Orchid Island Capital, Inc. - Annual Report: 2015 (Form 10-K)

---

---

 

 

 

 

 

 

 

 

Maryland		27-3269228
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

Title of Each Class	Name of Each Exchange on Which Registered
Common Stock, $0.01 par value	New York Stock Exchange

 

 

 

 

 

 

 

 

 

 

 

 

 

 

		Page
PART I
ITEM 1. Business.			1
ITEM 1A. Risk Factors			10
ITEM 1B. Unresolved Staff Comments.			38
ITEM 2. Properties.			38
ITEM 3. Legal Proceedings.			38
ITEM 4. Mine Safety Disclosures.			38
PART II
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.			39
ITEM 6. Selected Financial Data.			43
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.			44
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.			68
ITEM 8. Financial Statements and Supplementary Data.			73
ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.			100
ITEM 9A. Controls and Procedures.			100
ITEM 9B. Other Information.			101
PART III
ITEM 10. Directors, Executive Officers and Corporate Governance.			106
ITEM 11. Executive Compensation.			106
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.			106
ITEM 13. Certain Relationships and Related Transactions, and Director Independence.			106
ITEM 14. Principal Accountant Fees and Services.			106
PART IV
ITEM 15. Exhibits, Financial Statement Schedules.			107

 
 

·	our business and investment strategy;

·	our expected operating results;

·	our ability to acquire investments on attractive terms;

·	the effect of actual or proposed actions of the U.S. Federal Reserve with respect to monetary policy or interest rates;

·	the effect of rising interest rates on unemployment, inflation and mortgage supply and demand;

·	the effect of increased prepayment rates on the value of our assets;

·	our ability to access the capital markets;

·	our ability to obtain future financing arrangements;

·	our ability to successfully hedge the interest rate risk and prepayment risk associated with our portfolio;

·	the federal conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the U.S. Government;

·	our ability to make distributions to our stockholders in the future;

·	mortgage loan modification programs and future legislative action;

·	our understanding of our competition and our ability to compete effectively;

·	our ability to quantify risk based on historical experience;

·	our ability to qualify and maintain our qualification as a real estate investment trust, or REIT, for U.S. federal income tax purposes;

·	our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended, or the Investment Company Act;

·	our ability to maintain the listing of our common stock on the New York Stock Exchange, or NYSE;

·	market trends;

·	expected capital expenditures; and

·	the impact of technology on our operations and business.

 
 

 

·

Fixed-Rate Mortgages. Fixed-rate mortgages are those where the borrower pays an interest rate that is constant throughout the term of the loan. Traditionally, most fixed-rate mortgages have an original term of 30 years. However, shorter terms (also referred to as “final maturity dates”) have become common in recent years. Because the interest rate on the loan never changes, even when market interest rates change, there can be a divergence between the interest rate on the loan and current market interest rates over time. This in turn can make fixed-rate mortgages price-sensitive to market fluctuations in interest rates. In general, the longer the remaining term on the mortgage loan, the greater the price sensitivity to movements in interest rates and, therefore, the likelihood for greater price variability.

·

ARMs. ARMs are mortgages for which the borrower pays an interest rate that varies over the term of the loan. The interest rate usually resets based on market interest rates, although the adjustment of such an interest rate may be subject to certain limitations. Traditionally, interest rate resets occur at regular intervals (for example, once per year). We refer to such ARMs as “traditional” ARMs. Because the interest rates on ARMs fluctuate based on market conditions, ARMs tend to have interest rates that do not deviate from current market rates by a large amount. This in turn can mean that ARMs have less price sensitivity to interest rates and, consequently, are less likely to experience significant price volatility.

·

Hybrid Adjustable-Rate Mortgages. Hybrid ARMs have a fixed-rate for the first few years of the loan, often three, five, seven or ten years, and thereafter reset periodically like a traditional ARM. Effectively, such mortgages are hybrids, combining the features of a pure fixed-rate mortgage and a traditional ARM. Hybrid ARMs have price sensitivity to interest rates similar to that of a fixed-rate mortgage during the period when the interest rate is fixed and similar to that of an ARM when the interest rate is in its periodic reset stage. However, because many hybrid ARMs are structured with a relatively short initial time span during which the interest rate is fixed, even during that segment of its existence, the price sensitivity may be high.

