognized in
and
Attributed to
Attributed to
Income
TBA
Current
Future
Statement
Securities
Period
Periods
(GAAP)
Income (Loss)
(Non-GAAP)
(Non-GAAP)
Three Months Ended
September 30, 2020
$
4,079
$
3,467
$
(6,900)
$
7,512
June 30, 2020
(8,851)
1,715
(5,751)
(4,815)
March 31, 2020
(82,858)
(7,090)
(4,900)
(70,868)
December 31, 2019
10,792
(512)
3,823
7,481
September 30, 2019
(8,648)
2,479
1,244
(12,371)
June 30, 2019
(34,288)
(1,684)
1,464
(34,068)
March 31, 2019
(19,032)
(4,641)
2,427
(16,818)
Nine Months Ended
September 30, 2020
$
(87,630)
$
(1,908)
$
(17,551)
$
(68,171)
September 30, 2019
(61,968)
(3,846)
5,135
(63,257)
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, 2020
$
27,223
$
2,043
$
(6,900)
$
8,943
$
25,180
$
18,280
June 30, 2020
27,258
4,479
(5,751)
10,230
22,779
17,028
March 31, 2020
35,671
16,523
(4,900)
21,423
19,148
14,248
December 31, 2019
37,529
20,022
3,823
16,199
17,507
21,330
September 30, 2019
35,907
22,321
1,244
21,077
13,586
14,830
31
June 30, 2019
36,455
22,431
1,464
20,967
14,024
15,488
March 31, 2019
32,433
18,892
2,427
16,465
13,541
15,968
Nine Months Ended
September 30, 2020
$
90,152
$
23,045
$
(17,551)
$
40,596
$
67,107
$
49,556
September 30, 2019
104,795
63,644
5,135
58,509
41,151
46,286
(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, 2020, we generated $67.1 million of net interest income, consisting of $90.2 million of
interest income from RMBS assets offset by $23.0 million of interest expense on borrowings. For the comparable period ended
September 30, 2019, we generated $41.2 million of net interest income, consisting of $104.8 million of interest income from RMBS assets
offset by $63.6 million of interest expense on borrowings. The $14.6 million decrease in interest income was due to a 51 basis point ("bps")
decrease in the yield on average RMBS, combined with a $71.4 million decrease in average RMBS. The $40.6 million decrease in interest
expense was due to a 166 bps decrease in the average cost of funds, combined with an $88.7 million decrease in average outstanding
borrowings.
On an economic basis, our interest expense on borrowings for the nine months ended September 30, 2020 and 2019 was $40.6
million and $58.5 million, respectively, resulting in $49.6 million and $46.3 million of economic net interest income, respectively.
During the three months ended September 30, 2020, we generated $25.2 million of net interest income, consisting of $27.2 million of
interest income from RMBS assets offset by $2.0 million of interest expense on borrowings. For the three months ended September 30,
2019, we generated $13.6 million of net interest income, consisting of $35.9 million of interest income from RMBS assets offset by $22.3
million of interest expense on borrowings. The $8.7 million decrease in interest income was due to a 73 bps decrease in the yield on
average RMBS, combined with a $251.5 million decrease in average RMBS. The $20.3 million decrease in interest expense was due to a
225 bps decrease in the average cost of funds, combined with a $343.7 million decrease in average outstanding borrowings.
On an economic basis, our interest expense on borrowings for the three months ended September 30, 2020 and 2019 was $8.9
million and $21.1 million, respectively, resulting in $18.3 million and $14.8 million of economic net interest income, respectively.
The tables below provide information on our portfolio average balances, interest income, yield on assets, average borrowings, interest
expense, cost of funds, net interest income and net interest spread for the nine months ended September 30, 2020 and 2019 and each
quarter of 2020 to date and 2019 on both a GAAP and economic basis.
($ 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, 2020
$
3,422,564
$
27,223
3.18%
$
3,228,021
$
2,043
$
8,943
0.25%
1.11%
June 30, 2020
3,126,779
27,258
3.49%
2,992,494
4,479
10,230
0.60%
1.37%
March 31, 2020
3,269,859
35,671
4.36%
3,129,178
16,523
21,423
2.11%
2.74%
December 31, 2019
3,705,920
37,529
4.05%
3,631,042
20,022
16,199
2.21%
1.78%
September 30, 2019
3,674,087
35,907
3.91%
3,571,752
22,321
21,077
2.50%
2.36%
June 30, 2019
3,307,885
36,455
4.41%
3,098,133
22,431
20,967
2.90%
2.71%
March 31, 2019
3,051,509
32,433
4.25%
2,945,895
18,892
16,465
2.57%
2.24%
Nine Months Ended
September 30, 2020
$
3,273,068
$
90,152
3.67%
$
3,116,564
$
23,045
$
40,596
0.99%
1.74%
32
September 30, 2019
3,344,494
104,795
4.18%
3,205,260
63,644
58,509
2.65%
2.43%
($ in thousands)
Net Interest Income
Net Interest Spread
GAAP
Economic
GAAP
Economic
Basis
Basis
(2)
Basis
Basis
(4)
Three Months Ended
September 30, 2020
$
25,180
$
18,280
2.93%
2.07%
June 30, 2020
22,779
$
17,028
2.89%
2.12%
March 31, 2020
19,148
14,248
2.25%
1.62%
December 31, 2019
17,507
21,330
1.84%
2.27%
September 30, 2019
13,586
14,830
1.41%
1.55%
June 30, 2019
14,024
15,488
1.51%
1.70%
March 31, 2019
13,541
15,968
1.68%
2.01%
Nine Months Ended
September 30, 2020
$
67,107
$
49,556
2.68%
1.93%
September 30, 2019
41,151
46,286
1.53%
1.75%
(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 31 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, 2020 and 2019 was $90.2 million and $104.8 million, respectively. We
had average RMBS holdings of $3,273.1 million and $3,344.5 million for the nine months ended September 30, 2020 and 2019,
respectively. The yield on our portfolio was 3.67% and 4.18% for the nine months ended September 30, 2020 and 2019, respectively. For
the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019, there was a $14.6 million
decrease in interest income due to the 51 bps decrease in the yield on average RMBS, combined with the $71.4 million decrease in
average RMBS.
