ORC - Orchid Island Capital: The 17.5% Monthly Yield And A Penny Stock External Manager

2023-04-18 10:54:12 ET

Summary

• Orchid Island Capital is paying out an outsized 17.5% yield monthly but its payouts have declined by around 60% over the last three years.
• TBV fell to $11.93 per share for its fiscal 2022 fourth quarter, down around 45% from the year-ago comp.
• Net interest income fell 94.3% year-over-year but net income was boosted by a $1.04 per share net realized and unrealized gain on RMBS and derivative instruments.

Orchid Island Capital ( ORC ) last declared a monthly cash dividend of $0.16 per share , in line with its prior payout and for a 17.5% forward yield. I like the monthly payouts but this mREIT's near-term dividend payout history has been characterized by disruption and decline. The monthly payout stood at $0.40 per share in the short period before the pandemic but has since declined by 60% to its current level on the back of what has been a marked decline in Orchid's tangible book value ("TBV") and net income.

The first general guide to income investing is to avoid a dividend cut if you can and a 60% decline in payouts over three years does not bode well for the future direction of the monthly dividend. Orchid invests in residential mortgage-backed securities and held an agency RMBS portfolio valued at $3.5 billion as of the end of its fiscal 2022 fourth quarter. The business is built on paying out the difference in yield and cost of financing to shareholders, hence, it's come under pressure due to a still rising Fed funds rate. Is Orchid a buy at its current level? It depends. The stock is down 28% over the last year to reflect a TBV in decline and a loss of faith by shareholders in the direction of the payouts.

That Orchid's external manager Bimini Advisors ( BMNM ) is a penny stock trading on the OTC further heightens the overall risk profile of the mREIT. This is not a sleep-well-at-night income play with the outsized double-digit forward yield likely set for more pressure in future quarters with Orchid's TBV yet to fully stabilize. However, shareholders could come out ahead if TBV was to come in flat in future quarters as the mREIT maintains its yield at double-digits. The yield is the prize here but it's fraught with risks.

Tangible Book Value And Net Income

Orchid's TBV for its fiscal 2022 fourth quarter came in at $438.8 million , around $11.93 per share and up sequentially from $400.4 million or $11.42 per share in the third quarter. However, it was also down around 45% from $768.1 million, around $21.70 per share in the year-ago comp. The recent upward reversal of TBV after four consecutive quarters of decline is a positive development for shareholders and was likely helped by the recent dividend cuts leaving more cash on the mREIT's balance sheet.

Orchid realized a net interest income of $2.4 million, down 94.3% from $42.4 million in the year-ago comp. Net income came in at $0.95 per share, boosted by a gain of $1.04 per share from net realized and unrealized losses on RMBS and derivative instruments, with this declining to negative earnings per share of 0.09 when these realized and unrealized valuation fluctuations are excluded. Critically, net interest income collapsed during the quarter and whether or not Orchid covered its 3-monthly dividend of $0.48 per share depends on what metric you use. Against a net income of $0.95 per share, the company's payout ratio stands at 50.5%. However, most of this is non-cash and is constituted from temporary movements in derivative valuations. The dividend is not covered against net interest income with cash and equivalents falling to $205.7 million as of the end of the fourth quarter from $385.1 million in the year-ago quarter.

2023 Total Returns Outlook

The upsurge in Orchid's cost of funds to 2.26% during the fourth quarter will likely stay elevated through 2023 to keep its interest rate spread close to its record low of 1.53%. Orchid, like other mREITs, moves in somewhat of an inverse correlation with a Fed funds rate that will likely be hiked by a further 25 basis points even as inflation looks set to fall to the Fed's 2% target later this year. This will form the macroeconomic backdrop for Orchid's TBV performance in 2023 as the end of the fastest monetary tightening cycle in well over a decade should lead to broader stabilization of a stock price and dividend that has been collapsing.

The cuts have been destructive and it's hard to pencil in their near-term direction with the company unable to cover the current lowered payouts from its net interest income and with the outlook for TBV still so murky. I think the current 17.5% yield opens up a box of issues as it's largely unsupported by underlying net interest income even after a 60% decline from its pre-pandemic average. Hence, Orchid only forms a good buy for investors on the opposite end of risk averse. The yield is far in excess of most other mREITs and with no preferreds trading for ORC, it's either the commons or nothing else.

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