 

·

CMOs. CMOs are a type of RMBS the principal and interest of which are paid, in most cases, on a monthly basis. CMOs may be collateralized by whole mortgage loans, but are more typically collateralized by portfolios of mortgage pass-through securities issued directly by or under the auspices of Ginnie Mae, Freddie Mac or Fannie Mae. CMOs are structured into multiple classes, with each class bearing a different stated maturity. Monthly payments of principal, including prepayments, are first returned to investors holding the shortest maturity class. Investors holding the longer maturity classes receive principal only after the first class has been retired. Generally, fixed-rate mortgages are used to collateralize CMOs. However, the CMO tranches need not all have fixed-rate coupons. Some CMO tranches have floating rate coupons that adjust based on market interest rates, subject to some limitations. Such tranches, often called “CMO floaters,” can have relatively low price sensitivity to interest rates.

·

IOs. IOs represent the stream of interest payments on a pool of mortgages, either fixed-rate mortgages or hybrid ARMs. Holders of IOs have no claim to any principal payments. The value of IOs depends primarily on two factors, which are prepayments and interest rates. Prepayments on the underlying pool of mortgages reduce the stream of interest payments going forward, hence IOs are highly sensitive to prepayment rates. IOs are also sensitive to changes in interest rates. An increase in interest rates reduces the present value of future interest payments on a pool of mortgages. On the other hand, an increase in interest rates has a tendency to reduce prepayments, which increases the expected absolute amount of future interest payments.

·

IIOs. IIOs represent the stream of interest payments on a pool of mortgages, either fixed-rate mortgages or hybrid ARMs. Holders of IIOs have no claim to any principal payments. The value of IIOs depends primarily on three factors, which are prepayments, London Interbank Offered Rate (“LIBOR”) and term interest rates. Prepayments on the underlying pool of mortgages reduce the stream of interest payments, making IIOs highly sensitive to prepayment rates. The coupon on IIOs is derived from both the coupon interest rate on the underlying pool of mortgages and 30-day LIBOR. IIOs are typically created in conjunction with a floating rate CMO that has a principal balance and which is entitled to receive all of the principal payments on the underlying pool of mortgages. The coupon on the floating rate CMO is also based on 30-day LIBOR. Typically, the coupon on the floating rate CMO and the IIO, when combined, equal the coupon on the pool of underlying mortgages. The coupon on the pool of underlying mortgages typically represents a cap or ceiling on the combined coupons of the floating rate CMO and the IIO. Accordingly, when the value of 30-day LIBOR increases, the coupon of the floating rate CMO will increase and the coupon on the IIO will decrease. When the value of 30-day LIBOR falls, the opposite is true. Accordingly, the value of IIOs are sensitive to the level of 30-day LIBOR and expectations by market participants of future movements in the level of 30-day LIBOR. IIOs are also sensitive to changes in interest rates. An increase in interest rates reduces the present value of future interest payments on a pool of mortgages. On the other hand, an increase in interest rates has a tendency to reduce prepayments, which increases the expected absolute amount of future interest payments.

·

POs. POs represent the stream of principal payments on a pool of mortgages. Holders of POs have no claim to any interest payments, although the ultimate amount of principal to be received over time is known, equaling the principal balance of the underlying pool of mortgages. The timing of the receipt of the principal payments is not known. The value of POs depends primarily on two factors, which are prepayments and interest rates. Prepayments on the underlying pool of mortgages accelerate the stream of principal repayments, making POs highly sensitive to the rate at which the mortgages in the pool are prepaid. POs are also sensitive to changes in interest rates. An increase in interest rates reduces the present value of future principal payments on a pool of mortgages. Further, an increase in interest rates has a tendency to reduce prepayments, which decelerates, or pushes further out in time, the ultimate receipt of the principal payments. The opposite is true when interest rates decline.

·	investing in pass-through Agency RMBS and certain structured Agency RMBS, such as fixed and floating rate tranches of CMOs and POs, on a leveraged basis to increase returns on the capital allocated to this portfolio;

 

·

investing in certain structured Agency RMBS, such as IOs and IIOs, generally on an unleveraged basis in order to (i) increase returns due to the structural leverage contained in such securities, (ii) enhance liquidity due to the fact that these securities will be unencumbered or, when encumbered, retain the cash from such borrowings and (iii) diversify portfolio interest rate risk due to the different interest rate sensitivity these securities have compared to pass-through Agency RMBS;

·	investing in Agency RMBS in order to minimize credit risk;

·	investing in assets that will cause us to maintain our exclusion from regulation as an investment company under the Investment Company Act; and

·	investing in assets that will allow us to qualify and maintain our qualification as a REIT.

 
 

 

·	The relative durations of the respective portfolios — We generally seek to have a combined duration at or near zero. If our pass-through securities have a longer duration, we will allocate more capital to the structured security portfolio to achieve a combined duration close to zero.