Our interest income for the three months ended September 30, 2020 and 2019 was $27.2 million and $35.9 million, respectively. We
had average RMBS holdings of $3,422.6 million and $3,674.1 million for the three months ended September 30, 2020 and 2019,
respectively. The yield on our portfolio was 3.18% and 3.91% for the three months ended September 30, 2020 and 2019, respectively. For
the three months ended September 30, 2020 as compared to the three months ended September 30, 2019, there was an $8.7 million
decrease in interest income due to the 73 bps decrease in the yield on average RMBS, combined with the $251.5 million decrease in
average RMBS.
The table below presents the average portfolio size, income and yields of our respective sub-portfolios, consisting of structured RMBS
and PT RMBS, for the nine months ended September 30, 2020 and 2019, and for each quarter of 2020 to date and 2019.
($ 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, 2020
$
3,389,037
$
33,527
$
3,422,564
$
27,021
$
202
$
27,223
3.19%
2.41%
3.18%
June 30, 2020
3,088,603
38,176
3,126,779
$
27,004
254
27,258
3.50%
2.67%
3.49%
33
March 31, 2020
3,207,467
62,392
3,269,859
35,286
385
35,671
4.40%
2.47%
4.36%
December 31, 2019
3,611,461
94,459
3,705,920
36,600
929
37,529
4.05%
3.93%
4.05%
September 30, 2019
3,558,075
116,012
3,674,087
36,332
(425)
35,907
4.08%
(1.47)%
3.91%
June 30, 2019
3,181,976
125,909
3,307,885
34,992
1,463
36,455
4.40%
4.65%
4.41%
March 31, 2019
2,919,415
132,094
3,051,509
30,328
2,105
32,433
4.16%
6.37%
4.25%
Nine Months Ended
September 30, 2020
$
3,228,369
$
44,699
$
3,273,068
$
89,311
$
841
$
90,152
3.69%
2.51%
3.67%
September 30, 2019
3,219,822
124,672
3,344,494
101,652
3,143
104,795
4.21%
3.36%
4.18%
Interest Expense and the Cost of Funds
We had average outstanding borrowings of $3,116.6 million and $3,205.3 million and total interest expense of $23.0 million and $63.6
million for the nine months ended September 30, 2020 and 2019, respectively. Our average cost of funds was 0.99% for the nine months
ended September 30, 2020, compared to 2.65% for the comparable period in 2019. The $40.6 million decrease in interest expense was
due to the 166 bps decrease in the average cost of funds, combined with an $88.7 million decrease in average outstanding borrowings
during the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019.
Our economic interest expense was $40.6 million and $58.5 million for the nine months ended September 30, 2020 and 2019,
respectively. There was a 69 bps decrease in the average economic cost of funds to 1.74% for the nine months ended September 30,
2020 from 2.43% for the nine months ended September 30, 2019.
We had average outstanding borrowings of $3,228.0 million and $3,571.8 million and total interest expense of $2.0 million and $22.3
million for the three months ended September 30, 2020 and 2019, respectively. Our average cost of funds was 0.25% and 2.50% for three
months ended September 30, 2020 and 2019, respectively. There was a 225 bps decrease in the average cost of funds and a $343.7
million decrease in average outstanding borrowings during the three months ended September 30, 2020, compared to the three months
ended September 30, 2019.
Our economic interest expense was $8.9 million and $21.1 million for the three months ended September 30, 2020 and 2019,
respectively. There was a 125 bps decrease in the average economic cost of funds to 1.11% for the three months ended September 30,
2020 from 2.36% for the three months ended September 30, 2019.
Since all of our repurchase agreements are short-term, changes in market rates directly affect our interest expense. Our average cost
of funds calculated on a GAAP basis was 8 bps above the average one-month LIBOR and 10 bps below the average six-month LIBOR for
the quarter ended September 30, 2020. Our average economic cost of funds was 94 bps above the average one-month LIBOR and 76
bps above the average six-month LIBOR for the quarter ended September 30, 2020. The average term to maturity of the outstanding
repurchase agreements increased to 60 days at September 30, 2020 from 25 days at December 31, 2019.
The tables below present the average balance of borrowings outstanding, interest expense and average cost of funds, and average
one-month and six-month LIBOR rates for the nine months ended September 30, 2020 and 2019, and for each quarter in 2020 to date and
2019 on both a GAAP and economic basis.
($ 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, 2020
$
3,228,021
$
2,043
$
8,943
0.25%
1.11%
June 30, 2020
2,992,494
4,479
10,230
0.60%
1.37%
March 31, 2020
3,129,178
16,523
21,423
2.11%
2.74%
December 31, 2019
3,631,042
20,022
16,199
2.21%
1.78%
34
September 30, 2019
3,571,752
22,321
21,077
2.50%
2.36%
June 30, 2019
3,098,133
22,431
20,967
2.90%
2.71%
March 31, 2019
2,945,895
18,892
16,465
2.57%
2.24%
Nine Months Ended
September 30, 2020
$
3,116,564
$
23,045
$
40,596
0.99%
1.74%
September 30, 2019
3,205,260
63,644
58,509
2.65%
2.43%
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, 2020
0.17%
0.35%
0.08%
(0.10)%
0.94%
0.76%
June 30, 2020
0.55%
0.70%
0.05%
(0.10)%
0.82%
0.67%
March 31, 2020
1.34%
1.43%
0.77%
0.68%
1.40%
1.31%
December 31, 2019
1.90%
1.98%
0.31%
0.23%
(0.12)%
(0.20)%
September 30, 2019
2.22%
2.18%
0.28%
0.32%
0.14%
0.18%
June 30, 2019
2.45%
2.49%
0.45%
0.41%
0.26%
0.22%
March 31, 2019
2.51%
2.77%
0.06%
(0.20)%
(0.27)%
(0.53)%
Nine Months Ended
September 30, 2020
0.68%
0.83%
0.31%
0.16%
1.06%
0.91%
September 30, 2019
2.39%
2.48%
0.26%
0.17%
0.04%
(0.05)%
Gains or Losses
The table below presents our gains or losses for the nine and three months ended September 30, 2020 and 2019.
(in thousands)
Nine Months Ended September 30,
Three Months Ended September 30,
2020
2019
Change
2020
2019
Change
Realized (losses) gains on sales of RMBS
$
(24,522)
$
(5,135)
$
(19,387)
$
498
$
(5,491)
$
5,989
Unrealized gains (losses) on RMBS
38,440
39,255
(815)
1,168
(5,292)
6,460
Total gains (losses) on RMBS
13,918
34,120
(20,202)
1,666
(10,783)
12,449
Losses on interest rate futures
(13,161)
(20,421)
7,260
(119)
(893)
774
(Losses) gains on interest rate swaps
(67,713)
(36,322)
(31,391)
489
(9,918)
10,407
(Losses) gains on payer swaptions
(4,848)
(1,379)
(3,469)
242
(316)
558
(Losses) gains on TBA securities
(1,813)
(3,846)
2,033
3,431
2,479
952
(Losses) gains on U.S. Treasury securities -
short
(95)
-
(95)
36
-
36
Total (losses) gains from derivative instruments
(87,630)
(61,968)
(25,662)
4,079
(8,648)
12,727
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, 2020 and 2019, we received proceeds of $2,692.2 million and $1,948.1 million,
respectively, from the sales of RMBS. Most of these sales during the nine months ended September 30, 2020 occurred during the second
half of March 2020 as we sold assets in order to maintain sufficient cash and liquidity and reduce risk associated with the market turmoil
brought about by COVID-19. During the three months ended September 30, 2020 and 2019, we received proceeds of $668.9 million and
$258.3 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, which affect the pricing
of the securities in our portfolio. 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 2020 to date and 2019.
35
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, 2020
0.27%
0.68%
2.39%
2.89%
0.24%
June 30, 2020
0.29%
0.65%
2.60%
3.16%
0.31%
March 31, 2020
0.38%
0.70%
2.89%
3.45%
1.10%
December 31, 2019
1.69%
1.92%
3.18%
3.72%
1.91%
September 30, 2019
1.55%
1.68%
3.12%
3.61%
2.13%
June 30, 2019
1.76%
2.00%
3.24%
3.80%
2.40%
March 31, 2019
2.24%
2.41%
3.72%
4.27%
2.61%
(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.
Expenses
For the nine and three months ended September 30, 2020, the Company’s total operating expenses were approximately
$7.7 million and $2.8 million, respectively, compared to approximately $7.7 million and $2.6 million, respectively, for the nine
and three months ended September 30, 2019. The table below presents a breakdown of operating expenses for the nine and
three months ended September 30, 2020 and 2019.
(in thousands)
Nine Months Ended September 30,
Three Months Ended September 30,
2020
2019
Change
2020
2019
Change
Management fees
$
3,897
$
4,051
$
(154)
$
1,252
$
1,440
$
(188)
Overhead allocation
1,072
1,001
71
377
351
26
Accrued incentive compensation
(117)
(53)
(64)
158
173
(15)
Directors fees and liability insurance
750
750
-
242
260
(18)
Audit, legal and other professional fees
841
886
(45)
240
221
19
Direct REIT operating expenses
852
790
62
406
130
276
Other administrative
451
225
226
174
57
117
Total expenses
$
7,746
$
7,650
$
96
$
2,849
$
2,632
$
217
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, 2021 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 $500 million.
The Company is obligated to reimburse the Manager for any direct expenses incurred on its behalf and to pay the Manager the
Company’s pro rata portion of certain overhead costs set forth in the management agreement. Should the Company terminate the
management agreement without cause, it will pay the Manager a termination fee equal to three times the average annual management
fee, as defined in the management agreement, before or on the last day of the term of the agreement.
36
The following table summarizes the management fee and overhead allocation expenses for each quarter in 2020 to date and
2019.