·

The relative attractiveness of pass-through securities versus structured securities — To the extent we believe the expected returns of one type of security are higher than the other, we will allocate more capital to the more attractive securities, subject to the caveat that its combined duration remains at or near zero.

·

Liquidity — We seek to maintain adequate cash and unencumbered securities relative to our repurchase agreement borrowings to ensure we can meet any price or prepayment related margin calls from our lenders. To the extent we feel price or prepayment related margin calls will be higher/lower, we will allocate less/more capital to the pass-through Agency RMBS portfolio. Our pass-through Agency RMBS portfolio likely will be our only source of price or prepayment related margin calls because we generally will not apply leverage to our structured Agency RMBS portfolio. From time to time we may pledge a portion of our structured securities and retain the cash derived so it can be used to enhance our liquidity.

 

·	Deploying capital from our leveraged Agency RMBS portfolio to our unleveraged Agency RMBS portfolio;

·

Investing in Agency RMBS backed by mortgages that we believe are less likely to be prepaid to decrease the risk of excessive margin calls when monthly prepayments are announced. Prepayments are declared, and the market value of the related security declines, before the receipt of the related cash flows. Prepayment declarations give rise to a temporary collateral deficiency and generally results in margin calls by lenders;

·	Obtaining funding arrangements which defer or waive prepayment-related margin requirements in exchange for payments to the lender tied to the dollar amount of the collateral deficiency and a predetermined interest rate; and

·	Reducing our overall amount of leverage.

 
 

 

 

 

 

·

A portion of our pass-through Agency RMBS backed by ARMs and hybrid ARMs may initially bear interest at rates that are lower than their fully indexed rates, which are equivalent to the applicable index rate plus a margin. If a pass-through Agency RMBS backed by ARMs or hybrid ARMs is prepaid prior to or soon after the time of adjustment to a fully-indexed rate, we will have held that Agency RMBS while it was less profitable and lost the opportunity to receive interest at the fully-indexed rate over the remainder of its expected life.

·	If we are unable to acquire new Agency RMBS to replace the prepaid Agency RMBS, our returns on capital may be lower than if we were able to quickly acquire new Agency RMBS.

 

 
 

·	hedging can be expensive, particularly during periods of rising and volatile interest rates;

·	available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;

·	the duration of the hedge may not match the duration of the related liability;

·	certain types of hedges may expose us to risk of loss beyond the fee paid to initiate the hedge;

·	the amount of gross income that a REIT may earn from hedging transactions, other than hedging transactions that satisfy certain requirements of the Code, is limited by federal income tax provisions governing REITs;

·	the credit quality of the counterparty on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and

·	the counterparty in the hedging transaction may default on its obligation to pay.

 

 

 

 

 

 

 

 

·

our borrowings are secured by our pass-through Agency RMBS and a portion of our structured Agency RMBS under repurchase agreements. A decline in the market value of the pass-through Agency RMBS or structured Agency RMBS used to secure these debt obligations could limit our ability to borrow or result in lenders requiring us to pledge additional collateral to secure our borrowings. In that situation, we could be required to sell Agency RMBS under adverse market conditions in order to obtain the additional collateral required by the lender. If these sales are made at prices lower than the carrying value of the Agency RMBS, we would experience losses.

·

to the extent we are compelled to liquidate qualifying real estate assets to repay debts, our compliance with the REIT rules regarding our assets and our sources of gross income could be negatively affected, which could jeopardize our qualification as a REIT. Losing our REIT qualification would cause us to be subject to U.S. federal income tax (and any applicable state and local taxes) on all of our income and would decrease profitability and cash available for distributions to stockholders.

 

 

 

 

 

 

 

 

 
 

·	the likelihood that an actual market for our common stock will develop, or be continued once developed;

·	the liquidity of any such market;

·	the ability of any holder to sell shares of our common stock; or

·	the prices that may be obtained for our common stock.

 

·	actual or anticipated variations in our operating results or distributions;

·	changes in our earnings estimates or publication of research reports about us or the real estate or specialty finance industry;

·	increases in market interest rates that lead purchasers of our common stock to expect a higher dividend yield;

·	changes in market valuations of similar companies;

·	adverse market reaction to any increased indebtedness we incur in the future;

·	a change in our Manager or additions or departures of key management personnel;

·	actions by institutional stockholders;

·	speculation in the press or investment community; and

·	general market and economic conditions.

 

 

 

·	actual receipt of an improper benefit or profit in money, property or services; or

·	a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated.