($ in thousands)
Average
Average
Advisory Services
Orchid
Orchid
Management
Overhead
Three Months Ended
MBS
Equity
Fee
Allocation
Total
September 30, 2020
$
3,422,564
$
368,588
$
1,252
$
377
$
1,629
June 30, 2020
3,126,779
361,093
1,268
348
1,616
March 31, 2020
3,269,859
376,673
1,377
347
1,724
December 31, 2019
3,705,920
414,018
1,477
379
1,856
September 30, 2019
3,674,087
394,788
1,440
351
1,791
June 30, 2019
3,307,885
363,961
1,326
327
1,653
March 31, 2019
3,051,509
363,204
1,285
323
1,608
Nine Months Ended
September 30, 2020
$
3,273,068
$
368,785
$
3,897
$
1,072
$
4,969
September 30, 2019
3,344,494
373,984
4,051
1,001
5,052
Financial Condition:
Mortgage-Backed Securities
As of September 30, 2020, our RMBS portfolio consisted of $3,540.4 million of Agency RMBS at fair value and had a weighted
average coupon on assets of 3.62%. During the nine months ended September 30, 2020, we received principal repayments of $384.3
million compared to $389.5 million for the nine months ended September 30, 2019. The average prepayment speeds for the quarters
ended September 30, 2020 and 2019 were 17.0% and 16.4%, respectively.
The following table presents the 3-month constant prepayment rate (“CPR”) experienced on our structured and PT RMBS
sub-portfolios, on an annualized basis, for the quarterly periods presented. CPR is a method of expressing the prepayment
rate for a mortgage pool that assumes that a constant fraction of the remaining principal is prepaid each month or year.
Specifically, the CPR in the chart below represents the three month prepayment rate of the securities in the respective asset
category. Assets that were not owned for the entire quarter have been excluded from the calculation. The exclusion of certain
assets during periods of high trading activity can create a very high, and often volatile, reliance on a small sample of underlying
loans.
Structured
PT RMBS
RMBS
Total
Three Months Ended
Portfolio (%)
Portfolio (%)
Portfolio (%)
September 30, 2020
14.3
40.4
17.0
June 30, 2020
13.9
35.3
16.3
March 31, 2020
9.8
22.9
11.9
December 31, 2019
14.3
23.4
16.0
September 30, 2019
15.5
19.3
16.4
June 30, 2019
10.9
12.7
11.4
March 31, 2019
9.5
8.4
9.2
The following tables summarize certain characteristics of the Company’s PT RMBS and structured RMBS as of September 30, 2020
and December 31, 2019:
($ in thousands)
Weighted
Percentage
Average
37
of
Weighted
Maturity
Fair
Entire
Average
in
Longest
Asset Category
Value
Portfolio
Coupon
Months
Maturity
September 30, 2020
Adjustable Rate RMBS
$
960
0.0%
3.64%
167
1-Sep-35
Fixed Rate RMBS
3,357,501
94.8%
3.57%
339
1-Sep-50
Fixed Rate CMOs
151,110
4.3%
4.00%
316
15-Dec-42
Total Mortgage-backed Pass-through
3,509,571
99.1%
3.59%
338
1-Sep-50
Interest-Only Securities
30,796
0.9%
4.00%
270
25-Jul-48
Total Structured RMBS
30,796
0.9%
4.00%
270
25-Jul-48
Total Mortgage Assets
$
3,540,367
100.0%
3.62%
332
1-Sep-50
December 31, 2019
Adjustable Rate RMBS
$
1,014
0.0%
4.51%
176
1-Sep-35
Fixed Rate RMBS
3,206,013
89.3%
3.90%
342
1-Dec-49
Fixed Rate CMOs
299,205
8.3%
4.20%
331
15-Oct-44
Total Mortgage-backed Pass-through
3,506,232
97.6%
3.92%
341
1-Dec-49
Interest-Only Securities
60,986
1.7%
3.99%
280
25-Jul-48
Inverse Interest-Only Securities
23,703
0.7%
3.34%
285
15-Jul-47
Total Structured RMBS
84,689
2.4%
3.79%
281
25-Jul-48
Total Mortgage Assets
$
3,590,921
100.0%
3.90%
331
1-Dec-49
($ in thousands)
September 30, 2020
December 31, 2019
Percentage of
Percentage of
Agency
Fair Value
Entire Portfolio
Fair Value
Entire Portfolio
Fannie Mae
$
2,151,928
60.8%
$
2,170,668
60.4%
Freddie Mac
1,388,439
39.2%
1,420,253
39.6%
Total Portfolio
$
3,540,367
100.0%
$
3,590,921
100.0%
September 30, 2020
December 31, 2019
Weighted Average Pass-through Purchase Price
$
107.30
$
105.16
Weighted Average Structured Purchase Price
$
20.14
$
18.15
Weighted Average Pass-through Current Price
$
110.14
$
106.26
Weighted Average Structured Current Price
$
10.26
$
13.85
Effective Duration
(1)
1.790
2.780
(1)
Effective duration is the approximate percentage change in price for a 100 bps change in rates. An effective duration of 1.790 indicates that an
interest rate increase of 1.0% would be expected to cause a 1.790% decrease in the value of the RMBS in the Company’s investment portfolio
at September 30, 2020. An effective duration of 2.780 indicates that an interest rate increase of 1.0% would be expected to cause a 2.780%
decrease in the value of the RMBS in the Company’s investment portfolio at December 31, 2019. 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, 2020
and 2019, including securities purchased during the period that settled after the end of the period, if any.
($ in thousands)
2020
2019
Total Cost
Average
Price
Weighted
Average
Yield
Total Cost
Average
Price
Weighted
Average
Yield
Pass-through RMBS
$
3,012,072
$
107.22
1.67%
$
3,083,929
$
104.77
3.06%
Structured RMBS
-
-
-
12,265
18.06
7.82%
38
Borrowings
As of September 30, 2020, 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 19 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, 2020, we had obligations outstanding under the repurchase agreements of approximately $3,281.3 million with a
net weighted average borrowing cost of 0.24%. The remaining maturity of our outstanding repurchase agreement obligations ranged from
1 to 225 days, with a weighted average remaining maturity of 60 days. Securing the repurchase agreement obligations as of September
30, 2020 are RMBS with an estimated fair value, including accrued interest, of approximately $3,426.3 million and a weighted average
maturity of 341 months, and cash pledged to counterparties of approximately $24.8 million. Through October 30, 2020, we have been
able to maintain our repurchase facilities with comparable terms to those that existed at September 30, 2020 with maturities through May
13, 2021.
The table below presents information about our period end, maximum and average balances of borrowings for each quarter in
2020 to date and 2019.
($ 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, 2020
$
3,281,303
$
3,286,454
$
3,228,021
$
53,282
1.65%
June 30, 2020
3,174,739
3,235,370
2,992,494
182,245
6.09%
March 31, 2020
2,810,250
4,297,621
3,129,178
(318,928)
(10.19)%
(1)
December 31, 2019
3,448,106
3,986,919
3,631,042
(182,936)
(5.04)%
September 30, 2019
3,813,977
3,847,417
3,571,752
242,225
6.78%
June 30, 2019
3,329,527
3,730,460
3,098,133
231,394
7.47%
March 31, 2019
2,866,738
3,022,771
2,945,895
(79,157)
(2.69)%
(1)
The lower ending balance relative to the average balance during the quarter ended March 31, 2020 reflects the disposal of RMBS pledged as
collateral in order to maintain cash and liquidity in response to the dislocations in the financial and mortgage markets resulting from the
economic impacts of COVID-19. During the quarter ended March 31, 2020, the Company’s investment in RMBS decreased $642.1 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. Our principal immediate sources of liquidity include cash balances, unencumbered
assets and borrowings under repurchase agreements. Our borrowing capacity will vary over time as the market value of our interest
earning assets varies. Our balance sheet also generates liquidity on an on-going basis through payments of principal and interest we
receive on our RMBS portfolio. Despite the dislocations in the financial and mortgage markets and the economic impacts resulting from
COVID-19, 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.
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
39
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.
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, as it did during the three months ended March 31, 2020.
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, 2020, haircuts on our pledged collateral remained stable and as of September 30, 2020, our weighted average
haircut was approximately 4.9% of the value of our collateral.
As discussed earlier, 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.
The following table summarizes the effect on our liquidity and cash flows from contractual obligations for repurchase agreements and
interest expense on repurchase agreements.
(in thousands)
Obligations Maturing
Within One
Year
One to Three
Years
Three to Five
Years
More than
Five Years
Total
Repurchase agreements
$
3,281,303
$
-
$
-
$
-
$
3,281,303
Interest expense on repurchase agreements
(1)
2,062
-
-
-
2,062
Totals
$
3,283,365
$
-
$
-
$
-
$
3,283,365
(1)
Interest expense on repurchase agreements is based on current interest rates as of September 30, 2020 and the remaining term of the liabilities
existing at that date.
40
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, 2020, we had cash and cash equivalents of $199.8 million. We generated cash flows of
$475.8 million from principal and interest payments on our RMBS and had average repurchase agreements outstanding of $3,116.6 million
during the nine months ended September 30, 2020.
Stockholders’ Equity
On August 2, 2017, we entered into an equity distribution agreement (the “August 2017 Equity Distribution Agreement”) with two
sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our
common stock in transactions that were deemed to be “at the market” offerings and privately negotiated transactions. We issued a total
of 15,123,178 shares under the August 2017 Equity Distribution Agreement for aggregate gross proceeds of $125.0 million, and net
proceeds of approximately $123.1 million, net of commissions and fees, prior to its termination in July 2019.
On July 30, 2019, we entered into an underwriting agreement (the “Underwriting Agreement”) with Morgan Stanley & Co. LLC,
Citigroup Global Markets Inc. and J.P. Morgan Securities LLC, as representatives of the underwriters named therein, relating to the
offer and sale of 7,000,000 shares of our common stock at a price to the public of $6.55 per share. The underwriters purchased the
shares pursuant to the Underwriting Agreement at a price of $6.3535 per share. The closing of the offering of 7,000,000 shares of
common stock occurred on August 2, 2019, with net proceeds to us of approximately $44.2 million after deduction of underwriting
discounts and commissions and other estimated offering expenses.
On January 23, 2020, we entered into an equity distribution agreement (the “January 2020 Equity Distribution Agreement”) with
three sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $200,000,000 of shares
of our common stock in transactions that were deemed to be “at the market” offerings and privately negotiated transactions. We issued
a total of 3,170,727 shares under the January 2020 Equity Distribution Agreement for aggregate gross proceeds of $19.8 million, and
net proceeds of approximately $19.4 million, net of commissions and fees, prior to its termination in August 2020.
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 may 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 are deemed to be “at the market” offerings and privately negotiated transactions. Through
September 30, 2020, we issued a total of 3,073,326 shares under the August 2020 Equity Distribution Agreement for aggregate gross
proceeds of approximately $15.8 million, and net proceeds of approximately $15.6 million, net of commissions and fees.