 

 
 

·

“business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our outstanding voting stock or an affiliate or associate of ours who, at any time within the two-year period immediately prior to the date in question, was the beneficial owner of 10% or more of the voting power of our then-outstanding stock) or an affiliate of an interested stockholder for five years after the most recent date on which the stockholder became an interested stockholder, and thereafter require two supermajority stockholder votes to approve any such combination; and

·

“control share” provisions that provide that a holder of “control shares” of the Company (defined as voting shares of stock which, when aggregated with all other shares of stock owned by the acquiror or in respect of which the acquiror is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), entitle the acquiror to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of issued and outstanding “control shares,” subject to certain exceptions) generally has no voting rights with respect to the control shares except to the extent approved by our stockholders by the affirmative vote of two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.

 

·	85% of our REIT ordinary income for that year;

·	95% of our REIT capital gain net income for that year; and

·	any undistributed taxable income from prior years

 

 

		High				Low				Close				Dividends Declared
2015
First quarter		$	14.25			$	12.75			$	13.24			$	0.54
Second quarter			14.18				11.01				11.21				0.54
Third quarter			11.63				7.13				9.25				0.42
Fourth quarter			10.21				8.30				9.93				0.42
2014
First quarter		$	14.40			$	11.70			$	11.88			$	0.54
Second quarter			13.30				11.88				13.06				0.54
Third quarter			14.45				13.01				13.27				0.54
Fourth quarter			14.99				12.50				13.05				0.54

 

 

		February 13, 2013				December 31, 2013				December 31, 2014				December 31, 2015
Orchid Island Capital, Inc.			100.00				96.94				114.56				103.34
Agency REIT Peer Group			100.00				75.33				92.85				82.30
NAREIT Mortgage REIT TRR Index			100.00				87.97				103.71				94.50
S&P 500 Total Return Index			100.00				123.87				140.83				142.78

 

		Total number of securities to be issued upon exercise of outstanding options, warrants and rights				Weighted average exercise price of outstanding options, warrants and rights				Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Plan Category		(a)				(b)
Equity compensation plans approved by
security holders			23,508				-				3,932,113	(2)
Equity compensation plans not approved by
security holders(1)			-				-				-
Total			23,508				-				3,932,113

										Maximum Number
		Total Number				Weighted Average				of Shares That May Yet
		of Shares				Price Paid				Be Repurchased Under
		Repurchased(1)				Per Share				the Authorization
October			127,823			$	9.20				802,457
November			-				-				802,457
December			18,700				8.70				783,757
Totals / Weighted Average			146,523			$	9.14

(1)	All shares were purchased under an authorization covering up to 2,000,000 shares of common stock approved by the Board of Directors on July 29, 2015.  Unless modified or revoked by the Board, the authorization does not expire.

 

($ in thousands, except per share data)
		December 31,
		2015				2014				2013				2012
Balance Sheet Data:
Mortgage-backed securities		$	2,158,010			$	1,549,171			$	351,223			$	115,380
Total assets		$	2,241,837			$	1,657,808			$	363,576			$	118,861
Borrowings		$	1,986,313			$	1,436,651			$	318,557			$	103,941
Total liabilities		$	1,988,582			$	1,439,730			$	318,811			$	104,136
Total stockholders' equity		$	253,255			$	218,078			$	44,765			$	14,725
Book value per common share		$	11.64			$	13.06			$	13.40			$	95.55
		Year Ended December 31,
			2015				2014				2013				2012
Income Statement Data
Interest income		$	68,811			$	31,804			$	9,199			$	2,698
Interest expense			(7,271	)			(3,031	)			(1,126	)			(277	)
Net interest income			61,540				28,773				8,073				2,421
(Losses) gains			(52,575	)			234				(7,103	)			(1,154	)
Expenses			7,894				4,488				1,668				733
Net income		$	1,071			$	24,519			$	(698	)		$	534
Weighted average shares outstanding			20,266,706				9,890,058				3,011,912				981,665
Basic and diluted net income per share		$	0.05			$	2.48			$	(0.23	)		$	0.54
Dividends declared per share		$	1.92			$	2.16			$	1.40			$	-
Other Data (unaudited)
Average RMBS(1)		$	1,955,673			$	937,373			$	316,124			$	74,904
Average borrowings(1)		$	1,782,086			$	892,132			$	284,522			$	63,880
Average stockholders' equity(1)		$	251,607			$	134,327			$	42,955			$	14,419
Leverage ratio (at period end)(2)		7.9:1				6.6:1				7.1:1				7.1:1
Average yield on RMBS(3)			3.52	%			3.39	%			2.91	%			3.60	%
Average cost of funds(3)			0.41	%			0.34	%			0.40	%			0.43	%
Average economic cost of funds(4)			0.58	%			0.36	%			0.44	%			0.60	%
Average interest rate spread(5)			3.11	%			3.05	%			2.51	%			3.17	%
Average economic interest rate spread(6)			2.94	%			3.03	%			2.47	%			3.00	%

(1)	Average RMBS, borrowings and stockholders’ equity balances are calculated as the average of the quarterly averages.