Outlook
Economic Summary
The COVID-19 coronavirus that emerged in China in late 2019 and spread to the U.S. during the first quarter of 2020
continues to be the driving force behind economic activity both in the U.S. and abroad. As reported in our second quarter
earnings release, cases of COVID-19 were starting to surge in the U.S. starting in mid-June. This surge lasted into July and
August, particularly in the south and warmer states. By late summer the surge subsided and economic optimism rebounded
as evidenced by most measures of economic activity. As the weather turns colder in the fall and people spend more time
indoors, cases could start to increase again. This appears to be happening as we enter the fourth quarter, especially in
northern states across the U.S. and Europe. To date governments have not responded with such drastic measures such as
shelter in place orders like we saw in the spring. In contrast with the spring and summer, hospitalizations and serious cases
appear to be occurring less frequently, and the medical community appears more adept at dealing with the more severe cases.
The economic recovery from the severe contraction that occurred in the spring continues. However, the “V” shaped days
of the recovery are over, at least on a broad basis. Growth is very uneven with certain sectors approaching levels of activity
last seen before the onset of the pandemic, while others remain far short of such levels. A few sectors have surpassed pre-
41
pandemic levels – importantly housing among them, as well as retail sales. However, the leisure and hospitality sectors
remain far below pre-pandemic activity levels and are not expected to fully recover in the near term. The consequence of the
unbalanced recovery is a labor market that still has a long way to go to get back to February 2020 levels, as the unemployment
rate was reported at 7.9% in early October. While progress towards finding a vaccine continues, with many efforts showing
considerable promise, widespread access to a viable vaccine appears to be months away. Progress has also been made on
the treatment and testing side of the pandemic, especially with respect to the latter. The lower death and hospitalization rates
may be a result of the former.
Legislative Response and the Federal Reserve
Congress passed the CARES Act (described below) quickly in response to the pandemic’s emergence this spring and
followed with additional legislation over the ensuing months. However, as certain provisions of the CARES Act have expired,
such as supplemental unemployment insurance at the end of July, there appears to be a need for additional stimulus for the
economy to deal with the uneven recovery and still high level of unemployment. However, the government has been unable to
reach an agreement on additional measures. It appears the politicians in Washington and the national media are focused on
the presidential election on November 3rd and a compromise on additional stimulus may have to wait until after then. The Fed
on the other hand has provided, and continues to provide, as much support to the markets and the economy as it can within
the constraints of its mandate. During the third quarter of 2020, the Fed unveiled a new monetary policy framework that will
allow the Fed Funds rate to remain quite low, even if inflation is expected to temporarily surpass the 2% target level. Further,
the Fed will look past the presence of very tight labor markets, should they be present at the time. This marks a significant shift
from their prior policy framework, which was focused on the unemployment rate as a key indicator of impending inflation.
Adherence to this policy could steepen the U.S. Treasury curve as short term rates could remain low for a considerable period
but longer term rates could rise given the Fed’s intention to let inflation potentially run above 2% in the future as the economy
more fully recovers.
Interest Rates
Interest rates remained in a tight range throughout the third quarter of 2020 and seem likely to do so for the short to
medium term, especially given the change to the Fed’s monetary policy framework. With realized levels of volatility low, implied
volatility is also very low by historical norms. Mortgage rates continue to slowly decline, however, as originators slowly add
capacity and can handle ever increasing levels of production volume. The spread between rates available to borrowers and
the implied yield on a current coupon mortgage, known as the Primary/Secondary spread, has continued to compress. The
spread is still above long-term average levels so further compression is possible, meaning either rates available to borrowers
can remain at current levels should U.S. Treasury rates increase, or they could move lower if U.S. Treasury rates remain
stable. In either case, prepayment levels on RMBS securities are likely to remain high for the foreseeable future.
The Agency RMBS Market
The Agency RMBS market continues to be essentially bifurcated with two separate and distinct sub-markets. Lower
coupon fixed rate mortgages, coupons of 1.5% through 2.5%, are, or will be soon in the case of 1.5% coupons, the focus of
daily purchases by the Fed. Fed purchase activity maintains substantial price pressure under these coupons, and they benefit
from attractive TBA dollar roll drops. Higher coupons in the TBA market do not have the benefit of Fed purchases and trade
poorly. Importantly, the Fed tends to take the worst performing collateral out of the market. The absence of Fed purchases
means the market is left to absorb very high prepayment speeds on these securities. For these coupons, specified pools are in
very high demand and trade at very high premiums. These premiums continue to rise as prepayment activity remains very
elevated and is likely to do so for some time. This dynamic has existed since March and is likely to continue.
Recent Legislative and Regulatory Developments
The Fed conducted large scale overnight repo operations from late 2019 until July 2020 to address disruptions in the U.S.
Treasury, Agency debt and Agency MBS financing markets. These operations ceased in July 2020 after the central bank
42
successfully tamed volatile funding costs that had threatened to cause disruption across the financial system.
The Fed has taken a number of other actions to stabilize markets as a result of the impacts of the COVID-19 pandemic.
On Sunday, March 15, 2020, the Fed announced a $700 billion asset purchase program to provide liquidity to the U.S.
Treasury and Agency MBS markets. Specifically, the Fed announced that it would purchase at least $500 billion of U.S.
Treasuries and at least $200 billion of Agency MBS. The Fed also lowered the Fed Funds rate to a range of 0.0% – 0.25%,
after having already lowered the Fed Funds rate by 50 bps on March 3, 2020. On June 30, 2020, Fed Chairman Powell
announced expectations to maintain interest rates at this level until the Fed is confident that the economy has weathered
recent events and is on track to achieve maximum employment and price stability goals. On September 16, 2020, the Federal
Open Market Committee (“FOMC”) reaffirmed this commitment, as well as an intention to allow inflation to climb modestly
above their 2% target and maintain that level for a period sufficient for inflation to average 2% long term.
In response to the deterioration in the markets for U.S. Treasuries, Agency MBS and other mortgage and fixed income
markets as investors liquidated investments in response to the economic crisis resulting from the actions to contain and
minimize the impacts of the COVID-19 pandemic, on the morning of Monday, March 23, 2020, the Fed announced a program
to acquire U.S. Treasuries and Agency MBS in the amounts needed to support smooth market functioning. With these
purchases, market conditions improved substantially, and in early April, the Fed began to gradually reduce the pace of these
purchases. On June 30, 2020, Chairman Powell also announced the Fed’s intention to increase its holdings of U.S. Treasury
securities and Agency MBS over the coming months, at least at the current pace, to sustain smooth market functioning and
thereby foster the effective transmission of monetary policy to broader financial conditions. On September 16, 2020, the FOMC
reaffirmed this commitment. Since March, the Fed has taken various other steps to support certain other fixed income markets,
to support mortgage servicers and to implement various portions of the Coronavirus Aid, Relief, and Economic Security
(“CARES”) Act.
Congress and President Trump have adopted several pieces of legislation in response to the public health and economic
impacts resulting from the COVID-19 pandemic. The first two pieces of legislation provided, among other things, emergency
funding to develop a vaccine for COVID-19, medical supplies, grants for public health agencies, small business loans,
assistance for health systems in other countries, expanded coronavirus testing, paid leave, enhanced unemployment
insurance, expanded food security initiatives and increased federal Medicaid funding.
The CARES Act was passed by Congress and signed into law by President Trump on March 27, 2020. The CARES Act
provides many forms of direct support to individuals and small businesses in order to stem the steep decline in economic
activity. This over $2 trillion COVID-19 relief bill, among other things, provided for direct payments to each American making
up to $75,000 a year, increased unemployment benefits for up to four months (on top of state benefits), funding to hospitals
and health providers, loans and investments to businesses, states and municipalities and grants to the airline industry. On April
24, 2020, President Trump signed an additional funding bill into law that provides an additional $484 billion of funding to
individuals, small businesses, hospitals, health care providers and additional coronavirus testing efforts. Various provisions of
the CARES Act began to expire in July 2020, including a moratorium on evictions (July 25, 2020), expanded unemployment
benefits (July 31, 2020), and a moratorium on foreclosures (August 31, 2020). Additional legislative relief efforts stalled in
Congress, and expectations for a compromise prior to the 2020 election are low. On August 8, 2020, President Trump issued
Executive Order 13945, directing the Department of Health and Human Services, the Centers for Disease Control and
Prevention (“CDC”), the Department of Housing and Urban Development, and Department of the Treasury to take measures to
temporarily halt residential evictions and foreclosures, including through temporary financial assistance. On September 4,
2020, the CDC issued guidance extending eviction moratoriums for covered persons through the end of 2020.
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
43
implement both a risk-based capital framework and minimum leverage capital requirements. On September 25, 2020, the
Financial Stability Oversight Council released a statement on the proposed rule cautioning that, in its opinion, the credit risk
requirements were too low relative to other credit providers and would maintain a significant concentration of risk in the GSEs.
At this time, however, no decisions have been made on any additional steps to be taken as part of the GSE reform plan and
the economic impact of COVID-19 may delay GSE reform plans further. Although the Trump administration has made
statements of its intentions to reform housing finance and tax policy, many of these potential policy changes will require
congressional action.
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. LIBOR will be replaced with a new SOFR, a rate
based on U.S. repo trading. The new benchmark rate will be based on overnight Treasury General Collateral repo rates. The
rate-setting process will be managed and published by the Fed and the Treasury’s Office of Financial Research. Many banks
believe that it may take four to five years to complete the transition to SOFR, despite the 2021 deadline. We will monitor the
emergence of this new rate carefully as it will likely become the new benchmark for hedges and a range of interest rate
investments.
Effective January 1, 2021, Fannie Mae, in alignment with Freddie Mac, will extend 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 will apply to outstanding single-family pools and newly issued single-family pools and will first be
reflected when January 2021 factors are 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 currently anticipate, however, that
delinquent loans will be repurchased in most cases before the 24-month deadline under one of the exceptions listed below.
Exceptions include:
• 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;
• a loan subject to a short sale or deed-in-lieu of foreclosure;
• a loan referred to foreclosure.
Because of these exceptions, the GSEs currently 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, especially in light of the COVID-19 pandemic and the upcoming presidential and Congressional elections in
the United States.
Effect on Us
Regulatory developments, movements in interest rates and prepayment rates affect us in many ways, including the
following:
Effects on our Assets
44
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.
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, a commitment it reaffirmed on June 30, 2020 and September 16, 2020. If the Fed
modifies, reduces or suspends its purchases of Agency RMBS, our investment portfolio could be negatively impacted.