(2)	The leverage ratio is calculated by dividing total ending liabilities by ending stockholders’ equity.

(3)	Portfolio yields and costs of funds are calculated based on the average balances of the underlying investment portfolio/borrowing balances and are annualized for the quarterly periods presented.

(4)	Represents interest cost of our borrowings and the effect of Eurodollar and T-Note futures contracts and options to enter into interest rate swaps (“interest rate swaptions”) attributed to the period related to hedging activities, divided by average borrowings.

(5)	Average interest rate spread is calculated by subtracting average cost of funds from average yield on RMBS.

(6)	Average economic interest rate spread is calculated by subtracting average economic cost of funds from average yield on RMBS.

 

·	interest rate trends;

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

·	competition for investments in Agency RMBS;

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

·	prepayment rates on mortgages underlying our Agency RMBS, and credit trends insofar as they affect prepayment rates;

·	other market developments.

·	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.

(in thousands)
		2015				2014				2013
Interest income		$	68,811			$	31,804			$	9,199
Interest expense			(7,271	)			(3,031	)			(1,126	)
Net interest income			61,540				28,773				8,073
(Losses) gains on RMBS and derivative contracts			(52,575	)			234				(7,103	)
Net portfolio income			8,965				29,007				970
Expenses			(7,894	)			(4,488	)			(1,668	)
Net income (loss)		$	1,071			$	24,519			$	(698	)

Gains (Losses) on Derivative Instruments
(in thousands)
										Funding Hedges
		Recognized in								Attributed to				Attributed to
		Income				TBA				Current				Future
		Statement				Securities				Period				Periods
		(GAAP)				Income				(Non-GAAP)				(Non-GAAP)
Three Months Ended
December 31, 2015		$	12,770			$	362			$	(1,196	)		$	13,604
September 30, 2015			(22,506	)			55				(881	)			(21,680	)
June 30, 2015			(803	)			(88	)			(595	)			(120	)
March 31, 2015			(12,351	)			57				(306	)			(12,102	)
December 31, 2014			(9,562	)			-				(145	)			(9,417	)
September 30, 2014			3,057				-				(25	)			3,082
June 30, 2014			(5,728	)			-				(3	)			(5,725	)
March 31, 2014			(1,693	)			-				(30	)			(1,663	)
December 31, 2013			732				-				(42	)			774
September 30, 2013			(2,272	)			-				(28	)			(2,244	)
June 30, 2013			6,852				-				(4	)			6,856
March 31, 2013			(484	)			-				(65	)			(419	)
Years Ended
December 31, 2015		$	(22,890	)		$	386			$	(2,978	)		$	(20,298	)
December 31, 2014			(13,926	)			-				(203	)			(13,723	)
December 31, 2013			4,828				-				(139	)			4,967

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
December 31, 2015		$	19,092			$	2,371			$	(1,196	)		$	3,567			$	16,721			$	15,525
September 30, 2015			18,352				2,037				(881	)			2,918				16,315				15,434
June 30, 2015			16,753				1,567				(595	)			2,162				15,186				14,591
March 31, 2015			14,614				1,296				(306	)			1,602				13,318				13,012
December 31, 2014			12,146				1,126				(145	)			1,271				11,020				10,875
September 30, 2014			9,286				818				(25	)			843				8,468				8,443
June 30, 2014			6,589				676				(3	)			679				5,913				5,910
March 31, 2014			3,783				411				(30	)			441				3,372				3,342
December 31, 2013			2,806				309				(42	)			351				2,497				2,455
September 30, 2013			2,551				294				(28	)			322				2,257				2,229
June 30, 2013			2,429				322				(4	)			326				2,107				2,103
March 31, 2013			1,413				201				(65	)			266				1,212				1,147
Years Ended
December 31, 2015		$	68,811			$	7,271			$	(2,978	)		$	10,249			$	61,540				58,562
December 31, 2014			31,804				3,031				(203	)			3,234				28,773				28,570
December 31, 2013			9,199				1,126				(139	)			1,265				8,073				7,934