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
45
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. An increase in the Fed Funds rate or LIBOR would 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
COVID-19 continues to dominate the performance of the markets and economy. While both have recovered from the
depths of March, especially the financial markets, the economy continues to languish. The recovery has proven to be very
uneven, with some sectors back to or near pre-pandemic levels of activity while others remain far below with little prospect for
getting back to those levels soon. The unemployment rate remains elevated – with the most recent read at 7.9% - as millions
of Americans remain out of work.
The Fed has taken, and continues to take, steps to support markets and the economy. However, much needed additional
stimulus from Washington and the federal government has been absent since the end of the second quarter. The federal
government, with a presidential election on the horizon in November, appears hopelessly caught up in partisan politics and
unable to agree on another round of stimulus. Interest rates continue to trade in a narrow range and at extremely low levels.
The market expects the Fed Funds rate to remain at the effective lower bound near zero for an extended period of time, even
more so after the Fed altered its monetary policy framework during the third quarter. Henceforth, the Fed appears to be willing
to let inflation run above the 2% target level, even when unemployment is very low, before removing accommodation.
The Agency RMBS market continues to be bifurcated between the production coupons – the target of Fed asset
purchases – and higher coupons in specified pool form. The TBA market for higher coupons remains weak as the sector lacks
support form the Fed and prepayment speeds are extremely high, resulting in poor expected returns for investors. This leads
investors to look to the specified pool market – with lower expected prepayment speeds – for attractive returns.
Since the economy cannot fully recover absent the containment of the COVID-19 pandemic, which is not expected to
occur in the near term, current market conditions are likely to persist. As a result, we expect prepayment speeds will remain
elevated, the Fed will be active in the Agency RMBS market with asset purchases, funding levels will remain low and the most
attractive returns available will be either in the TBA dollar roll market with lower coupons or with specified pools in higher
coupons.
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, 2019.
Capital Expenditures
At September 30, 2020, we had no material commitments for capital expenditures.
46
Off-Balance Sheet Arrangements
At September 30, 2020, we did not have any off-balance sheet arrangements.
Dividends
In addition to other requirements that must be satisfied 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.
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
$
1.395
$
4,662
2014
2.160
22,643
2015
1.920
38,748
2016
1.680
41,388
2017
1.680
70,717
2018
1.070
55,814
2019
0.960
54,421
2020 - YTD
(1)
0.660
44,055
Totals
$
11.525
$
332,448
(1)
On October 14, 2020, the Company declared a dividend of $0.065 per share to be paid on November 25, 2020. 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, 2020.
Inflation
Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors
influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our
distributions will be determined by our Board of Directors consistent with our obligation to distribute to our stockholders at
least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification; in each case, our
activities and balance sheet are measured with reference to historical cost and/or fair market value without considering
inflation.
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.
47
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.
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.
48
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, 2020 and December 31, 2019, 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.
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, 2020 and December 31, 2019.
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.
Interest Rate Sensitivity
(1)
Portfolio
Market
Book
Change in Interest Rate
Value
(2)(3)
Value
(2)(4)
As of September 30, 2020
-200 Basis Points
2.29%
21.52%
-100 Basis Points
1.07%
10.10%
-50 Basis Points
0.48%
4.54%
+50 Basis Points
(0.42)%
(3.92)%
+100 Basis Points
(1.38)%
(12.99)%
+200 Basis Points
(4.55)%
(42.74)%
As of December 31, 2019
-200 Basis Points
(0.07)%
(0.63)%
-100 Basis Points
0.27%
2.43%
-50 Basis Points
0.27%
2.49%
+50 Basis Points
(0.74)%
(6.73)%
+100 Basis Points
(1.88)%
(17.09)%
+200 Basis Points
(5.14)%
(46.66)%
(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,
49
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.
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, 2020, we had unrestricted cash and cash equivalents of $199.8 million and unpledged securities of approximately
$124.2 million (not including 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
50
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 major financial institutions with acceptable credit ratings. However, there is no guarantee our
efforts to manage counterparty credit risk will be successful and we could suffer significant losses if unsuccessful.
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 Controls 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.
51
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, 2019. There have been no material changes to those factors for the three months
ended September 30, 2020, other than as set forth in our Quarterly Report on Form 10-Q for the quarter ended March 31,
2020, and such risk factors are incorporated by reference herein.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The table below presents the Company’s share repurchase activity for the three months ended September 30, 2020.
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
(2)
the Authorization
(2)
July 1, 2020 - July 31, 2020
-
$
-
-
837,311
August 1, 2020 - August 31, 2020
-
-
-
837,311
September 1, 2020 - September 30, 2020
303
5.05
-
837,311
Totals / Weighted Average
303
$
5.05
-
837,311
(1)
Includes 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. These repurchases do not reduce the number of shares available under the stock
repurchase program authorization.
(2)
On July 29, 2015, the Company's Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company's common stock. On
February 8, 2018, the Board of Directors approved an increase in the stock repurchase program for up to an additional 4,522,822 shares of the
Company's common stock. Unless modified or revoked by the Board, the authorization does not expire.
The Company did not have any unregistered sales of its equity securities during the three months ended September 30,
2020.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.
ITEM 5. OTHER INFORMATION
None.
52
ITEM 6. EXHIBITS
Exhibit No.
3.1
3.2
3.3
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.
53
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 30, 2020
By:
/s/ Robert E. Cauley
Robert E. Cauley
Chief Executive Officer, President and Chairman of the Board
Date: October 30, 2020
By:
/s/ George H. Haas, IV
George H. Haas, IV
Secretary, Chief Financial Officer, Chief Investment Officer and
Director (Principal Financial and Accounting Officer)